The dispute
The Macmillan publishing house and Amazon had a recent, very public spat about Kindle book pricing. Amazon had been paying Macmillan about $12.50 per e-book for a $25 list-price new release–the same as it would have paid for a physical book–and then selling it through Kindle for $10. Macmillan wanted that stopped.
Instead, it wanted AMZN to raise the Kindle price to $13-$15 and use the iPad (and now Kindle, starting in June) agency model to pay it. That model, also used by publishers in dealing with independent bookstores, calls for the sale revenue to be split 70% for the publisher and 30% to the retailer. If AMZN didn’t agree, Macmillan apparently threatened to withhold its titles from e-book sale on Amazon for six months after publication, while Apple would be allowed to sell them on day one.
The arguing even went as far as having AMZN cease selling Macmillan books through its website for a short time. AMZN then issued a surly letter to customers and acceded to Macmillan’s demands.
What’s wrong with this picture?
Work out how much Macmillan will get paid for a book under the pricing scheme it prefers. Instead of $12.50, it will get at most .7 x $15 = $10.50, or $2 less than it would under the old arrangement. I’ll bet any authors whose contracts specify royalties based on the revenue Macmillan receives for their books are really loving that.
Who is Macmillan anyway?
Macmillan is the umbrella name that houses the publishing interests in the US and the UK of the privately-owned German publishing group Verlagsgruppe Georg von Holtzbrinck. The Holtzbrinck Group also owns book interests in Germany, as well as newspapers and magazines, including the cultural icon, Die Zeit. From what I can tell from the group’s websites, Holtzbrinck is also heavily involved in all sorts of internet activities, focused particularly on central Europe.
Why the panic from Macmillan?
After all, e-books have been around for a while. And, although fast-growing, e-books are still a small category.
Outside Macmillan no one really knows for sure what it’s thinking. But the way other publishers are closing ranks behind Macmillan argues that this is an industry issue, not something specific to Macmillan.
Two questions:
I think it’s important to ask both “Why take less money?” and “Why do this now?”
Why do this now?
There are two possibilities.
–One is that Macmillan saw the launch of the iPad as its first chance to play AMZN off against a credible rival (what a comment this would be about Sony!).
–The other is that Kindle e-book sales are beginning to expand at an accelerating rate, and are beginning to hurt the profitability of traditional bookstores more seriously. We know that the Kindle is cannibalizing AMZN’s own sales of physical books. Since AMZN pays the publishers the same whether it sells a physical book or an e-book, the publishers are actually better off with an AMZN e-book sale, since they have no cost of goods. The same with Barnes and Noble. So I think their concerns must be about the bricks-and-mortar bookstore channel.
Why do this at all?
I think there are three reasons, all having to do with uncertainty surrounding the trade (general interest reading) part of the publishing industry.
1. Figures from the Association of American Publishers, the industry marketing association, seem to show that the sales of general interest books in the US are stagnating. So anything that rocks the boat must be scary to the companies involved.
From 2002 through 2008, the latest numbers available, trade books + mass market paperbacks (that is, ignoring textbooks and religious books, which together make up about 60% of industry sales) had sales that grew from $8.4 billion to $9.3 billion. That’s a gain of 10.9%. Full-year 2009 numbers aren’t out yet, but will probably be up about 5%. That doesn’t sound so bad.
But compare these results with the progress of GDP and another picture emerges. The overall economy of the US grew by about 35% from 2002-2008–split into about 2/3 being general rise in the price level and 1/3 being “real” growth. In other words, trade publishing isn’t even keeping up with inflation. So reading books is actually shrinking as a part of economic life in the US.
2. E-Books vs. physical books may not be a zero-sum game. That is to say, replacing sales of physical books with e-books may not be the whole story.
Right now book publishers have three distribution channels: traditional bookstores, discount stores like Wal-Mart or Costco, and internet retailers like AMZN. In theory, a shift to e-books moves revenue from the first two channels to the third. In reality, it’s probably almost entirely from traditional bookstores to AMZN. At some point, this movement decreases the profits of bricks-and-mortar operations so much that they start to turn the lights out. One can imagine circumstances–not today or tomorrow, but some day–where this distribution channel becomes irrelevant.
Such a development would, of course, increase the power of the remaining distributors, all of whom are formidable firms in their own right. But there may be another issue, as well.
What happens to the casual reader who occasionally picks up a novel at a store near the train station, or the family that brings the kids to a bookstore to pick out books for a long trip or vacation? Do they go online instead, or do they just stop reading?
Are these customers simply a one-time loss or are physical bookstores a “farm team” of sorts for later online purchasers? I assume the publishers have done enough market research to have reasonable guesses. But I’m sure no one wants to actually find out–or at least not before they have to.
3. If you ask anyone in the music industry, they’d probably tell you that AAPL is the last company they’d want to have as a distributor. In this case, however, AMZN already has 80% of the e-book market. That market is also just starting to explode in size. It grew by 68% in 2008 and appears to have almost tripled last year to about $350 million in US sales. So it will soon be an important business. Having only one distributor for your content puts the publishers in a potentially hazardous position. What do they do if AMZN says it’s only willing to pay $7 for a new release instead of $12.50?
So it’s arguably better to have AAPL vs. AMZN than to have AMZN alone. In the long term, that may not be true. But for the moment, at least, AAPL’s willingness to develop an e-book platform, and provide a pricing umbrella that will protect physical book sales, seems more than enough for the publishing industry.
Investment implications?
Growth investors will doubtless figure that this development is a plus for AAPL, since publishers want the iPad to succeed. They’re probably also turning over in their heads the idea that price may not be the essential point in the decision between e-books and physical ones, as publishers seem to be assuming. If that were to turn out to be the case, so much the better for AMZN, which will continue to pick up book market share and not have to suffer large losses subsidizing Kindle book sales.
Value investors are probably making asset value calculations for publishers assuming the worst case–that their trade book businesses are worth zero, and not factoring in any boost to text/professional sales from e-readers focused on that market (although I believe strongly that there will be one). If the stock still looks cheap, then… “Deep value” investors are doubtless looking at bricks-and-mortar bookstore chains.
A final note
There’s an article in yesterday’s New York Times that suggests that the $9.99 price is very important to e-book readers. If the (angry) people quoted are indicative, readers will blame publishers and authors for the higher prices. I doubt their response will be piracy. But if they simply don’t buy new releases in any form, the publishers’ gambit will have backfired.
See also my earlier posts, It’s vintage Amazon and Kindle economics (l).
A more final note on March 1, 2010
Today’s business section in the New York Times has an article with figures on the cost to distribute a paper book vs. an e-book. I don’t think it addresses the economics of publishing very well, but the numbers are interesting. It also makes two noteworthy observations in the final column: only about one book in four published makes money, and even famous authors appear to have no idea how their royalties are figured–that is, how they get paid.