Not sure how much of this I agree with. Publishing decrying Amazon's monopoly is a little like calling the kettle black, in my opinion.
Publishing's Ecosystem on the Brink: The Backstory
Subtlety is out. Bloomberg Businessweek’s January 25th cover shows a book engulfed in flames. The book’s title? “Amazon Wants to Burn the Book Business.” A towering pile of books dominates the front page of Sunday’s NYT Business Section. The pile starts well below the fold (print edition), breaks through the section header at the top of the page, and leans precariously. Books are starting to tumble off. “The Bookstore’s Last Stand,” reads the headline.
These stories capture pretty well the state of book publishing: this appears to be no ordinary, cyclical crisis that future authors and publishers will shrug off. To understand how the book industry got into this predicament, however, a broader perspective may be needed. The cover story of February’s Harper’s Magazine provides that, discussing a fundamental shift in the federal approach to antitrust law that’s affected bookselling and countless other industries. It’s a story that hasn’t previously been told in a major periodical, to our knowledge.
We’ll get to that in a moment. First, let’s set the stage with the other two stories.
Burning Down the Houses
Brad Stone’s Businessweek story discusses Amazon’s campaign to prevent other booksellers from securing a foothold in the booming e-book market and the company’s furious reaction to Random House’s decision last March to adopt agency pricing for e-books, just as five of the other “Big Six” trade publishers had the previous year. (Before agency pricing, Amazon could sell e-books from Big Six publishers at deep discounts, taking losses at a rate that Barnes & Noble could never afford to match. See How Apple Saved Barnes & Noble, Probably for more.)
Mr. Stone writes that after Random House’s March 2011 agency-pricing announcement,
Amazon could no longer run the best play out of its playbook – slash prices and sustain losses in the short term to gain market share over the long term. … “For the first time, a level playing field was going to get forced on Amazon,” says James Gray [of UK bookseller John Smith & Son and formerly of Ingram Content Group]. Amazon execs “were basically spitting blood and nails.”
Amazon’s response to Random House’s move was stunning and swift:
The next month, an Amazon recruiter sent an e-mail to several editors at big publishing houses, looking for someone to launch a new New York-based publishing imprint. “The imprint will be supported with a large budget, and its success will directly impact the success of Amazon’s overall business,” read the e-mail, which was obtained by Bloomberg Businessweek.
Even with a large budget, directly affecting the success of Amazon’s overall business is a tall order for a new publishing imprint. Amazon pulled in well north of $40 billion in revenue last year (final numbers aren’t yet in), dwarfing the combined revenues of the Big Six publishers.
Luring a substantial contingent of bestselling authors away from the Big Six seems the only plausible route for an imprint to affect Amazon’s overall business. Amazon needed someone with a substantial industry pedigree to pull this off. Amazon quickly – in time for last spring’s Book Expo America -- landed just the man for the job: Larry Kirshbaum, formerly of Warner Books.
Just three months after Random House’s announcement, Amazon had all but declared war on the six unruly members of its book supply chain. Jeff Bezos had $6 billion in cash, the patience to absorb losses for years, and a former Big Six chief to lead the fight. The long-running behind-the-scenes battle for control of the publishing industry had finally broken into full public view.
Barnes & Noble’s New Role: The Contender
While Amazon directly threatens traditional publishers with its new imprint, it continues to undermine the ecosystem on which book publishers, and most new authors, depend. Julie Bosman describes this well in her NYT article, focusing on the last remaining brick-and-mortar bookseller with nationwide clout:
Without Barnes & Noble, the publishers’ marketing proposition crumbles. The idea that publishers can spot, mold and publicize new talent, then get someone to buy books at prices that actually makes economic sense suddenly seems a reach. …
What publishers count on from bookstores is the browsing effect. Surveys indicate that only a third of the people who step into a bookstore and walk out with a book actually arrived with the specific desire to buy one.
“That display space they have in the store is really one of the most valuable places that exists in this country for communicating to the consumer that a book is a big deal,” said Madeline McIntosh, president of sales, operations and digital for Random House.
Established authors, for the most part, do fine selling through online bookstores. It’s new authors who lose out if browsing in bookstores becomes a thing of the past. Advances for unproven and non-bestselling authors have already plummeted, by all accounts. Literary diversity is at risk.
To understand just how precarious things are, realize that last year’s Borders’ bankruptcy represented an enormous reduction in browsing space, shuttering 650 stores. (B&N has about 700 stores.) One benefit of the loss of Borders should have been a short-term lift to B&N’s 700 stores and the 1,500 or so remaining independent bookstores. B&N’s sales were indeed up in the nine weeks before Christmas, Ms. Bosman reports. How much? Borders’ collapse led to a bounce of just four percent, compared to the prior Christmas. That’s what’s passing for good news in brick-and-mortar bookselling at the moment.
There is a bright spot, however. Barnes & Noble, led by William Lynch, has exceeded all expectations in the past two years with its launch of the Nook. B&N’s 300-member Silicon Valley office, after giving Amazon’s Kindle developers a two-year head start, beat Amazon to the tablet market by fully twelve months, and introduced what’s generally seen as the state-of-the-art e-ink reader, the Nook Simple Touch, eight months ago.
B&N, in other words, has been out-engineering Amazon, and Ms. Bosman’s story is the best account we’ve had of B&N’s efforts. In the process, B&N has seen its e-book market share climb from zero, two Christmases ago, to roughly 27% today.
B&N remains vulnerable, however. The engineering race against Amazon continues, and Amazon has leverage for acquiring content for its Kindle (see Contracts on Fire: Amazon’s Lending Library Mess) that B&N can’t match. And, critically, one tool that should help B&N, our antitrust laws, is instead poised to undo it.
This brings us to an unlikely tale of books, chickens, beer, and a Silicon Valley gentlemen’s agreement.
The Backstory: Amazon, Chicken Processors & Silicon Valley
Harper’s cover art rivals Businessweek’s: an enormous businessman wearing a gray pinstriped suit is preparing to literally eat the competition, a jumbo handful of gray-suited men and women. In the article, “Killing the Competition: How the New Monopolies Are Destroying Open Markets,” (key excerpts at link, full article by subscription) Barry Lynn views the state of book publishing through a different lens.
Mr. Lynn makes the case that Amazon’s dominance isn’t just a story of an industry disrupted by online commerce and digital upheaval, it’s about the abandoning of New Deal era protections of retailers in 1975 (promoted by backers as a means to fight inflation, says Mr. Lynn) and what he portrays as a shift in 1981 in the Justice Department’s interpretation of antitrust law based on “Chicago School” theories of efficiency and consumer welfare. The upshot appears to be that non-consumer markets (business-to-business markets and labor markets) are often insufficiently protected from monopolies.
To a chicken grower, for example, the relevant market isn’t restaurants or household consumers of chicken, it’s the market of chicken processors. Through a variety of machinations, including long-term contracts and the physical placement of processing plants (think baseball, before free agency), chicken growers now routinely have a market of only one processor to sell to.
Chicken growers own their land, buildings, and equipment, and all of the debt and risk that go with them, but these entrepreneurs have no real control over their economic lives. Growers buy their chicks and feed from their poultry processor, for example, and processors often require growers to make new investments in buildings and equipment. The processors, Mr. Lynn seems to suggest, have something much better than mere capital: the economic power to dictate how others use theirs.
It’s not just chicken growers who face constrained markets, Mr. Lynn writes. In free-wheeling Silicon Valley, computer engineers and digital animation workers employed by Apple, Google, Intel, and Pixar, among others, were subject to a secret agreement not to bid on each others’ employees, according to a Justice Department lawsuit filed, and settled, in 2010. (On Friday, former employees of some of the companies filed an antitrust lawsuit in federal court in San Jose based on the Justice Department investigation.)
It’s even hit beer. The 1,750 U.S. microbrewers may appear to operate in a competitive environment, but they nearly all sell through two distributors: ABI and MillerCoors control 90% of the distribution market.
