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eBook pricing problems

by Eric on March 25th, 2011

This post is a bit of a departure from my normal fare. Apologies to my normal readers. I needed to write it, though, and I’ve been told I should publish it. So here we go. (It’s long. ~2400 words.)

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First off, I want to make something clear: I have essentially nothing to do with the publishing industry. I’m a technical writer who has been in software my entire career. I’m experimenting with writing fiction, and as a prospective author, am very curious about where the industry is going during the largest crisis point in its history.

But as far as the publishing industry is concerned, I’m nothing more than a gadfly. I observe and care enough to comment, but that’s all.

I also have closely watched what’s happened with the recorded music and recorded video industries as they struggled with a transition to digital. Both industries were slow to realize what was happening. As is typical in an internet-focused society, customers took it upon themselves to fill a need the music and movie producers weren’t filling. And so we had Napster.

This isn’t an article about piracy or abusive copyright laws or anything like that, though. This is an article about business models and pricing. Or, the best I can understand them as an interested outsider.

During publishing’s struggles with the rapid rise of ebooks over the last two years, they’ve claimed that books are different, and they won’t have the problems switching to digital that other media have shown.

And, in some ways they’re right – I’d wager that three and a half years after the first market-significant ereader (the Kindle) hit the market, a higher percentage of newly released books are available as digital downloads than we saw with music, and particularly movies. Older books are becoming digitally available far faster than we saw with music and movies. But, the major publishers (who I’ll refer to from now on as the “big-6”) aren’t doing a very good job of managing the transition, and this article tries to figure out why.

I think most of you reading this know that the publishing industry makes most of its money through hardcover bestsellers. The actual costs to produce a hardcover vs. a paperback are not that much higher, yet the retail price is typically around double. Lots more revenue for the publisher, and as authors are paid a royalty based on percentages, everything scales nicely in the publishers’ favor on hardbacks.

Take note of the second word describing where they make their money: “bestseller.” For decades, lists have been made through reputable sources (New York Times, etc.) detailing which books sold the most over the last week. Authors lucky enough to get their names on these lists are now deemed “bestselling authors” and, once earned, that tag can fuel marketing hype on future books in an attempt to repeat the process. Not to mention the free publicity gained from being on those lists.

The profits gleaned from these hardcover bestsellers basically fund the rest of the companies’ efforts – works from mid-list authors, overhead, etc.

What’s happening now with digital publishing, however, is threatening both words in that money making product: “hardcover” AND “bestseller.” The savvy publishing CEOs are seeing this, but they’ve got some seriously tough choices to make in how to react. And from what I can see, most big-6 companies are reacting in a way that protects short-term profits over long-term viability.

First, let’s look at hardcovers. In the most recent industry sales figures reported by the AAP, ebook revenue went from $32.4 million in January 2010 to $69.9 million in January 2011. A 115.7% increase, and a $37.5 million increase in revenue.

Paper books (basically hardcovers, paperbacks, and mass-market books you see in the bookstore that aren’t young adult or kids books), simultaneously dropped from $216 million to $171.7 million at the same time. A 21% drop, and a $34.3 million decrease in revenue.

While these number cancel themselves out, publishers generally make less net profit on ebooks, so their overall profit is dropping. And they’re understandably concerned about it. Any business would be.

Now, let’s look at the trends: ebooks are growing at impossible rates (but rates which have been maintained for about two years), and paper is declining rapidly. If you were in charge of a business that had 23% of its market growing wildly, and the other 77% dropping quickly, how would you react? Figure out how to maximize your new-found revenue stream, or protect what has historically been the bulk of your business? It’s not an easy or obvious choice.

Until April of 2010, ebooks and print books were sold the same way: The wholesale model. The retailer pays the publisher a certain amount for a book (usually around half the cover price) and can sell that book for whatever price they see fit. Including selling it at a loss. Mostly due to Amazon, this led to books rarely being priced above $9.99. Publishers saw this as “devaluing” their product (read this as “taking away hardcover sales”) and, at the behest of Apple and it’s new iPad, changed the way ebooks were sold. They’ve switched to the Agency Model of ebook sales which allows the publishers to dictate selling price, in return for giving 30% of the revenues to the vendors (Amazon, Apple, Kobo, Barnes & Noble, etc.).

What the big-6 seem to be doing as a result is pricing ebooks in a way that attempts to protect hardcover revenues. While this has the initial appearance of pricing ebooks fairly (hardcover retail price is $28, ebook is $13) the effect on the street is to make the hardcover and ebook price nearly equal. This produces a disconnect with customers. (“Hold it, you have to pay real money to print the hardcover, and digital is produced for free, why do they cost the same?”) Many people will buy the hardcover in this case, but many won’t buy either. They want the digital, but at a cost they deem fair. Nearly equal to print in their eyes doesn’t equate to fair. There’s also cases where publishers have not dropped ebook prices after the paperback comes out, making the ebook significantly more expensive than paper.

This model of ebook selling isn’t even a year old yet, so there are certainly kinks to work out. I wish them the best of luck with it, because, as I’ll detail later, it’s a model that’s completely missing the point.

Let’s switch over to that other half of the money making pair of words: “bestseller.”

Recently, there have been a rash of articles out decrying the “race to $1” and how digital self-publishers and independents selling books at $1 are completely devaluing their product by forcing prices down to unsustainable levels. Many of them read like panic. And that’s what they are. But not because of price. It’s because of what it might do to the bestseller lists now that ebooks are included. Let’s take a look at the Amazon ebook bestseller list.

In the top 20, there are 9 books priced at $1 or less, and 4 priced over $10. Two of those four, by the way, were priced under $10 before March 1st, and have been slowly dropping in the rankings since their prices rose. This article goes even further and shows 53% of the top 100 are priced at $5 or less, and 34% at $1.

