Last week’s announcement by the Justice Department that they are suing Apple and several of the world’s biggest book publishers for conspiring to keep eBook prices high generated plenty of media coverage. One challenge in wading through this coverage is that most of it tends to be written by…journalists. And some journalists are also authors. And authors seem to have a soft spot for publishers who fight for higher prices. So, we get lots of coverage sympathetic to the plight of the poor book publishers. Amazon is evil, you see.

Absent from most of this coverage are two main questions: a) what is the right price for eBooks and who gets to set it, and b) why are eBooks not interoperable on different devices? These questions, in my mind, are far more interesting than the ongoing struggle of publishers to adapt to Amazon’s dominance in book retailing. In fact, the answers can significantly help legacy publishers stay competitive for the future and avoid extinction.

eBook Pricing

First, a conversation about eBook pricing. Readers of this blog are familiar with my many discussions on digital good pricing and price elasticity. There’s “Weighing In On the Amazon/Macmillan Pricing Debate” where I detail that the market can tell you your optimal (i.e., highest profit producing) price for digital goods. Each incremental digital good has no additional cost. The marginal cost of distributing it is zero. So you really want to maximize total profit by finding the price that produces the most number of copies sold. In these markets, you make a mistake when you set your price by looking at your legacy costs (which were designed for a physical goods market in pre-digital times). Digital markets produce much lower profit per item, since digital markets tend to have lower prices for goods. (See “As Big Media Goes Digital, Markets Shrink“.) In all the discussions about why book publishers demand that eBooks should be $15 and not $10, they say it is because they cannot afford to sell books at $10. That is, they cannot cover their legacy cost models on that number. Right. Which is why you must rebuild your cost structure for a digital goods industry with far lower prices. You start by paying your top execs much less than millions of dollars a year. Then you move your offices out of fancy midtown office buildings. Why should eBooks cost $15? Amazon is far more of an expert on optimal book pricing. They have far more data than publishers, since they experiment with pricing hundreds of thousands of times a day across millions of titles. Amazon can tell you the exact price for a title that will produce the most number of copies sold. Amazon is pretty sure that number is closer to $10 than to $15. Yes, they want to sell more Kindles. And they believe that lower eBook prices mean more eBooks sold which means more demand for Kindle. The negative coverage of Amazon is centered on them selling eBooks below cost in order to reach the $10 price point. But that is a function of publishers setting the cost higher than $10. If the profit-maximizing price for an eBook is $10, then publishers must adapt to set a wholesale price lower than that, even if it means your legacy cost structure doesn’t allow it. And that’s the rub. [By the way, as publishers continue to resist this market force, new "publisher" models are appearing and will replace the traditional functions of publishers with more digital-friendly models.]

Openness and Interoperability

Now, how do legacy book publishers fight back? Well, to begin, their biggest mistake prior to over-reaching on pricing was to insist retailers DRM their eBook titles. Just like in online music, this insistence on anti-copying protection (albeit with limited usefulness) not only creates inconveniences for consumers, it allows for dominant proprietary ecosystems to form (like Apple did with iPod/iTunes, where tracks bought from iTunes only played on iPods, Kindle books can only be read on Kindles.) Instead, publishers should have demanded the opposite. All eBooks should be sold in open, interoperable formats, so an eBook sold at Amazon could be read on a Nook, etc. This would have separated the reader market from the retail market and lessened Amazon’s eBook dominance. It may be too late for this change to work, but it is worth exploring. Incidentally, I predicted this in 2009 with this piece, “The Book Industry Is In Trouble, But Piracy Is Just A Symptom.”

Here’s the essence of what I see — we have authors and publishers screaming that Amazon wants to sell their books at prices lower than the arbitrary costs the authors and publishers have set. But why must eBook prices be $15? What is so magical about that price? Will it maximize profit? I am skeptical that this price does optimize profit. I see how it attempts to protect a legacy cost structure that is out-of-whack with a digital goods market. Yes, Amazon is a relentless competitor. But they always seem to be on the side of lower prices. And as consumers, we love this about Amazon. But none of the articles I have read seem to mention that the winner in a lower-price eBook market is the person authors are all writing books for in the first place. The reader.

(Incidentally, I am completely unmoved by the argument that if Amazon forces traditional publishers to sell books at lower costs, then the publishers will go away and we won’t have books anymore. Hogwash. The publishers built for a printed books world may go away, but their digital native versions will replace them.)