For book publishers, the relevant market isn’t readers (direct sales are few), but booksellers, and Amazon has firm control of bookselling’s online future as it works to undermine bookselling’s remaining brick-and-mortar infrastructure. Amazon controls every growing segment of the industry: online physical books, downloadable audio books, online used books, and e-books. Amazon commands about 75% of the online market for print books, and 60% of the e-book market (a percentage that decreased from Amazon’s reported 90% two years ago, as a result of agency pricing).
Mr. Lynn reports on a conversation with the head of one of the largest publishing houses in the U.S.:
He explained that Amazon was once a “wonderful customer with whom to do business.” As Jeff Bezos’s company became more powerful, however, it changed. “The question is, do you wear your power lightly? … Mr. Bezos has not. He is reckless. He is dangerous.”
The head of a small publishing house in Manhattan, Mr. Lynn reports, was even more blunt:
“Amazon is a bully,” he said, his voice rising, his cheeks flushing. “Anyone who gets that powerful can push people around, and Amazon pushes people around. They do not exercise their power responsibly.”
Neither man allowed me to use his name. Amazon, they made clear, had long since accumulated sufficient influence over their business to ensure that even these most dedicated defenders of the book – and of the First Amendment – dare not speak openly of the company’s predations.
Mr. Lynn then turns to Amazon’s blackout of Macmillan’s buy buttons, two years ago this week:
At the time, Amazon and Macmillan were scrapping over which firm would set the price for Macmillan’s e-books. Amazon wanted to price every Macmillan e-book, and indeed every e-book of every publisher, at $9.99 or less. This scorched-earth tactic, which guaranteed that Amazon lost money on many of the e-books it sold, was designed to cement the online retailer’s dominance in the nascent market. It also had the effect of persuading customers that this deeply discounted price, which publishers considered ruinously low, was the “natural” one for an e-book.
In January 2010, Macmillan at last claimed the right to set the price for each of its own products as it alone saw fit. Amazon resisted this arrangement, known in publishing as the “agency model.” When the two companies deadlocked, Amazon simply turned off the buttons that allowed customers to order Macmillan titles, in both their print and their e-book versions. The reasoning was obvious: the sudden loss of sales, which could amount to a sizable fraction of Macmillan’s total revenue, would soon bring the publisher to heel.
This was not the first time Amazon had used this stratagem. The retailer’s executives had previously cut off small firms such as Ten Speed Press and Melville House Publishing for bucking their will. But the fight with Macmillan was by far the most public of these showdowns.
In the late 1970s, when a single book retailer first captured a 10 percent share of the U.S. market, Congress and the regulatory agencies were swift to react. As the head of the Federal Trade Commission put it: “The First Amendment protects us from the chilling shadow of government interference with the media. But are there comparable dangers if other powerful economic or political institutions assume control...?”
***
Today, … a single private company has captured the ability to dictate terms to the people who publish our books, and hence to the people who write and read our books. It does so by employing the most blatant forms of predatory pricing to destroy its retail competitors. … [It] justifies its exercise of raw power in the same way our economic autocrats always do: it claims that the resulting “efficiencies” will serve the interests of the consumer.
The book industry is in play, and has been for a while. The good news is that people are finally starting to pay attention.
Showing posts with label macmillan. Show all posts
Showing posts with label macmillan. Show all posts
31 January 2012
07 March 2011
Scott Turow on Random House: Local Booksellers May Be the Big Winners
From the Authors Guild:
Random House, the largest trade book publisher in the U.S., announced last week that it is adopting the agency model for selling e-books. For readers and authors concerned about a diverse literary marketplace, this is welcome news, a chance for online bookselling to avoid the winner-take-all trap. Random House's move gives brick-and-mortar bookstores, many of which are now selling e-books but cannot afford to lose money on those sales, a fighting chance in the new print + digital landscape.
"Book retailers have faced extraordinary challenges in recent years," said Authors Guild President Scott Turow, "a double whammy of recession and a shift to digital books that had cut many stores out. For anyone who loves bookstores, this is the best news out of the publishing industry in a long time. Random House's move may prove to be a lifeline for some bookstores."
Apple introduced the agency model into bookselling last year when it launched the iPad and the iBookstore. In January 2010, as Steve Jobs was announcing Apple's new device, Amazon controlled an estimated 90% of the U.S. e-book market. The price of entry into that market was steep: Amazon, using the reseller model for e-books, was routinely selling e-books at a substantial loss to build the market and to ward off competitors such as Barnes & Noble, which had just begun selling the Nook. As we described in last month's alert (How Apple Saved Barnes & Noble. Probably.):
Apple wouldn't sell e-books under the reseller model that Amazon had been using to lock down the market. (Under that model, the publisher sells e-books to a reseller at a discount of about 50%. The reseller can then sell the e-book at any price, constrained only by antitrust law and the reseller's ability to absorb losses.) Instead, Apple would sell e-books under the same "agency model" it used for iPhone apps. Under the agency model, Apple acts as the publisher's agent, selling e-books at the price established by the publisher and taking a 30% commission on each sale. To participate, a publisher would have to agree to a set of ceilings on e-book prices, generally $12.99 or $13.99 for new books. A publisher would also have to agree not to sell to others under more favorable terms.
If the agency model took hold, unfettered discounting of e-books would be out. Amazon would lose its ability to buy market share in a nascent, booming industry.
Macmillan leapt at the agency model, and Amazon fought back. In a dramatic, week-long showdown, Amazon removed the buy buttons from print and digital editions of virtually all of Macmillan's books. Macmillan stood firm, and five of the big six trade publishers (all except Random House) quickly adopted the agency model. The Guild immediately backed the agency model as essential for creating a healthy, diverse e-book retailing environment, even though it would mean lower royalties for many authors in the near term.
Barnes & Noble benefitted more than anyone from publishers' adoption of the agency model. It still had to subsidize sales of many Random House titles to stay in the game with Amazon, but it didn't have to lose money on the sales of other titles. Barnes & Noble's share of the e-book market grew at a pace that surprised everyone in the industry and is now approaching 20%.
The biggest beneficiaries of Random House's shift to the agency model may be independent booksellers, many of which are now selling e-books through an arrangement with Google. While Barnes & Noble could absorb some losses in selling Random House e-books, this was out of the question for most independent booksellers. Many readers will soon be able to support their local booksellers when they buy e-books, without paying a stiff price for their loyalty.
"Getting local booksellers into the e-book game is essential," said Mr. Turow. "Equally essential, if e-books are going to help sustain a vibrant literary culture, is restoring the traditional division of proceeds between authors and publishers. Random House and other major publishers have a lot of work to do on that score."
For a discussion of e-book royalties, see E-Book Royalty Math: The House Always Wins and The E-Book Royalty Mess: An Interim Fix.
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Random House, the largest trade book publisher in the U.S., announced last week that it is adopting the agency model for selling e-books. For readers and authors concerned about a diverse literary marketplace, this is welcome news, a chance for online bookselling to avoid the winner-take-all trap. Random House's move gives brick-and-mortar bookstores, many of which are now selling e-books but cannot afford to lose money on those sales, a fighting chance in the new print + digital landscape.
"Book retailers have faced extraordinary challenges in recent years," said Authors Guild President Scott Turow, "a double whammy of recession and a shift to digital books that had cut many stores out. For anyone who loves bookstores, this is the best news out of the publishing industry in a long time. Random House's move may prove to be a lifeline for some bookstores."
