Book wars: A monopolist vs. the cartel

By Steven Pearlstein

What is about to play out is the next round in a long-running battle between a manufacturing cartel (the publishers) and a monopoly retailer (Amazon) for control of the value chain that links book writers and their readers.
Author royalties are set differently for printed books and e-books. Photo / Thinkstock
Author royalties are set differently for printed books and e-books. Photo / Thinkstock

The book world is once again in a state of high dudgeon over the "thuggish" behaviour of Amazon, which has begun slow-walking customer orders for books published by Hachette (James Patterson, Malcolm Gladwell, a.k.a. J.K. Rowling) in an effort to win more favourable terms in its next contract with the publisher.

In a series of breathless commentaries, Amazon has been likened to Vladimir Putin, Tony Soprano and Darth Vader, and accused of pursuing a "scorched-earth capitalism" designed to drive all publishers and competing booksellers out of business. The future of Western culture and democracy are said to hang in the balance.

While the stakes, I suspect, are a good deal less dramatic than that, something interesting is going on here. In business terms, what is about to play out is the next round in a long-running battle between a manufacturing cartel (the publishers) and a monopoly retailer (Amazon) for control of the value chain that links book writers and their readers.

In most respects, it is similar to the battles in other parts of the news and entertainment sector where digital technology has also upset the old order but a new order has yet to emerge.

Four years ago, in an earlier round of this battle, the publishers were victorious. It began when Amazon removed the "Buy It Now" button from all Macmillan books after the publisher demanded a new pricing model for e-books that would have forced Amazon to raise its prices.

Macmillan responded by refusing to sell Amazon any of its books. Amazon, fearing it would lose its overwhelming dominance in the e-book business to Apple and the new iPad, caved to the publishers' demand.

Read more:
Amazon defends tactics against publisher Hachette
Amazon feud with publisher Hachette escalates

Round 2, however, went to Amazon. Prompted by a complaint by Amazon, the Justice Department launched a price-fixing investigation that uncovered a flagrant conspiracy among Apple and five of the biggest publishing houses to break Amazon's Kindle monopoly and raise e-book prices.

To settle the government's allegations, the publishers agreed to pay $100 million in fines and rebates, and to modify their contracts to give Amazon the right to set whatever retail prices it wanted.

Now with those modified contracts expiring, the publishers and Amazon are about to do battle once again.

The Amazon view, reflecting the tech culture, is that digital revolution makes it possible to reduce the role of the middlemen and gatekeepers of the old economy - the publishers - whose pricing models and ways of doing business limited competition and extracted too much money for themselves while adding too little value.

If the publishers prevail, the Amazon camp foresees higher prices, fewer books by unknown writers and a slowdown in the transition to e-books.

The industry's view is that by bringing the price-fixing case against the publishers, the government destroyed the last best hope of real competition in the book industry, in the name of trying to save it. While markets are great for things like toilet paper and soft drinks, it argues, they cannot be trusted to sustain a healthy book ecosystem capable of producing quality books.

If Amazon is allowed to squeeze publishers even further, the industry warns that publishers will be starved for the money they use to support mid-list writers and new authors, reducing the book business to mass-appeal best-sellers and an endless supply of uncurated self-published dreck.

I recently gained some new perspective on these issues while trying to sell my first book. While I came away from the process with a greater appreciation for what publishers, editors and agents do, I also came away thinking that the industry's pricing practices are a bit screwy.

Let's start with the author's advance - or more precisely, the non-refundable cash advance against the author's royalty payments for every book sold. In theory, the advance is supposed to reflect the publisher's best estimate of how many books will be sold. In practice, 80 per cent of books don't sell enough copies to "earn out" the advance.

This is a curious way for an industry to set pay for talent. If publishers are so bad at predicting book sales and can't stop themselves from overpaying on advances, then why not change to a system that doesn't require them to take virtually all of the upfront risk?

As it happens, authors from time to time have offered to take a smaller advance in exchange for a royalty rate higher than the 15 per cent industry standard. Such offers, however, are routinely and universally rejected.

This is the kind of business practice that is common in cartel-like industries, like real estate agents and their 6 per cent commissions. In this case, it's a way for publishers to stop themselves from getting into self-destructive bidding wars for best-selling authors and celebrity writers.

And as long as all the publishers tacitly agree to play by the same rules, it allows them to under-pay these winners, to the benefit of both their shareholders and authors who never earn back their advances.

This practice, however, is now threatened by self-publishing platforms at Amazon and elsewhere that make it possible for authors to bypass publishers completely - to hire freelance editors and publicists and sell their e-books directly to readers online, keeping as much as 70 per cent of the sales price.

Given this threat to the publishers' role as exclusive gatekeepers to the book distribution system, my guess is that it's only a matter of time before the key negotiations with authors will be over royalty percentages rather than advances. This more competitive arrangement would also force publishers to demonstrate they are providing good value for their services.

Another oddity of the publishing world is that those royalties are set differently for printed books and e-books. The accompanying chart, drawn from a recent presentation made by HarperCollins to industry analysts, tells the story.

Authors make about $1.60 less from a typical e-book sale than a hardcover sale, while the publishing house is left with $2.20 more in gross profit (that's the money used to pay for editing, marketing and general overhead, as well as profit for investors).

In other words, while the work done by author and publisher is exactly the same for a printed book or an e-book, what they are paid for that work is significantly different.

Now ask yourself: Wouldn't it make more sense for the industry to change the way it structures royalties and wholesale prices so that everyone - the publishers, the authors and multi-channel retailers such as Amazon - are economically indifferent to what form of a book customers want to buy?

The irony here is that despite the best efforts of the publishers to slow the migration from $28 hardbacks to $10 e-books, the shift has provided a significant boost to their profits and profitability. Cannibalising their old business turns out to have been very good for the publishers' bottom line.

So you can perhaps understand why Amazon - which for all its market power makes very little profit on its e-book sales - is now demanding a bigger slice of the pie.

In this latest clash between the monopolist and the cartel, neither side comes with clean hands or pure heart. The publishers are more than a little disingenuous in conflating their own interests with those of authors, readers and booksellers. And Amazon might want to consider that its admirable campaign to lower book prices may have reached a point of diminishing return, with the risk that further cuts really will have an adverse effect on consumer choice and the quality of what is published.

Rather than using readers and writers as hostages in their ongoing battle over discounts, commissions and co-op fees, both sides might better use their ingenuity to come up with a simpler and more rational structure for the industry's economics that is better able to adapt to changing technology and market realities.

Note: For those who might question my motives in writing this column, let me acknowledge that I am hopelessly conflicted. I write under contract with The Washington Post, which is owned by Jeffrey P. Bezos, Amazon's founder and chief executive. I also have a handshake agreement to co-author a book for St. Martin's Press, a division of Macmillan.

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