Reader Steve writes me with the following (full disclosure: I may have made out with Steve in 11th grade. He also may have sat me down and made me watch Star Wars, since my nerd cred was sorely lacking.):
I wanted to get your disciplined economist’s opinion on the topic of the pricing of electronic books. Be gentle I’m sure to make all econ n00b mistakes.
Awwww…no worries, it happens to the best of us!
I recently bought an iPad and since I love to read I immediately went to the new iBook online bookstore.
Lucky duck…iPads are so pretty, and I kind of want one, even though I haven’t quite figured out what they do yet.
The price for the online books (at least for the ones I knew) were the same as the paperback versions of the books that you buy in stores. My gut reaction was: NO WAI!!!!1oneoneone
I know, right?
How can they charge the same price for these online books when their cost to provide me the e-book must be orders of magnitudes cheaper than the normal book?! Ok… there are probably some extra up front costs to format the books for the iBook application and the servers to provide access to download the content… but more than the ink, the paper, shipping to stores… nuh uhn.
Okay, so let’s think about supply and demand. In an unregulated market, prices persist at the point where supply and demand equalize. Supply depends on the variable costs of producers, so technically the up-front costs are a non-issue, though they do affect whether a company wants to be selling books in the first place. Demand depends on a bunch of things, including consumers’ income, tastes, etc. This means that you can mess around with prices either by shifting supply or by shifting demand. What’s important is that prices depend on the costs and preferences of both producers and consumers and not just on one party or the other. (See lessons 3-5 here for some video guidance.)
(Note: The book market doesn’t look quite like this, but the point that the graph illustrates is still valid.)
Because of this interaction, it isn’t necessarily the case that products that are cheaper to produce will be lower-priced for consumers. (For example, one copy of Microsoft Windows cetainly costs more than a gallon of orange juice, even though on the margin that extra gallon of orange juice cost more to produce than one more Windows CD.) If people are willing to pay more for the versions that are cheaper to produce, the price difference could go in either direction. (Homework:try shifting the supply curve in the graph down and the demand curve up by various amounts to see what happens to price.) People could be willing to pay more for all sorts of reasons that don’t correspond to some objective measure of value – maybe they think books are heavy and way too flammable, maybe their 500 page novels don’t fit in their briefcases, maybe they like the random typos and quirks that show up in eBooks, whatever.
Retailers seem to think that the increased willingness-to-pay more or less equalizes the reduction in production costs (and theoretically wholesale costs), which is why they would price eBooks at points comparable to their physical counterparts. Why might retailers (and publishers) think that people (as a group at least) are willing to pay more for eBooks? Here’s one publisher’s take on the matter:
Cader is a publisher himself, and a smart guy who tends to be ahead of the curve in marketplace trends, so publishing types pay attention when he speaks. Among his advice to the industry is this one:
“People who can afford an ereading device can afford all proposed ebook prices.”
By that, Cader means that it’s unreasonable for a consumer to say he can’t afford to pay more for an ebook.
Well then. He might be a bit of a jackass, but he’s not necessarily wrong. He’s just guessing that the majority of people bought Kindles and iPads because they were cool, not because they were such heavy readers that the eBooks (iBooks?) would save them money overall.
That’s the basic supply and demand explanation. There could be other factors in play here, however, that haven’t even entered your realm of consciousness. I mean, have you ever considered that rather than pricing eBooks too high, retailers are pricing real books too low in order to upset publishers?
To pressure Penguin, Amazon is pricing recent Penguin releases at a very Kindle-esque $9.99.
How do lower prices hurt Penguin? As The Wall Street Journal explains:
“Since Amazon can’t sell the digital editions of Penguin’s books, it is, in effect, showing its customers that Amazon is still the place to go for discount pricing. The low price also serves to put pressure on Penguin, as publishers passionately dislike the steep discounts. Many publishers say a $9.99 price tag on a new hardcover book cheapens the value in the minds of consumers.”
Fun. And don’t even get me started on the possibility that large retailers are either using books as loss leaders or are specifically engaging in predatory pricing of books- pricing books below marginal cost in the short-term in order to drive out competition:
That “predatory” behavior…has taken the form of a price war, with the three retail giants offering 10 of the season’s most highly anticipated new books for as little as $8.98 each. At that price, Amazon, Wal-Mart, and Target are actually losing money, since books generally wholesale for about half their list price.
I’m guessing that you’ve already gotten more than you’ve bargained for, and I haven’t even gotten to the second main part of your question.
The interesting thing was it seems like… all the online “publishers” are on the same page (heh) with regards to this pricing scheme. I would think that some publishers would sell the books for less because their costs are less… then my next thought was… do the publishers have an agreement not to go below the costs of the paperbacks… and then if they do have such an agreement… is this illegal… and how/can the end consumer address these concerns? I know we can always choose to vote with our wallets… but usually that works better if you are voting for a competing product… which is tough if all the big vendors are colluding.
Well…first, let me clarify a minor point- there are publishers, like Penguin and Macmillan and such, and then there are retailers, like Amazon. In a traditional retail setup, the retailer pays the wholesaler (the publisher in this case) a specified amount for the book and then sets the price at its own discretion. This, for example, is the way that Amazon operates. And yes, sometimes the wholesaler can write contracts that state either a maximum or minimum price that the retailer can sell at. (This is called resale price maintenance, and until 2007 was illegal. I was about as perplexed by the concept then as I am now.)
Here’s where it gets interesting on a number of levels. Amazon uses Kindle books as a loss-leader, selling most of them at $9.99 and paying the publisher $12 to $14. They do this because they make a s**t ton of cash on the Kindles, and more people will buy Kindles if they can get cheap eBooks on them. (In economic terms, Kindles and Kindle books are complements, where a reduction in the price of one leads to an increase in demand for the other.) This in a way should make publishers happy, but it actually upsets them because Amazon is creating artificially low-priced competition for their “real” books. (I have to infer from this that real books have higher margins for the publishers, since otherwise their objections wouldn’t make sense.)
Apple, on the other hand, doesn’t act like a retailer. It just sets up the iBook store and leaves the publishers to set prices (up to $15). Apple makes money off of this by charging a commission of 30% of the sale price. (It also makes money because the iPad is wicked expensive but people seem to want it anyway.) Publishers seem to like this deal better since they can control the ultimate price (and therefore the degree to which eBooks cannibalize other sales), even if it means that they make less money on eBooks directly. As a case in point, Macmillan and Amazon had a nice little spat when the iPad was announced, since Macmillan really wanted Amazon to commit to a Kindle book price of $15 (as was being set through Apple) and Amazon wanted no part of it, since it thought it would have a substantial negative impact on the demand for the Kindle. Amazon eventually relented, so I would expect you to see $15 prices for a number of Kindle books. So, in a way yeah, publishers and retailers do sometimes have agreements for eBook prices to not undercut that of real books.
The weird (read, unfortunate) thing in all of this is that publishers are generally against low-priced eBooks because, uh, people might buy too many of them. (If only I had that problem…) As a cautionary tale to these publishers, I would like to point out that it was in fact Polaroid that developed the first digital camera…and couldn’t bring it to market properly because it didn’t fit the cheap camera/expensive film model. Yay for technological progress.
PS Should I just wait and hope that someone comes out with a used bookstore app.
LOVE IT. See, this makes eBooks effectively even more expensive since you can’t resell them later…I kind of do want to wait for someone to come up with a mechanism for transferring ownership rights so that a “used” market can exist. I mean, am I ever really going to read that Kindle copy of Twilight ever again? (That’s a thing, right?)