Apple introduced the agency model into bookselling last year when it launched the iPad and the iBookstore. In January 2010, as Steve Jobs was announcing Apple's new device, Amazon controlled an estimated 90% of the U.S. e-book market. The price of entry into that market was steep: Amazon, using the reseller model for e-books, was routinely selling e-books at a substantial loss to build the market and to ward off competitors such as Barnes & Noble, which had just begun selling the Nook. As we described in last month's alert (How Apple Saved Barnes & Noble. Probably.):
Apple wouldn't sell e-books under the reseller model that Amazon had been using to lock down the market. (Under that model, the publisher sells e-books to a reseller at a discount of about 50%. The reseller can then sell the e-book at any price, constrained only by antitrust law and the reseller's ability to absorb losses.) Instead, Apple would sell e-books under the same "agency model" it used for iPhone apps. Under the agency model, Apple acts as the publisher's agent, selling e-books at the price established by the publisher and taking a 30% commission on each sale. To participate, a publisher would have to agree to a set of ceilings on e-book prices, generally $12.99 or $13.99 for new books. A publisher would also have to agree not to sell to others under more favorable terms.
If the agency model took hold, unfettered discounting of e-books would be out. Amazon would lose its ability to buy market share in a nascent, booming industry.
Macmillan leapt at the agency model, and Amazon fought back. In a dramatic, week-long showdown, Amazon removed the buy buttons from print and digital editions of virtually all of Macmillan's books. Macmillan stood firm, and five of the big six trade publishers (all except Random House) quickly adopted the agency model. The Guild immediately backed the agency model as essential for creating a healthy, diverse e-book retailing environment, even though it would mean lower royalties for many authors in the near term.
Barnes & Noble benefitted more than anyone from publishers' adoption of the agency model. It still had to subsidize sales of many Random House titles to stay in the game with Amazon, but it didn't have to lose money on the sales of other titles. Barnes & Noble's share of the e-book market grew at a pace that surprised everyone in the industry and is now approaching 20%.
The biggest beneficiaries of Random House's shift to the agency model may be independent booksellers, many of which are now selling e-books through an arrangement with Google. While Barnes & Noble could absorb some losses in selling Random House e-books, this was out of the question for most independent booksellers. Many readers will soon be able to support their local booksellers when they buy e-books, without paying a stiff price for their loyalty.
"Getting local booksellers into the e-book game is essential," said Mr. Turow. "Equally essential, if e-books are going to help sustain a vibrant literary culture, is restoring the traditional division of proceeds between authors and publishers. Random House and other major publishers have a lot of work to do on that score."
For a discussion of e-book royalties, see E-Book Royalty Math: The House Always Wins and The E-Book Royalty Mess: An Interim Fix.
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11 February 2011
The E-Book Royalty Mess: An Interim Fix
The E-Book Royalty Mess: An Interim Fix
February 11, 2011. To mark the one-year anniversary of the Great Blackout, Amazon's weeklong shut down of e-commerce for nearly all of Macmillan's titles, we're sending out a series of alerts on the state of e-books, authorship, and publishing. The first installment ("How Apple Saved Barnes & Noble. Probably.") discussed the outcome, of that battle, which introduced a modicum of competition into the distribution of e-books. The second, ("E-Book Royalty Math: The House Always Wins") took up the long-simmering e-royalty debate, and showed that publishers generally do significantly better on e-book sales than on hardcover sales, while authors always do worse.
Today, we look at the implications of that disparity, and suggest an interim solution to minimize the harm to authors.
Negotiating a publishing contract is frequently contentious, but authors have long been able to take comfort in this: once the contract is signed, the interests of the author and the publisher are largely aligned. If the publisher works to maximize its revenues, it will necessarily work to maximize the author's royalties. This is the heart of the traditional bargain, whereby the author licenses the publisher long-term, exclusive book rights in the world's largest book market in exchange for an advance and the promise of diligently working to the joint benefit of author and publisher.
Now, for the first time, publishers have strong incentives to work against the author's interests.
As we discussed in our last alert, authors and publishers have traditionally acted as equal partners, splitting the net proceeds from book sales. Most sublicenses, for example, provide for a fifty-fifty split of proceeds, and the standard hardcover trade book royalty -- 15% of the retail price -- represented half of the net proceeds from selling the book when the standard was established.* But trade book publishers currently offer e-book royalties at precisely half what the terms of a traditional proceeds-sharing arrangement would dictate -- paying just 25% of net income on e-book sales. That's why the shift from hardcover to e-book sales is a win for publishers, a loss for authors.
The Pushback
The publisher's standard reply to this -- which we heard yet again after last week's alert -- is a muddle, conflating fixed costs with variable costs. Let's address that before we move on.
For any book, a publisher has two types of fixed costs: those attributable to the publisher's operations as a whole (office overhead, investments in infrastructure, etc.) and those attributable to the particular work (author's advance, editing, design). The variable costs for the book are the unit costs of production. These costs (print, paper, binding, returns, royalty) tell a publisher how much more it costs to get, say, 10,000 additional hardcover books to stores and sell them. The publisher's gross profit per unit (unit income minus unit costs) is the amount against which the author's royalties are traditionally and properly measured. With this sort of analysis, a publisher can compare the gross profitability per unit of, for example, a hardcover to a trade paperback edition.
Investments in technology change nothing. Publishers never argued, for example, that hardcover royalties needed to be cut when they began equipping their editorial and design staffs with expensive (at the time) personal computers, buying pricey computers and software for their designers, tying those computers together with ever-more-powerful Ethernet cables and routers, and hiring support staff to maintain it all. Publishers simply took their share of the gross profits from book sales and applied it to all of their costs, as they always have. What remains after deducting those costs is deemed the publisher's net profit. Similarly, authors take their share of the proceeds of their book sales and apply it to their overhead (food, clothing, shelter, and computer technology) and costs (their labor and out-of-pocket costs to write the manuscript). What remains is the author's net profit.
The proper question is this: how much better off is a publisher if it sells a book, print or digital, than it is if it doesn't? That is what we measured. We then compared that to the author's print and digital royalties per book.
Publisher's E-Gains + Author's E-Losses = E-Bias
Applying standard trade hardcover and e-book terms to Kathryn Stockett's "The Help," David Baldacci's "Hell's Corner," and Laura Hillenbrand's "Unbroken," we found that publishers do far better by selling e-books than hardcovers (realizing "e-gains" of 27% to 77%), while the authors do much worse (suffering "e-losses" of 17% to 39%). Publishers can't help being influenced by the gains; e-bias will inevitably drive their decisions.
Some simplified examples show how e-bias plays out in publishing decisions:
1. Promotional Bias. Assume a publisher is contemplating whether to invest a portion of a book's limited marketing budget in stimulating the sale of digital books (paying for featured placement in the Kindle or Nook stores, perhaps) or in encouraging print sales through a promotion at physical bookstores. Either way, the publisher expects the investment to boost sales by 1,000 copies. A sensible publisher would spend the money to promote digital books, pocketing an additional $1,570 to $4,170 on those sales compared to hardcover sales. Such a decision, however, would cost Ms. Stockett, Mr. Baldacci, and Ms. Hillenbrand $1,470, $1,570, and $670, respectively, in royalties.
2. Print-Run Bias. E-gains of 27% to 77% become irresistible when a publisher looks at risk-adjusted returns on investment, as any businessperson would. Once a book is typeset for print, the publisher must invest an additional $30,000 to have 10,000 hardcover books ready for sale, using the figures from our prior alert. Once the digital template is created and distributed to the major vendors, on the other hand, there is no additional cost to having the book ready for purchase by an unlimited number of customers. Even the encryption fee (50 cents per book, at most) isn't incurred until the reader purchases the book. In this environment a publisher is nearly certain to keep print runs as short as possible, risking unavailability at bookstores, in order to decrease overall risk and maximize the publisher's return on investment.
Publishers, in short, will work to increase e-book sales at the inevitable expense of hardcover sales, tilting more and more purchases toward e-books, and their lower royalties. Publishers, as sensible, profit-maximizing entities, will work against their authors' best interests.
An Interim Solution: Negotiate an E-Royalty Floor
This won't go on forever. Bargain basement e-royalty rates are largely a result of negotiating indifference. The current industry standards for e-royalties began to gel a decade or so ago, when there was no e-book market to speak of. Authors and agents weren't willing to walk away from publishing contracts over a royalty clause that had little effect on the author's earnings.
