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Reader Question: So You’re Telling Me I Have To Pay More To NOT Have A Real Book?

May 5th, 2010 · 14 Comments
Econ 101 · Markets · Reader Questions

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?)

Tags: Econ 101 · Markets · Reader Questions

14 responses so far ↓

  • 1 dWj // May 5, 2010 at 1:47 pm

    You made it through the whole post without using the term “two-part tariff”.

  • 2 Dave // May 5, 2010 at 1:52 pm

    Wow, so much good stuff going on in this post.

    Perhaps you’re paying more for an iBook (not an eBook, as the Kindle prices are lower) because of the convenience of not having to carry around several different books. I think this is equivalent to the idea that you pay more to get a movie On Demand ($6 for a 1080p on DirecTV) than if you were to rent it at a video store ($4 for Blu-ray). You’re paying for convenience.

    Yes, you don’t have that book around later but a) how many of us really re-read old books, and b) aren’t we supposed to be paying more to be “green” and not add to the destruction of forests?

    There’s far too much for me to try to comment on everything but suffice it to say I think this is a great question, an interesting phenomenon, and good analysis by econgirl.

  • 3 Colin // May 5, 2010 at 1:52 pm

    Maybe this is a bit ‘conspiracy theorist’ ish.

    But what if publishers don’t WANT to sell ebooks?

    The digital music revolution hasn’t exactly been kind on the record labels. Maybe the book publishers see this, and are trying to stave off demise by artificially deflating the number of ebooks available via high prices?

  • 4 econgirl // May 5, 2010 at 2:08 pm

    @ dWj: I avoided it mainly because technically you don’t have to have a Kindle, for example, to read Kindle books. Personally, I read them on my iPhone, and there are readers made for the iPad and for PC as well. Given the Kindle’s business model, I’m pretty much Amazon’s worst nightmare.

    @ Colin: Publishers are pretty much saying exactly that in the form of “we don’t want anything to compete with our dinosaur books, and we don’t like you putting even the dinosaur books on sale because it makes them look cheap.” This mentality is going to persist until people stop with the mindset that they shouldn’t have to pay for things that they can’t pick up and throw across the room.

  • 5 Lumpy // May 5, 2010 at 3:54 pm

    That was such a second-base answer (mostly because of the chart). Go 11th grade Steve!

  • 6 Julia // May 5, 2010 at 9:00 pm

    So what is the economic rationale on selling and pricing goods that are 1) used and 2) show no usage? A single digital “book” doesn’t go stale, doesn’t show use after 1000’s of readers, is highly portable, and might use non-proprietary technology to be read. The value to the 1000th user should be the same to the 1st user (timing aside for hot topics). One item could serve many users if they were willing to queue up for it. Does a good like that conform to normal market behavior? Or how does it change the market?

    Napster changed the market dynamic greatly – until it got legally squashed. If you could predict using economic logic (and keeping the lawyers out of the discussion), where would it have gone? Where might e-books similarly go?

  • 7 Leigh Caldwell // May 6, 2010 at 10:50 am

    A good exploration of a complex topic.

  • 8 Leigh Caldwell // May 6, 2010 at 10:56 am

    Oops sorry, I hit the submit button before I intended to!

    *cough* As I was saying… A good exploration of a complex topic.

    One fact that may be of interest is this: the marginal cost of ink, paper and distribution is smaller than you might think – typically less than 10% of the price of a book.

    So even if all these demand and substitution effects weren’t going on, the scope to cut prices on ebooks would only be about 10%.

    When that’s all you have to play with, other effects are much more likely to dominate. And above all in a new market like this, setting expectations is hugely important.

    If $15 comes to be the default price for an ebook, publishers will be profitable for decades (as, by extension, will authors – as popular, well-known authors are the main scarce resource of the publishing industry).

    If on the other hand $7 is the default price, the publishing industry will continue to be mired in commercial difficulties for the foreseeable future.

    And whatever price gets anchored in consumers’ heads today, you can be sure it will be very hard to shift. So the stakes of the next 1-2 years are high.

  • 9 John F. Opie // May 6, 2010 at 1:24 pm

    Really, the short answer to the question is “because they can”.

    Publishers own two things: intellectual property (the contents of the book) and, until they sell it to you, the physical book itself. Publishers really make all their money off the intellectual property: without copyrights and a legal system to enforce them, you could buy a book and start making photocopies of it and sell to all your friends for a small fraction of what you paid (with the assumption that you make up in volume what you lack in individual “sales”).

    Because of this, publishers are willing and able to pay for that intellectual property, and generally acquire all publishing rights in perpetuity (aka “forever”) as a result. The only way for them to ever recover these costs (and, more importantly, all the costs incurred buying manuscripts that never recoup their initial investment costs) is to price according to their needs, not their customer’s needs, if they are going to stay in business and maybe even actually turn a profit.

    The chap named Cader in your example underscores a fairly recent change in the industry, where they target readers according to their ability to pay (or at least their apparent willingness to pay, based on their initial outlay for a reading device, based on the principle that anyone crazy enough to pay for an iPad is crazy enough to pay us lots of money for content as well (you may replace crazy with stupid if so desired…).

    Perhaps we are seeing the development of the first honest-to-god Giffen good: something that sells more when it is more expensive.

    Me, I don’t buy Apple products because I dislike their brave new world of onerous digital rights management.

  • 10 Dhillon // May 9, 2010 at 7:35 pm

    Lucky Steve

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