Kindle, iPad, MacMillan, and the Death of a Business Model

If you visited Amazon.com this weekend, hoping to buy a book that happened to have been published by MacMillan, you got a rude surprise. You couldn’t do it. Whether you hoped to buy an e-book for the Kindle, or an old-fashioned physical book, Amazon wouldn’t sell it to you. In a protest against the pricing model that MacMillan and other publishers had negotiated with Apple for the iBookstore, Amazon simply removed the “buy” button from MacMillan’s books.

The protest didn’t last very long — just long enough to be noticed and to make the New York Times on the evening of January 29. By the evening of the 31st, Amazon had relented, with the following statement:

Dear Customers:

Macmillan, one of the “big six” publishers, has clearly communicated to us that, regardless of our viewpoint, they are committed to switching to an agency model and charging $12.99 to $14.99 for e-book versions of bestsellers and most hardcover releases.

We have expressed our strong disagreement and the seriousness of our disagreement by temporarily ceasing the sale of all Macmillan titles. We want you to know that ultimately, however, we will have to capitulate and accept Macmillan’s terms because Macmillan has a monopoly over their own titles, and we will want to offer them to you even at prices we believe are needlessly high for e-books. Amazon customers will at that point decide for themselves whether they believe it’s reasonable to pay $14.99 for a bestselling e-book. We don’t believe that all of the major publishers will take the same route as Macmillan. And we know for sure that many independent presses and self-published authors will see this as an opportunity to provide attractively priced e-books as an alternative.

Kindle is a business for Amazon, and it is also a mission. We never expected it to be easy!

Thank you for being a customer.

What was behind this? It begins with Amazon’s original price policy for the Kindle, where most new mass-market hardcovers would sell in the Kindle edition for $9.95.

This was, from the start, a bit of a “loss leader.” Amazon was paying for the books at the usual 50 percent discount. That is, a book that lists for $29.95 was sold to Amazon for $14.98. This is just like your local grocery store setting the price for milk and eggs below cost so that you’ll come in and buy other things on which they make a profit, and was done for the same reason — once you have a Kindle and are used to buying books on it, you’ll start to buy other books on which Amazon does make a decent margin.

The book publishers didn’t like this much. They thought, quite reasonably, that if you could buy a Kindle book for $9.95, you wouldn’t want to buy their hardcovers for $29.95. They were afraid that the e-books would cannibalize the market for old-fashioned paper books, on which they had built their businesses for centuries. As long as Amazon had a near-lock on the market though, publishers didn’t really have a lot of choice. And after all, they actually made just as much profit on a Kindle e-book as they did on the physical hardcover.

Then Apple developed the iPad, and the iBookstore to go with it. Apple negotiated a different model with the publishers. In the new model, instead of selling the book to Apple for half the cover price and letting Apple set its prices as it pleased, it would instead set the price at which Apple could sell the book and allow Apple to keep a 30 percent “agency fee” or commission. This works well for Apple. Instead of selling loss leaders and losing money like Amazon, Apple is guaranteed 30 percent of the publisher’s price. On the publisher’s part, they get to set the price but they agreed with Apple to set a “reasonable” e-book price, normally between $12.99 and $15.99.

Let’s compare these models, with our base being a new mainstream novel that will be published in hardcover for $29.95.

So, as you can see, the publishers are fighting for the right to charge more, make less money per book, and guarantee Steve Jobs a 30 percent margin. Amazon, on the other hand, is fighting to charge less per book even though they are losing money with every sale. Now it all makes perfect sense.

Right?

Of course, this could be a sign that Steve Jobs is just smarter than Jeff Bezos, but Bezos is no slouch. If we assume that everyone involved is smarter than we are, how could this possibly make sense?

The key is the mainstream publishers’ worry that e-books will cannibalize the sales of physical books. Mainstream book publishers, along with mainstream music publishers and the legacy media newspapers, are actually primarily manufacturers. The costs of the content, in royalties to the authors, are only about 10 percent of the cover price of the book, and less than that for the record. It’s the costs of setting type or mastering, printing the books or pressing the disks, shipping, cataloging, and selling them that dominates the costs of publishing.

Now, along come e-books and readers, like the Kindle and the iPad. Suddenly the whole business of publishing has changed. You can sell a physical book or an e-book — but each copy of the e-book costs literally one one-millionth as much to produce.

What Apple and MacMillan and the others are doing is trying to preserve their existing business model by forcing the price of e-books to be high enough to not cut too badly into the physical book market. What Bezos and Amazon are doing is trying to cut the price of e-books to encourage adoption.

Who is going to win? Bet on Bezos. The mainstream publishers can hold on for a while, based on reputation and while e-readers aren’t widely available; there’s still some prestige to being published by a reputable publisher like MacMillan. But eventually, some publisher will realize that a book that would have sold for $29.95 in a physical edition can be sold for the cost of the royalty, plus a small markup for production and administration. Our $29.95 novel would sell instead for $3.95. When that happens, except for coffee table books and an occasional print-on-demand hard copy, the physical book is dead.

This weekend kerfuffle is really the death throes of a business model — traditional book publishers trying to preserve their traditional publishing methods for a little longer.

Half a century ago, Eric Frank Russell invented the ancient Chinese curse: “May you live in interesting times!” Confronted with the Internet, electronic books, and online publications, traditional media and legacy publishers must feel they are living in interesting times.