Once the digital market gets large enough, authors with strong sales records won't put up with this: they'll go where they'll once again be paid as full partners in the exploitation of their creative work. That day is fast approaching, and would probably be here already, were it not for a tripwire in the contracts of thousands of in-print books. That tripwire? If the publisher increases its e-royalty rates for a new book, the e-royalty rates of countless in-print books from that publisher will automatically match the new rate or be subject to renegotiation.
So, what's to be done in the meantime? Here's a solution that won't cascade through countless backlist books: soften the e-bias by eliminating the author's e-loss. That is, negotiate for an e-royalty floor tied to the prevailing print book royalty amount.
Turning again to our last alert for examples, here are the calculations of e-losses and e-gains without an e-royalty floor:
"The Help," by Kathryn Stockett
Author's Standard Royalty: $3.75 hardcover; $2.28 e-book.
Author's E-Loss = -39%
Publisher's Margin: $4.75 hardcover; $6.32 e-book.
Publisher's E-Gain = +33%
"Hell's Corner," by David Baldacci
Author's Standard Royalty: $4.20 hardcover; $2.63 e-book.
Author's E-Loss = -37%
Publisher's Margin: $5.80 hardcover; $7.37 e-book.
Publisher's E-Gain = +27%
"Unbroken," by Laura Hillenbrand
Author's Standard Royalty: $4.05 hardcover; $3.38 e-book.
Author's E-Loss = -17%
Publisher's Margin: $5.45 hardcover; $9.62 e-book.
Publisher's E-Gain = +77%
Here are the calculations with an e-royalty floor:
"The Help," by Kathryn Stockett
Author's Adjusted Royalty: $3.75 hardcover; $3.75 e-book.
Author's E-Loss = Zero
Publisher's Margin: $4.75 hardcover; $4.85 e-book.
Publisher's E-Gain = +2%
"Hell's Corner," by David Baldacci
Author's Adjusted Royalty: $4.20 hardcover; $4.20 e-book.
Author's E-Loss = Zero
Publisher's Margin: $5.80 hardcover; $5.80 e-book.
Publisher's E-Gain = Zero
"Unbroken," by Laura Hillenbrand
Author's Adjusted Royalty: $4.05 hardcover; $4.05 e-book.
Author's E-Loss = Zero
Publisher's Margin: $5.45 hardcover; $8.85 e-book.
Publisher's E-Gain = +62%
While this wouldn't restore authors to full partnership status in the sale of their work, it would prevent them from being harmed as publishers try to maximize their revenues. This is only an interim solution, however. In the long run, authors will demand to be restored to full partnership, and someone will give them that status.
Part 4 of this series will look at online piracy and book publishing.
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*A traditional industry rule of thumb was that the price of a hardcover should be five or six times the cost of production. (John P. Dessauer, Book Publishing: What It Is, What It Does. R.R. Bowker 1974, p. 92). To keep the math simple, let's assume that it's priced at five times the cost of production, that there are no returns, and that the bookseller pays the publisher 50% of the list price for the book. Of the 50% the publisher receives, subtract 20% for the cost of production (one-fifth the retail price) and the net proceeds are 30% of the retail list price. Split that in two, and one arrives at the author's standard hardcover royalty, 15% of the retail list price. (A current rule of thumb is that the cost of producing a hardcover is about 15% of the retail price, but the actual costs vary widely.)
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February 11, 2011. To mark the one-year anniversary of the Great Blackout, Amazon's weeklong shut down of e-commerce for nearly all of Macmillan's titles, we're sending out a series of alerts on the state of e-books, authorship, and publishing. The first installment ("How Apple Saved Barnes & Noble. Probably.") discussed the outcome, of that battle, which introduced a modicum of competition into the distribution of e-books. The second, ("E-Book Royalty Math: The House Always Wins") took up the long-simmering e-royalty debate, and showed that publishers generally do significantly better on e-book sales than on hardcover sales, while authors always do worse.
Today, we look at the implications of that disparity, and suggest an interim solution to minimize the harm to authors.
Negotiating a publishing contract is frequently contentious, but authors have long been able to take comfort in this: once the contract is signed, the interests of the author and the publisher are largely aligned. If the publisher works to maximize its revenues, it will necessarily work to maximize the author's royalties. This is the heart of the traditional bargain, whereby the author licenses the publisher long-term, exclusive book rights in the world's largest book market in exchange for an advance and the promise of diligently working to the joint benefit of author and publisher.
Now, for the first time, publishers have strong incentives to work against the author's interests.
As we discussed in our last alert, authors and publishers have traditionally acted as equal partners, splitting the net proceeds from book sales. Most sublicenses, for example, provide for a fifty-fifty split of proceeds, and the standard hardcover trade book royalty -- 15% of the retail price -- represented half of the net proceeds from selling the book when the standard was established.* But trade book publishers currently offer e-book royalties at precisely half what the terms of a traditional proceeds-sharing arrangement would dictate -- paying just 25% of net income on e-book sales. That's why the shift from hardcover to e-book sales is a win for publishers, a loss for authors.
The Pushback
The publisher's standard reply to this -- which we heard yet again after last week's alert -- is a muddle, conflating fixed costs with variable costs. Let's address that before we move on.
For any book, a publisher has two types of fixed costs: those attributable to the publisher's operations as a whole (office overhead, investments in infrastructure, etc.) and those attributable to the particular work (author's advance, editing, design). The variable costs for the book are the unit costs of production. These costs (print, paper, binding, returns, royalty) tell a publisher how much more it costs to get, say, 10,000 additional hardcover books to stores and sell them. The publisher's gross profit per unit (unit income minus unit costs) is the amount against which the author's royalties are traditionally and properly measured. With this sort of analysis, a publisher can compare the gross profitability per unit of, for example, a hardcover to a trade paperback edition.
Investments in technology change nothing. Publishers never argued, for example, that hardcover royalties needed to be cut when they began equipping their editorial and design staffs with expensive (at the time) personal computers, buying pricey computers and software for their designers, tying those computers together with ever-more-powerful Ethernet cables and routers, and hiring support staff to maintain it all. Publishers simply took their share of the gross profits from book sales and applied it to all of their costs, as they always have. What remains after deducting those costs is deemed the publisher's net profit. Similarly, authors take their share of the proceeds of their book sales and apply it to their overhead (food, clothing, shelter, and computer technology) and costs (their labor and out-of-pocket costs to write the manuscript). What remains is the author's net profit.
The proper question is this: how much better off is a publisher if it sells a book, print or digital, than it is if it doesn't? That is what we measured. We then compared that to the author's print and digital royalties per book.
Publisher's E-Gains + Author's E-Losses = E-Bias
Applying standard trade hardcover and e-book terms to Kathryn Stockett's "The Help," David Baldacci's "Hell's Corner," and Laura Hillenbrand's "Unbroken," we found that publishers do far better by selling e-books than hardcovers (realizing "e-gains" of 27% to 77%), while the authors do much worse (suffering "e-losses" of 17% to 39%). Publishers can't help being influenced by the gains; e-bias will inevitably drive their decisions.
Some simplified examples show how e-bias plays out in publishing decisions:
1. Promotional Bias. Assume a publisher is contemplating whether to invest a portion of a book's limited marketing budget in stimulating the sale of digital books (paying for featured placement in the Kindle or Nook stores, perhaps) or in encouraging print sales through a promotion at physical bookstores. Either way, the publisher expects the investment to boost sales by 1,000 copies. A sensible publisher would spend the money to promote digital books, pocketing an additional $1,570 to $4,170 on those sales compared to hardcover sales. Such a decision, however, would cost Ms. Stockett, Mr. Baldacci, and Ms. Hillenbrand $1,470, $1,570, and $670, respectively, in royalties.
