If you are following the eBook pricing dispute between Amazon and pretty much all the major book publishers, you know that this is indicative of the struggles most traditional media companies are having in adapting to lower-cost digital distribution outlets. As a quick summary, Amazon has been buying eBooks for its Kindle from the book publishers on a wholesale basis (reportedly around $12 – $15 per book). The publishers are hopeful Amazon would them mark the eBooks up and sell them for the same price as hardcovers, around $18 – $25 each. Amazon, with an eye towards building a large eBook market, and with all of its pricing data culled from its more than 90MM users, believes the right price for most eBooks is $10 or less. And as such, they have been willing to sell many eBooks at a loss, hoping to eventually force publishers to sell eBooks at a lower, perhaps optimal price. They would know. They sell gabillions of items to about 100MM consumers every day. Between them and eBay, they probably know more about the price elasticity of most goods than every good manufacturer out there.

Remembering your Econ class, you also know that most goods are elastic; as price lowers, demand increases. An optimum point exist that maximizes profit. I am pretty sure that the book industry, like the music industry before it, has not maximized profit by finding the optimum price. This is generally because the book publishers are not retailers — they have never forged a relationship directly with a customer. To optimize pricing (particularly on a per title basis), you need to conduct lots of tests and analyze lots of data. Amazon does this in near-real time and, I am told, is constantly optimizing pricing, page layout, merchandising, bundling, shopping cart path, and many other ecommerce variables. While Amazon may have other motives for pursuing lower-priced eBooks (to sell more Kindles?), they are smart enough to know that once a market is established, it is hard to raise prices when competition exists. And with Apple entering the iBook/eBook market, they know they will have competition. So, why would publishers NOT want Amazon to find the optimal profit-maximizing price? Because, like many entrenched media companies, they have massive legacy cost structures that don’t support selling books at, say $6 wholesale. They offer many unreasonable arguments against this: books are “worth” more, authors won’t make enough money, it’s bad for the industry, etc. These are not economic arguments, but are meant to maintain the status quo economics as long as possible. And it’s ultimately bad for them. The music industry has held firm that music is “worth” $1 – $1.30 per song, regardless of the track. For 7 years, they would not experiment with pricing under $1. (eMusic just convinced Sony and Warner last year to try…and I understand the results are positive.) But is all music really worth $1 a song? No, it is not. We know hundreds of thousands of tracks have sold 10 or fewer units digitally. That is the market telling you something. As a way forward, Macmillan adopted Sony Music’s agency model which allows Macmillan to actually set the selling price for its eBooks and pay a sales commission to Amazon. You would expect that Macmillan would then be interested, since it controls pricing, in finding the optimal price. But I suspect its Amazon partnership does not allow it to get real-time feedback from price experimentation. And if they really were experimenting, you would expect that some people would see a title for $10 and others for $18. The bottom line is that “value” or “worth” is not decided in a board room, it is decided by the market. And low-cost digital distribution, where the marginal cost of each incremental item sold is zero, brings consumer expectation that price must fall. They don’t care if the rent on your offices at 50th and Broadway are $8M a year. Traditional media companies whose products are going digital must accept lower unit selling prices and massively cut their operating costs in order to survive. Trying to play hardball with the market ultimately won’t work. See the music industry whose sales are now $20B worldwide, down from $40B, and I think are going much closer to $10B – $12B before finding bottom. For more reading on this, see my post on piracy in the book industry, the movie industry ignoring market signals from Redbox, and a reminder of what we went through at eMusic with the music industry.