the investigation
Media reports yesterday indicate the US Justice Department is investigating five of the top six book publishing firms (Random House is the exception) and Apple for price-fixing in the e-book market. Settlement talks aimed at avoiding litigation are apparently going on, at least with some of the publishers. A parallel investigation by EU regulators seems to be happening, as well.
what’s at issue
It’s all about trade books. Publishers have traditionally wholesaled physical bestsellers to bookstores at 50% of the suggested retail price. The store owners then figured out how much to mark them up–or whether to sell them as loss leaders. A hardcover with a retail price marked on it of $25, for example, would be sold to a bookstore for $12.50. The store might retail it for, say, $16–or for $10, if they so desired. Stores could return unsold copies for a refund.
As little as two years ago, publishers were following the same procedure in the nascent e-book market.
This created a potential problem, however.
AMZN was aiming to become the dominant seller of e-books, to be read on its proprietary Kindle device. It was taking every e-book it paid a publisher $12.50 for and retailing it for $9 or $10. Yes, the company lost around $3 a book. But short-term profits have never been an AMZN concern. And the company was shifting avid readers in droves from being physical book buyers to becoming Kindle aficionados.
Publishers began to hear the giant Perot-ish (Perotian?) sucking sound of their physical book distribution network disappearing into cyberspace. How to respond?
AAPL, which was just about to launch the first iPad, came along with a proposal. Publishers shouldn’t necessarily wholesale e-books to e-retailers. Instead, they should (technically, anyway) remain owners of the e-books (with no physical inventory, what difference would it make?) and hire companies like AAPL as commission-earning agents to put buyer and seller together…kind of like the way real estate agents sell houses. That way, publishers could set retail selling prices themselves. This wasn’t an entirely new idea. Publishers already had similar deals with some small independent bookstores.
AAPL proposed to charge a fee of 30% of the proceeds for each sale. And, oh…by the way…publishers would also agree not to allow their e-books to be sold anywhere else at a lower price.
Publishers said okay and then broke the news to AMZN. No more selling e-books at a loss. E-books had to be priced at the publisher-determined price of around $13-$14; AMZN had to take 30% of the proceeds.
AMZN said no. The five publishers now being investigated immediately responded by revoking AMZN’s permission to sell their e-books. AMZN took the books off its website. But a few days later, AMZN caved and agreed to the publishers’ terms.
consequences
Saying what might have been is a little like writing an alternate history, which is rightly classified as a branch of science fiction. Nevertheless, here’s my take on the effects of APPL/publisher deal:
–imposing what amounts to the agency model on AMZN broke the company’s momentum in the e-book business and slowed the growth of the medium.
–this gave the publishers time to try to figure out how to support the physical book distribution network. I don’t know what good that’s done. It certainly didn’t save Borders
–it caused AMZN to refocus its competition strategy on the price/quality of the reader
–it gave BKS time to perfect the Nook and allow it to emerge as a viable competitor to the Kindle
–it gave APPL another selling point for the iPad, although the device seems to me to be much better for magazines, scholarly journals and textbooks than for regular trade fiction/non-fiction.
what would a settlement mean?
I’m assuming that the main result of any settlement would be to allow AMZN to set the retail price of e-books wherever it wants.
Under today’s rules, a newly-released bestseller in e-book form sells for about $14. Sale proceeds are split, with $9.80 going to the publisher and $4.20 to the retailer/agent. AMZN might reduce its e-book bestseller price to $9.99. I think that’s an easy decision. That was its desired price point two years ago–and one which, at least at that time, proved to be a powerful psychological motivator for customers to choose an e-book over a physical one. Unlike the situation in 2010, AMZN could pay the publisher $9.80 and have $.19 left over.
What about $7.99? That would put AMZN back into roughly the same the loss-leader position it had adopted a few years ago. To my mind, this would be a vintage AMZN move. But is it necessary? Given the much larger size of the e-book market today relative to the physical book market, are the losses this strategy would produce manageable?
Maybe a smaller form factor iPad would make AAPL a bigger player in the bestseller book business, but as things stand now AAPL doesn’t need trade e-books to spur iPad sales.
What about Barnes and Noble (BKS)? The company seems to me to be the obvious loser if AMZN is able to lower e-book prices. That would accelerate the demise of the BKS bricks and mortar bookstores. Having a competitor sell e-books at cost would also appear to diminish the chances of the Nook ever becoming a profit-making device.
On the other hand, the AMZN move would likely increase pressure on BKS to sell its Nook name and technology. GOOG has been rumored as a possible buyer, which, I presume, is the reason BKS has a market cap north of $750 million–and has been rising since the price-fixing investigation was leaked to the press.
The real question, of course, is the price someone like GOOG would be willing to pay. I have no clue. I also don’t have any confidence that I’d be able to come up with a meaningful estimate. That’s okay with me, though. As an equity investor, you’re in this position a lot. It just means I won’t get involved with the stock.