2. Print-Run Bias. E-gains of 27% to 77% become irresistible when a publisher looks at risk-adjusted returns on investment, as any businessperson would. Once a book is typeset for print, the publisher must invest an additional $30,000 to have 10,000 hardcover books ready for sale, using the figures from our prior alert. Once the digital template is created and distributed to the major vendors, on the other hand, there is no additional cost to having the book ready for purchase by an unlimited number of customers. Even the encryption fee (50 cents per book, at most) isn't incurred until the reader purchases the book. In this environment a publisher is nearly certain to keep print runs as short as possible, risking unavailability at bookstores, in order to decrease overall risk and maximize the publisher's return on investment.
Publishers, in short, will work to increase e-book sales at the inevitable expense of hardcover sales, tilting more and more purchases toward e-books, and their lower royalties. Publishers, as sensible, profit-maximizing entities, will work against their authors' best interests.
An Interim Solution: Negotiate an E-Royalty Floor
This won't go on forever. Bargain basement e-royalty rates are largely a result of negotiating indifference. The current industry standards for e-royalties began to gel a decade or so ago, when there was no e-book market to speak of. Authors and agents weren't willing to walk away from publishing contracts over a royalty clause that had little effect on the author's earnings.
Once the digital market gets large enough, authors with strong sales records won't put up with this: they'll go where they'll once again be paid as full partners in the exploitation of their creative work. That day is fast approaching, and would probably be here already, were it not for a tripwire in the contracts of thousands of in-print books. That tripwire? If the publisher increases its e-royalty rates for a new book, the e-royalty rates of countless in-print books from that publisher will automatically match the new rate or be subject to renegotiation.
So, what's to be done in the meantime? Here's a solution that won't cascade through countless backlist books: soften the e-bias by eliminating the author's e-loss. That is, negotiate for an e-royalty floor tied to the prevailing print book royalty amount.
Turning again to our last alert for examples, here are the calculations of e-losses and e-gains without an e-royalty floor:
"The Help," by Kathryn Stockett
Author's Standard Royalty: $3.75 hardcover; $2.28 e-book.
Author's E-Loss = -39%
Publisher's Margin: $4.75 hardcover; $6.32 e-book.
Publisher's E-Gain = +33%
"Hell's Corner," by David Baldacci
Author's Standard Royalty: $4.20 hardcover; $2.63 e-book.
Author's E-Loss = -37%
Publisher's Margin: $5.80 hardcover; $7.37 e-book.
Publisher's E-Gain = +27%
"Unbroken," by Laura Hillenbrand
Author's Standard Royalty: $4.05 hardcover; $3.38 e-book.
Author's E-Loss = -17%
Publisher's Margin: $5.45 hardcover; $9.62 e-book.
Publisher's E-Gain = +77%
Here are the calculations with an e-royalty floor:
"The Help," by Kathryn Stockett
Author's Adjusted Royalty: $3.75 hardcover; $3.75 e-book.
Author's E-Loss = Zero
Publisher's Margin: $4.75 hardcover; $4.85 e-book.
Publisher's E-Gain = +2%
"Hell's Corner," by David Baldacci
Author's Adjusted Royalty: $4.20 hardcover; $4.20 e-book.
Author's E-Loss = Zero
Publisher's Margin: $5.80 hardcover; $5.80 e-book.
Publisher's E-Gain = Zero
"Unbroken," by Laura Hillenbrand
Author's Adjusted Royalty: $4.05 hardcover; $4.05 e-book.
Author's E-Loss = Zero
Publisher's Margin: $5.45 hardcover; $8.85 e-book.
Publisher's E-Gain = +62%
While this wouldn't restore authors to full partnership status in the sale of their work, it would prevent them from being harmed as publishers try to maximize their revenues. This is only an interim solution, however. In the long run, authors will demand to be restored to full partnership, and someone will give them that status.
Part 4 of this series will look at online piracy and book publishing.
--------------------------------
*A traditional industry rule of thumb was that the price of a hardcover should be five or six times the cost of production. (John P. Dessauer, Book Publishing: What It Is, What It Does. R.R. Bowker 1974, p. 92). To keep the math simple, let's assume that it's priced at five times the cost of production, that there are no returns, and that the bookseller pays the publisher 50% of the list price for the book. Of the 50% the publisher receives, subtract 20% for the cost of production (one-fifth the retail price) and the net proceeds are 30% of the retail list price. Split that in two, and one arrives at the author's standard hardcover royalty, 15% of the retail list price. (A current rule of thumb is that the cost of producing a hardcover is about 15% of the retail price, but the actual costs vary widely.)
--------------------------------
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05 February 2011
Authors Guild on eBooks, Part 2: E-Book Royalty Math: The Big Tilt
You'd better open your doors because this is going to blow them right off. Feel free to Tweet or repost.
E-Book Royalty Math: The Big Tilt
To mark the one-year anniversary of the Great Blackout, Amazon's weeklong shut down of e-commerce for nearly all of Macmillan's titles, we’re sending out a series of alerts this week and next on the state of e-books, authorship, and publishing. The first installment (“How Apple Saved Barnes & Noble. Probably.”) discussed the outcome, one year later, of that battle. Today, we look at the e-royalty debate, which has been simmering for a while, but is likely to soon heat up as the e-book market grows.
E-book royalty rates for major trade publishers have coalesced, for the moment, at 25% of the publisher’s receipts. As we’ve pointed out previously, this is contrary to longstanding tradition in trade book publishing, in which authors and publishers effectively split the net proceeds of book sales (that's how the industry arrived at the standard hardcover royalty rate of 15% of list price). Among the ills of this radical pay cut is the distorting effect it has on publishers’ incentives: publishers generally do significantly better on e-book sales than they do on hardcover sales. Authors, on the other hand, always do worse.
How much better for the publisher and how much worse for the author? Here are examples of author’s royalties compared to publisher’s gross profit (income per copy minus expenses per copy), calculated using industry-standard contract terms:
“The Help,” by Kathryn Stockett
Author’s Standard Royalty: $3.75 hardcover; $2.28 e-book. Author’s E-Loss = -39%
Publisher’s Margin: $4.75 hardcover; $6.32 e-book. Publisher’s E-Gain = +33%
“Hell’s Corner,” by David Baldacci
Author's Standard Royalty: $4.20 hardcover; $2.63 e-book. Author’s E-Loss = -37%
Publisher’s Margin: $5.80 hardcover; $7.37 e-book. Publisher’s E-Gain = +27%
“Unbroken,” by Laura Hillenbrand
Author’s Standard Royalty: $4.05 hardcover; $3.38 e-book. Author’s E-Loss = -17%
Publisher’s Margin: $5.45 hardcover; $9.62 e-book. Publisher’s E-Gain = +77%
So, everything else being equal, publishers will naturally have a strong bias toward e-book sales. It certainly does wonders for cash flow: not only does the publisher net more, but the reduced royalty means that every time an e-book purchase displaces a hardcover purchase, the odds that the author’s advance will earn out -- and the publisher will have to cut a check for royalties -- diminishes. In more ways than one, the author’s e-loss is the publisher’s e-gain.
Inertia, unfortunately, is embedded in the contractual landscape. If the publisher were to offer more equitable e-royalties in new contracts, it would ripple through much of the publisher’s catalog: most major trade publishers have thousands of contracts that require an automatic adjustment or renegotiation of e-book royalties if the publisher starts offering better terms. (Some publishers finesse this issue when they amend older contracts, many of which allow e-royalty rates to quickly escalate to 40% of the publisher’s receipts. Amending old contracts to grant the publisher digital rights doesn’t trigger the automatic adjustment, in the publisher's view.) Given these substantial collateral costs, publishers will continue to strongly resist changes to their e-book royalties for new books.
Resistance, in the long run, will be futile. As the e-book market continues to grow, competitive pressures will almost certainly force publishers to share e-book proceeds fairly. Authors with clout simply won’t put up with junior partner status in an increasingly important market. New publishers are already willing to share fairly. Once one of those publishers has the capital to pay even a handful of authors meaningful advances, or a major trade publisher decides to take the plunge, the tipping point will likely be at hand.