This is a natural effect of bestseller lists being based on unit counts. If something is 99c, people will buy it on a lark. At worst, you’re out some time and a buck. No big loss. What’s happening, though, is those 99c books are taking up slots on bestseller lists that publishers want. If they can’t get their books onto bestseller lists, they’re losing both marketing cred and a tool that might generate further sales. Those lists are also very effective free publicity. Publishers see more and more cheap books on the bestseller lists, and automatically think “We’ll have to do the same thing to stay on those lists like we used to. We can’t afford to price at $1.”

So, how we’re at a conundrum. Price high to protect hardback revenue, or price low to remain on the bestseller lists? The problem is, the motivation for both answers is wrong. Why? Because success here is being judged solely by unit count. Of course, dropping print prices isn’t an option, because it’s subject to the same pricing issues any physical product must adhere to: you have to charge enough to pay for the item’s production.

In an environment with an ever-increasing digital component, judging success by how many you sold is doomed to fail. You have to judge success by how much revenue you took in. Why? Because after you’ve paid all the costs to get to the point of having an ebook to sell, everything after that is essentially free. Yes, there’s a small fee for digital distribution, and authors have a percentage royalty they’ve earned. But as that’s a percentage royalty, and not a per-unit royalty, it scales. The publisher’s job at that point should be to maximize revenue. In a way, this is the same for print, but as you actually have to plan how many copies you’re printing and pay for them in advance, there’s much more upfront investment risk involved every time you print more copies.

Digital has no production cost once you’ve reached the point of having something to sell.

Read that last sentence again. Once you understand that and its implications on pricing flexibility, you’re already ahead of big-6 publishing. Yes, there’s marketing and sales costs, but publishers are doing that for print, anyway.

Limited studies have been done on the most effective price points for digital books. It’s actually a very difficult thing to study because there isn’t much available data, and books aren’t easily replaceable by other books. As an example, I might pay $15 for an ebook of A Dance with Dragons, but I won’t pay $13 (or even $10, but maybe $8) for Brandon Sanderson’s next book. So, any study done along these lines has to be taken with a grain of salt. That said, it’s been demonstrated in one case that pricing ebooks between $2 and $6 provides the most revenue. It might not sell the most copies compared to other prices, but that price range will bring in the most revenue. Authors make the most (as they’re getting the same percentage of a bigger pie) and publishers make the most when the ebooks are priced in that range.

Which, of course, causes a big problem for publishers. If a customer has the choice of a $6 ebook or a $28 hardcover, which are most of them going to choose? Even if that hardcover is selling for $14 online, most people are going to choose the ebook. And the publisher will make less money from that customer.

It’s estimated that on a typical $28 hardcover, the publisher sees around $6 in revenue after production and royalty costs are taken into account. On that $6 ebook, they’ll see about half that ($2.70). Same customer, same book, half the revenue.

And THAT is why publishers are freaking out. They see that revenue difference, and price the ebook higher – $13-$15 or so. They can then net the same revenue in the ebook ($5.80 – $6.80) that they get from the hardcover. They’re pricing the ebook to fit their existing, per-unit revenue model instead of fixing their model to fit a market with a rapidly increasing digital component. You know – the ONLY part of their business that’s growing…

The problem, of course, is that most of those ebooks aren’t making bestseller lists because they’re priced too high. They see $1 books on the bestseller lists, plug the numbers into their unit-based revenue model, and collapse from heart failure.

There isn’t an easy solution here. The print book industry has a bunch of practices we’d find bizarre if instituted today (returns, advances, and year-long lead times are at the forefront) but can’t be easily unwound. In an era where digital is rapidly replacing print, new practices must be instituted to survive. Propping up the old models works in the short term, but market forces are bigger than that. Customers will figure out how to get their product in the manner and format they want. The publishers most ready to serve that need will be the ones to succeed in the long term.

What I think publishers should do is price their ebooks around $6. That’s the expensive end of the maximum revenue part of the curve illustrated in an earlier link. This gives near-maximum revenue from ebooks but still allows sales to occur without harming income. Price too cheaply, and you lose flexibility. Price too expensively, and you hurt your revenue. Six dollars seems to be the sweet spot. Yes, this might hurt print sales quantities. But do you want to maximize the amount of money you make overall, or the amount you make per sale? In a digitally-dominated market, you can’t have both.

Here’s some food for thought. Baen Books does everything I recommend. They sell DRM-free ebooks for $6. I believe there are no territorial restrictions on those ebooks, but I don’t know that for a fact. And they seem to be doing better than publishing as a whole, even in print, despite also giving away over 250 of their titles for free.

Many times, I’ve seen Baen brought up in discussions around ebook publication, and nearly every time the automatic response is “That model may work for Baen, but it won’t work for us.” Variations on that phrase are repeated so often, they’re taken as dogma. Nobody questions it.

I know for a fact there are small, indie publishers out there who, instead of writing off Baen’s model, are figuring out how to structure their company to make that model work for them. And they’re the ones that will benefit the most from the accelerating digital transition.

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4 Comments
  1. Thanks for this — incisive and interesting! I have blogged it from an author’s perspective.

  2. Why cannot both the publisher and author put the same amount in their pockets for an ebook as they do for a hardcover and simply pass the production savings (all of it) on to the reader? Another much overlooked fact is that it is a practice of many readers to buy a book and share it with friends and or family members. This is not easily done with ebook s, thus my family, for example purchases4 or five ebook s where we would have purchased one hard cover to share before. The result of fair pricing is a win for all stakeholders. The publisher and the author sell more units making the same on each unit as they do on hard cover and the reader gets a price that takes into consideration that he has purchased ONLY intellectual property and has NOTHING concrete to line their shelves or share.

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