In the meantime, what’s to be done? We’ll address that in our next installment in this series, on Monday.
Our assumptions and calculations for the figures above follow.
--------------------------------------------------------
Doing the Numbers: Hardcover
To keep things as simple as possible, we assumed that for hardcovers: (1) the publisher sells at an average 50% discount to the wholesaler or retailer (2) the royalty rate is 15% of list price (as it is for most hardcover books, after 10,000 units are sold), (3) the average marginal cost to manufacture the book and get it to the store is $3, and (4) the return rate is 25% (a handy number -- if one of four books produced is returned, then the $3 marginal cost of producing the book is spread over three other books, giving us a return cost of $1 per book). We also rounded up retail list price a few pennies to give us easy figures to work with.
“The Help,” by Kathryn Stockett has a hardcover retail list price of $25. The standard royalty (15% of list) would be $3.75. The publisher grosses $12.50 per book at a 50% discount. Subtract from that the author's royalty ($3.75), cost of production ($3), and cost of returns ($1), and the publisher nets $4.75 on the sale of a hardcover book.
“Hell’s Corner” by David Baldacci, has a retail list price is $28. The standard royalty is $4.20; the publisher's gross is $14. Subtract royalties ($4.20), production and return costs ($4), and the publisher nets $5.80.
“Unbroken,” by Laura Hillenbrand has a hardcover list price of $27. Standard royalties are $4.05. The publisher's gross is $13.50. Subtract royalties of $4.05 and production and return costs of $4, and the publisher nets $5.45.
Doing the Numbers: E-Book
E-book royalty rates are uniform among the major trade publishers, but pricing and discounting formulas fall into two camps: the reseller model favored by Amazon (Random House is the only large trade publisher using this model) and the agency model introduced by Apple a year ago. (See yesterday’s alert for more information on these models.)
Under the reseller model, the online bookseller pays 50% of the retail list price of the book to the publisher and sells the book at whatever price the bookseller chooses (for bestsellers, Amazon typically sells Random House e-books at a significant loss). Random House frequently prices the e-book at the same price as the hardcover until a paperback edition is available.
Under the agency model, the online bookseller pays 70% of the retail list price of the e-book to the publisher. The bookseller, acting as the publisher’s agent, sells the e-book at the price established by the publisher, but the publisher is constrained by agreement with Apple and others to set a price significantly below that for the hardcover version.
The unit costs to the publisher, under either model, are simply the author’s royalty and the encryption fee, for which we’ll use a generous 50 cents per unit.
Here’s the math:
“The Help” has an e-book list price of $13 and is sold under the agency model. Publisher grosses 70% of retail price, or $9.10. Author's royalty is 25% of publisher receipts, or $2.28. Publisher nets $6.32. ($9.10 minus $2.28 royalties and $0.50 encryption fee.)
“Hell’s Corner” is also sold under the agency model at a retail list price of $15 list price. Publisher grosses 70% of retail price, $10.50. Author's royalty is 25% of publisher receipts, or $2.63. Publisher nets $7.37. ($10.50 minus $2.63 royalties and $0.50 encryption fee.)
“Unbroken” is sold by Random House under the reseller model at a retail list price of $27. Publisher grosses $13.50 on the sale. Author’s royalty, at 25%, is $3.38. Random House nets $9.62. ($13.50 minus $3.38 royalties and $0.50 encryption fee.)
------------
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E-Book Royalty Math: The Big Tilt
To mark the one-year anniversary of the Great Blackout, Amazon's weeklong shut down of e-commerce for nearly all of Macmillan's titles, we’re sending out a series of alerts this week and next on the state of e-books, authorship, and publishing. The first installment (“How Apple Saved Barnes & Noble. Probably.”) discussed the outcome, one year later, of that battle. Today, we look at the e-royalty debate, which has been simmering for a while, but is likely to soon heat up as the e-book market grows.
E-book royalty rates for major trade publishers have coalesced, for the moment, at 25% of the publisher’s receipts. As we’ve pointed out previously, this is contrary to longstanding tradition in trade book publishing, in which authors and publishers effectively split the net proceeds of book sales (that's how the industry arrived at the standard hardcover royalty rate of 15% of list price). Among the ills of this radical pay cut is the distorting effect it has on publishers’ incentives: publishers generally do significantly better on e-book sales than they do on hardcover sales. Authors, on the other hand, always do worse.
How much better for the publisher and how much worse for the author? Here are examples of author’s royalties compared to publisher’s gross profit (income per copy minus expenses per copy), calculated using industry-standard contract terms:
“The Help,” by Kathryn Stockett
Author’s Standard Royalty: $3.75 hardcover; $2.28 e-book. Author’s E-Loss = -39%
Publisher’s Margin: $4.75 hardcover; $6.32 e-book. Publisher’s E-Gain = +33%
“Hell’s Corner,” by David Baldacci
Author's Standard Royalty: $4.20 hardcover; $2.63 e-book. Author’s E-Loss = -37%
Publisher’s Margin: $5.80 hardcover; $7.37 e-book. Publisher’s E-Gain = +27%
“Unbroken,” by Laura Hillenbrand
Author’s Standard Royalty: $4.05 hardcover; $3.38 e-book. Author’s E-Loss = -17%
Publisher’s Margin: $5.45 hardcover; $9.62 e-book. Publisher’s E-Gain = +77%
So, everything else being equal, publishers will naturally have a strong bias toward e-book sales. It certainly does wonders for cash flow: not only does the publisher net more, but the reduced royalty means that every time an e-book purchase displaces a hardcover purchase, the odds that the author’s advance will earn out -- and the publisher will have to cut a check for royalties -- diminishes. In more ways than one, the author’s e-loss is the publisher’s e-gain.
Inertia, unfortunately, is embedded in the contractual landscape. If the publisher were to offer more equitable e-royalties in new contracts, it would ripple through much of the publisher’s catalog: most major trade publishers have thousands of contracts that require an automatic adjustment or renegotiation of e-book royalties if the publisher starts offering better terms. (Some publishers finesse this issue when they amend older contracts, many of which allow e-royalty rates to quickly escalate to 40% of the publisher’s receipts. Amending old contracts to grant the publisher digital rights doesn’t trigger the automatic adjustment, in the publisher's view.) Given these substantial collateral costs, publishers will continue to strongly resist changes to their e-book royalties for new books.
Resistance, in the long run, will be futile. As the e-book market continues to grow, competitive pressures will almost certainly force publishers to share e-book proceeds fairly. Authors with clout simply won’t put up with junior partner status in an increasingly important market. New publishers are already willing to share fairly. Once one of those publishers has the capital to pay even a handful of authors meaningful advances, or a major trade publisher decides to take the plunge, the tipping point will likely be at hand.
In the meantime, what’s to be done? We’ll address that in our next installment in this series, on Monday.
Our assumptions and calculations for the figures above follow.
--------------------------------------------------------
Doing the Numbers: Hardcover
To keep things as simple as possible, we assumed that for hardcovers: (1) the publisher sells at an average 50% discount to the wholesaler or retailer (2) the royalty rate is 15% of list price (as it is for most hardcover books, after 10,000 units are sold), (3) the average marginal cost to manufacture the book and get it to the store is $3, and (4) the return rate is 25% (a handy number -- if one of four books produced is returned, then the $3 marginal cost of producing the book is spread over three other books, giving us a return cost of $1 per book). We also rounded up retail list price a few pennies to give us easy figures to work with.
“The Help,” by Kathryn Stockett has a hardcover retail list price of $25. The standard royalty (15% of list) would be $3.75. The publisher grosses $12.50 per book at a 50% discount. Subtract from that the author's royalty ($3.75), cost of production ($3), and cost of returns ($1), and the publisher nets $4.75 on the sale of a hardcover book.
“Hell’s Corner” by David Baldacci, has a retail list price is $28. The standard royalty is $4.20; the publisher's gross is $14. Subtract royalties ($4.20), production and return costs ($4), and the publisher nets $5.80.
“Unbroken,” by Laura Hillenbrand has a hardcover list price of $27. Standard royalties are $4.05. The publisher's gross is $13.50. Subtract royalties of $4.05 and production and return costs of $4, and the publisher nets $5.45.
Doing the Numbers: E-Book
E-book royalty rates are uniform among the major trade publishers, but pricing and discounting formulas fall into two camps: the reseller model favored by Amazon (Random House is the only large trade publisher using this model) and the agency model introduced by Apple a year ago. (See yesterday’s alert for more information on these models.)
Under the reseller model, the online bookseller pays 50% of the retail list price of the book to the publisher and sells the book at whatever price the bookseller chooses (for bestsellers, Amazon typically sells Random House e-books at a significant loss). Random House frequently prices the e-book at the same price as the hardcover until a paperback edition is available.
Under the agency model, the online bookseller pays 70% of the retail list price of the e-book to the publisher. The bookseller, acting as the publisher’s agent, sells the e-book at the price established by the publisher, but the publisher is constrained by agreement with Apple and others to set a price significantly below that for the hardcover version.
The unit costs to the publisher, under either model, are simply the author’s royalty and the encryption fee, for which we’ll use a generous 50 cents per unit.
Here’s the math:
“The Help” has an e-book list price of $13 and is sold under the agency model. Publisher grosses 70% of retail price, or $9.10. Author's royalty is 25% of publisher receipts, or $2.28. Publisher nets $6.32. ($9.10 minus $2.28 royalties and $0.50 encryption fee.)
“Hell’s Corner” is also sold under the agency model at a retail list price of $15 list price. Publisher grosses 70% of retail price, $10.50. Author's royalty is 25% of publisher receipts, or $2.63. Publisher nets $7.37. ($10.50 minus $2.63 royalties and $0.50 encryption fee.)
“Unbroken” is sold by Random House under the reseller model at a retail list price of $27. Publisher grosses $13.50 on the sale. Author’s royalty, at 25%, is $3.38. Random House nets $9.62. ($13.50 minus $3.38 royalties and $0.50 encryption fee.)
------------
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04 February 2011
How Apple Saved Barnes & Noble. Probably.
Here's the text on an email I recieved from the Authors Guild this week:
How Apple Saved Barnes & Noble. Probably.
Happy blackout anniversary! Where were you when the lights went out? We're sending out a series of alerts this week and next that look at the state of e-books, authorship and publishing to mark the one-year anniversary of the Great Blackout, when Amazon attempted to protect its near complete dominance of the rapidly growing e-book market through a stunning, punitive act against a publisher that dared to challenge its terms. (To see our account of this showdown as it happened -- posted last Groundhog Day -- go to "The Right Battle at the Right Time.")
It was one year ago last Saturday that Amazon turned out the lights on nearly all of Macmillan's books, removing the "buy buttons" from the print and electronic editions of thousands of titles. Macmillan authors, many of whom had linked their websites to Amazon pages that were suddenly disabled and useless, found themselves cut off from readers who frequented the dominant online bookstore.
Amazon's stunning move was a preemptive strike, an attempt to keep Macmillan from going through with its plan to shift to an "agency model" for selling e-books. Macmillan, which immediately saw its online sales plummet, stood firm and prevailed: Amazon ended the blackout after a week.
The story of the blackout and its aftermath reveals much about the high-stakes device and format war that's reshaping the publishing industry. Last year's Amazon-Macmillan showdown was a critical battle in that war.
One Year Ago: Amazon's 90% E-Book Market Share
By last January, Amazon seemed destined to retain an overwhelming share of the e-book market. It then, by most accounts, commanded about 90% of the U.S. trade e-book market. Barnes & Noble had entered the game just two months before, launching the Nook in time, barely, for the critical holiday season. Few in the industry were optimistic about Barnes & Noble's e-book efforts, however.
Amazon's strategy, it seemed clear, was to leverage its formidable advantages -- including its dominance of the online print book market -- to all but lock up the e-book market. If it was successful, Amazon would control the equivalent of a vast online book club. Any publisher wanting to sell to the club would have to agree to Amazon's terms. This was an ugly prospect: book clubs tend to be resilient, but ultra low-margin enterprises for all involved, except the proprietor.
Amazon went all-in with the Kindle and its proprietary e-reading software. This commitment was most evident on Amazon's home page -- surely the most valuable retail space on the Internet -- on which it featured the Kindle nearly every day since its launch.
Amazon's most potent weapon in the e-book format and device war, however, was the strategy it deployed so effectively in its conquest of online bookselling: using its seemingly limitless financial resources to discount books at rates no competitor could long sustain. Amazon now pushed this tactic to a new level, routinely buying e-books at wholesale prices of $13 and $14 and immediately selling them at a loss, for $9.99. This not only built customer enthusiasm for the Kindle and e-books, but helped crush online and offline competitors that were selling physical books. Amazon could win the future as it finished off the past.
The prospects for Barnes & Noble in this environment were decidedly grim. Its net income had plummeted during the recession, falling 65% in two years. For Amazon, however, it was as if the Great Recession hadn't happened. Its revenues had grown 65% and its net income increased 72% over the prior two years. Its market capitalization, which had climbed past $55 billion (it stands at $77 billion today), towered over Barnes & Noble's $1 billion.
The e-book market, by all appearances, was for sale to the highest bidder -- the retailer willing and able to sell the most digital books at a loss. Barnes & Noble was in no shape to compete against Amazon in that game.
Then the game shifted.
Enter Apple
On Wednesday, January 27, 2010, Steve Jobs announced the launch of the iPad and the iBookstore.
Apple wouldn't sell e-books under the reseller model that Amazon had been using to lock down the market. (Under that model, the publisher sells e-books to a reseller at a discount of about 50%. The reseller can then sell the e-book at any price, constrained only by antitrust law and the reseller's ability to absorb losses.) Instead, Apple would sell e-books under the same "agency model" it used for iPhone apps. Under the agency model, Apple acts as the publisher's agent, selling e-books at the price established by the publisher and taking a 30% commission on each sale. To participate, a publisher would have to agree to a set of ceilings on e-book prices, generally $12.99 or $13.99 for new books. A publisher would also have to agree not to sell to others under more favorable terms.
If the agency model took hold, unfettered discounting of e-books would be out. Amazon would lose its ability to buy market share in a nascent, booming industry.
Five of the big six trade publishers (not Random House) allowed their logos to be displayed at Apple's iPad announcement. The next day, Thursday, Macmillan CEO John Sargent informed Amazon that it would be shifting to the agency model when the iPad was released. It appears that he was the first publisher to do so.
If there were any doubts about the stakes in this battle, they were erased the following day, when Amazon retaliated by removing the buy buttons from all Macmillan titles (with exceptions for textbooks and scholarly books, where Amazon faced stiff online competition). It removed the buy buttons from all editions -- not just the electronic version -- in an attempt to use its clout in the print book industry to enforce its preferred business model in the e-book industry.
Though the e-book market was growing fast, cutting off Macmillan and its authors from Amazon's print book market -- Amazon controlled an estimated 75% of online trade book print sales in the U.S. at the time -- was far more punitive than just severing Macmillan's ties to the e-book market. Amazon had used this buy button removal tactic before to punish publishers in the U.S. and the U.K. who fail to fall in line with Amazon's business plans, but it had never done so as boldly or comprehensively.
Amazon blinked, perhaps after consulting with antitrust counsel. After a one-week blackout, Amazon and Macmillan came to terms, and Macmillan could sell e-books through Amazon using the agency model. Four of the other big six would come to terms with Amazon on the agency model. Random House, the largest trade publisher, has chosen not to use the agency model, for reasons we will describe in the future (hint: Stieg Larsson).
One Year Later
Barnes & Noble is, unexpectedly, the biggest beneficiary of Apple's entry into the e-book market. With five of the big six trade book publishers using the agency model, Barnes & Noble was able to enter the e-book market based largely on its customer relationships and on technological innovation, rather than on its willingness to burn through capital to subsidize book sales. Its share of the e-book market has grown rapidly over the past year, approaching 20% of trade sales. Its introduction of the Nook Color reportedly gave it a substantial lift over the holidays.
Barnes & Noble still finds itself subsidizing sales of Random House e-books -- it generally matches Amazon's price on those titles -- but those costs appear manageable. Barnes & Noble faces substantial challenges, as do all physical bookstores, as publishing moves to its partly digital future, but it appears to have regained its footing. Should the agency model ever collapse, however, Barnes & Noble could quickly find itself at Amazon's mercy. Amazon's growth and profitability continue to soar, and its appetite for out-discounting competitors at any cost appears undiminished.
In the meantime, Apple is not standing still. According to numerous, but conflicting, reports Apple may be revising the terms for booksellers using iPhone and iPad apps as e-readers. We will be watching these developments closely.
Tomorrow: The E-Royalty Debate
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How Apple Saved Barnes & Noble. Probably.
Happy blackout anniversary! Where were you when the lights went out? We're sending out a series of alerts this week and next that look at the state of e-books, authorship and publishing to mark the one-year anniversary of the Great Blackout, when Amazon attempted to protect its near complete dominance of the rapidly growing e-book market through a stunning, punitive act against a publisher that dared to challenge its terms. (To see our account of this showdown as it happened -- posted last Groundhog Day -- go to "The Right Battle at the Right Time.")
It was one year ago last Saturday that Amazon turned out the lights on nearly all of Macmillan's books, removing the "buy buttons" from the print and electronic editions of thousands of titles. Macmillan authors, many of whom had linked their websites to Amazon pages that were suddenly disabled and useless, found themselves cut off from readers who frequented the dominant online bookstore.
Amazon's stunning move was a preemptive strike, an attempt to keep Macmillan from going through with its plan to shift to an "agency model" for selling e-books. Macmillan, which immediately saw its online sales plummet, stood firm and prevailed: Amazon ended the blackout after a week.
The story of the blackout and its aftermath reveals much about the high-stakes device and format war that's reshaping the publishing industry. Last year's Amazon-Macmillan showdown was a critical battle in that war.
One Year Ago: Amazon's 90% E-Book Market Share
By last January, Amazon seemed destined to retain an overwhelming share of the e-book market. It then, by most accounts, commanded about 90% of the U.S. trade e-book market. Barnes & Noble had entered the game just two months before, launching the Nook in time, barely, for the critical holiday season. Few in the industry were optimistic about Barnes & Noble's e-book efforts, however.
Amazon's strategy, it seemed clear, was to leverage its formidable advantages -- including its dominance of the online print book market -- to all but lock up the e-book market. If it was successful, Amazon would control the equivalent of a vast online book club. Any publisher wanting to sell to the club would have to agree to Amazon's terms. This was an ugly prospect: book clubs tend to be resilient, but ultra low-margin enterprises for all involved, except the proprietor.
Amazon went all-in with the Kindle and its proprietary e-reading software. This commitment was most evident on Amazon's home page -- surely the most valuable retail space on the Internet -- on which it featured the Kindle nearly every day since its launch.
Amazon's most potent weapon in the e-book format and device war, however, was the strategy it deployed so effectively in its conquest of online bookselling: using its seemingly limitless financial resources to discount books at rates no competitor could long sustain. Amazon now pushed this tactic to a new level, routinely buying e-books at wholesale prices of $13 and $14 and immediately selling them at a loss, for $9.99. This not only built customer enthusiasm for the Kindle and e-books, but helped crush online and offline competitors that were selling physical books. Amazon could win the future as it finished off the past.
The prospects for Barnes & Noble in this environment were decidedly grim. Its net income had plummeted during the recession, falling 65% in two years. For Amazon, however, it was as if the Great Recession hadn't happened. Its revenues had grown 65% and its net income increased 72% over the prior two years. Its market capitalization, which had climbed past $55 billion (it stands at $77 billion today), towered over Barnes & Noble's $1 billion.
The e-book market, by all appearances, was for sale to the highest bidder -- the retailer willing and able to sell the most digital books at a loss. Barnes & Noble was in no shape to compete against Amazon in that game.
Then the game shifted.
Enter Apple
On Wednesday, January 27, 2010, Steve Jobs announced the launch of the iPad and the iBookstore.
Apple wouldn't sell e-books under the reseller model that Amazon had been using to lock down the market. (Under that model, the publisher sells e-books to a reseller at a discount of about 50%. The reseller can then sell the e-book at any price, constrained only by antitrust law and the reseller's ability to absorb losses.) Instead, Apple would sell e-books under the same "agency model" it used for iPhone apps. Under the agency model, Apple acts as the publisher's agent, selling e-books at the price established by the publisher and taking a 30% commission on each sale. To participate, a publisher would have to agree to a set of ceilings on e-book prices, generally $12.99 or $13.99 for new books. A publisher would also have to agree not to sell to others under more favorable terms.
If the agency model took hold, unfettered discounting of e-books would be out. Amazon would lose its ability to buy market share in a nascent, booming industry.
Five of the big six trade publishers (not Random House) allowed their logos to be displayed at Apple's iPad announcement. The next day, Thursday, Macmillan CEO John Sargent informed Amazon that it would be shifting to the agency model when the iPad was released. It appears that he was the first publisher to do so.
If there were any doubts about the stakes in this battle, they were erased the following day, when Amazon retaliated by removing the buy buttons from all Macmillan titles (with exceptions for textbooks and scholarly books, where Amazon faced stiff online competition). It removed the buy buttons from all editions -- not just the electronic version -- in an attempt to use its clout in the print book industry to enforce its preferred business model in the e-book industry.
Though the e-book market was growing fast, cutting off Macmillan and its authors from Amazon's print book market -- Amazon controlled an estimated 75% of online trade book print sales in the U.S. at the time -- was far more punitive than just severing Macmillan's ties to the e-book market. Amazon had used this buy button removal tactic before to punish publishers in the U.S. and the U.K. who fail to fall in line with Amazon's business plans, but it had never done so as boldly or comprehensively.
Amazon blinked, perhaps after consulting with antitrust counsel. After a one-week blackout, Amazon and Macmillan came to terms, and Macmillan could sell e-books through Amazon using the agency model. Four of the other big six would come to terms with Amazon on the agency model. Random House, the largest trade publisher, has chosen not to use the agency model, for reasons we will describe in the future (hint: Stieg Larsson).
One Year Later
Barnes & Noble is, unexpectedly, the biggest beneficiary of Apple's entry into the e-book market. With five of the big six trade book publishers using the agency model, Barnes & Noble was able to enter the e-book market based largely on its customer relationships and on technological innovation, rather than on its willingness to burn through capital to subsidize book sales. Its share of the e-book market has grown rapidly over the past year, approaching 20% of trade sales. Its introduction of the Nook Color reportedly gave it a substantial lift over the holidays.
Barnes & Noble still finds itself subsidizing sales of Random House e-books -- it generally matches Amazon's price on those titles -- but those costs appear manageable. Barnes & Noble faces substantial challenges, as do all physical bookstores, as publishing moves to its partly digital future, but it appears to have regained its footing. Should the agency model ever collapse, however, Barnes & Noble could quickly find itself at Amazon's mercy. Amazon's growth and profitability continue to soar, and its appetite for out-discounting competitors at any cost appears undiminished.
In the meantime, Apple is not standing still. According to numerous, but conflicting, reports Apple may be revising the terms for booksellers using iPhone and iPad apps as e-readers. We will be watching these developments closely.
Tomorrow: The E-Royalty Debate
------------
Feel free to forward, post, or tweet. Here is a short URL for linking: http://tiny.cc/s6433
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