Amazon.com is getting a very public thrashing these days. Stephen Colbert flipped his middle finger at the e-commerce retailer on his Comedy Central TV program. Best-selling author James Patterson called Amazon a budding monopolist, while fellow writer Scott Turow described the company as the “Darth Vader of the literary world.” Other writers and publishers have compared the company to a bully, the Mafia and even Russian leader Vladimir Putin.
Amazon’s crime? It is embroiled in a contractual dispute with Hachette Book Group, one of the largest publishers in the U.S., whose stable of authors includes Patterson and Turow, as well as J.K. Rowling, Nicolas Sparks and J.D. Salinger. While the actual contract terms being disputed have not been disclosed, Amazon and Hachette disagreed on the deep discounting of e-books, according to a May 28 story in The New York Times. The publisher feared that further price declines on its digital tomes would spill over to its print books. Last year, 60% of Hachette’s U.S. e-book sales came from Amazon, according to an investor presentation made by Hachette’s parent company, Lagardere Group, in June.
Amazon has contributed to the public vitriol through a series of retaliations against Hachette, including removing the pre-order buttons on upcoming books by popular authors — such as Rowling’s The Silkworm, which is written under the pen name Robert Galbraith. It has delayed shipment on other books, pared down discounts on some volumes and removed certain titles from search. The retailer is also in a similar fight with Time Warner and has suspended some DVD pre-orders, according to a June 10 story in the Times. Amazon’s actions have baffled even some of its supporters, who question the company’s uncharacteristically anti-consumer tactics.
The dispute is more than just a contractual tiff between a big publisher and a major retailer, experts say. Rather, it is a fight for the future of publishing itself. Publishers’ profits continue to come under pressure as the Internet transforms yet another industry resistant to change. “The largest secular change in the distribution of books has been the rise of online versus bricks and mortar as a channel of distribution,” notes Wharton management professor Daniel Raff.
“The macro picture here is that all analog goods are becoming digital goods in media,” says David Pakman, a partner at venture capital firm Venrock. “Newspapers became websites. Magazines became apps, CDs became downloads, and now downloads are becoming streams. Physical books are becoming e-books…. [Media faces an] electronic future, not a physical future.”
“You make a mistake when you set your price by looking at your legacy costs, which were designed for a physical goods market in pre-digital times.” –David Pakman
Hachette and other traditional publishers are bucking against their digital destiny when they complain about Amazon’s pricing, Pakman suggests. “These are protectionist arguments,” he notes. “[Publishers] built an industry over 50 or 100 years that assumes a certain amount of profit and a certain amount of retail pricing.” But the cost of digital delivery has fallen to “basically zero,” he points out. Instead of having to print books and physically deliver them, electronic copies are sent online. “Why wouldn’t prices fall?”
Publishers are trying to justify the costs of their traditional business even as the Internet reduces expenses. “You make a mistake when you set your price by looking at your legacy costs, which were designed for a physical goods market in pre-digital times,” Pakman says. “Digital markets produce much lower profit per item since they tend to have lower prices for goods. You must rebuild your cost structure for a digital goods industry with far lower prices.” That could mean taking steps that would likely be unpopular with executives, including “moving to a less fancy office and lowering [managers’] salaries,” he adds.
Digital vs. Traditional
Amazon’s growth in e-book sales has caused particular distress as bookstore chains trim operations or close entirely. Meanwhile, other e-book sellers do not come close to challenging Amazon, whose share of the digital market is 67%, according to a May 28 story in Publishers Weekly. When it comes to printed books sold online, Amazon’s share is 64%. Amazon is “a very large and very deep-pocketed organization, and the major commercial publishers make a lot of their sales through it,” Raff points out. “No wonder these publishers are worried. It poses a threat to them in a way your old Main Street bookstore never could.”
Indeed, Hachette’s authors felt compelled to rally around their publisher to help it fight Amazon. Hachette is the first of the five major publishing houses to negotiate a contract with Amazon following charges in 2012 by the U.S. Justice Department that the publishers and Apple conspired to fix prices of e-books. The remaining four are HarperCollins, Macmillan, Penguin and Simon & Schuster. Last year, Penguin merged with Random House, which was not charged in that case.
Given its market power, Amazon has achieved a strong position to negotiate pricing. The publishers tried to gain greater leverage by partnering with Apple, but a federal court found the group to be colluding to control retail prices of e-books. Publishers were opposed to Amazon’s $9.99 pricing on new and bestselling e-books; they worked with Apple to impose a new type of contract — known as an “agency” contract — that made retailers the agents of publishers, giving the latter greater say on retail prices for books. By imposing agency contracts, publishers departed from a century-old tradition of selling books to retailers at a discounted wholesale price; retailers would then set their own prices for consumers.
Before agency contracts were implemented, “Amazon set very low prices to get market share,” notes Wharton marketing professor John Zhang. However, those prices were not ideal “as far as maximizing profitability is concerned,” Zhang adds. To offset slim or no profits on book sales, Amazon relies on sales of other products on its site. In 2013, global media sales accounted for 29% of $74.4 billion in total revenue for Amazon. Media sales include books, digital movies and TV shows.
As low prices lured readers to Amazon, business began to decline at other booksellers that could not compete. The number of booksellers dwindled, and publishers’ dependence on Amazon’s sales deepened. “The concern was that Amazon would squeeze publishers and throw its weight around once it became dominant,” Zhang notes. “Sure enough, that’s what it is doing [with Hachette].”
“The concern was that Amazon would squeeze publishers and throw its weight around once it became dominant. Sure enough, that’s what it is doing [with Hachette].” –John Zhang
The settlement with the Justice Department included agreeing to court-stipulated consent decrees. Those agreements are expiring this fall, and Hachette’s contract negotiations with Amazon could be a test case for what other publishers might encounter. “The other publishers are very worried because soon enough it’s going to be them on the other side of this discussion,” Raff says.
But Pakman argues that because Amazon constantly monitors pricing and consumer demand, it is in a good position to know the price that maximizes sales. “My view is that Amazon is fighting to get closer to that optimal price…,” he notes. “[Amazon has] far more data than publishers since it experiments with pricing hundreds of thousands of times a day across millions of titles. Amazon can tell you the exact price for a title that will produce the most number of copies sold.” If an e-book priced at $10 maximizes profits, then publishers must set a lower wholesale price even if it takes time for their cost structure to adjust to it, he adds.
After all, book prices set by publishers can be somewhat arbitrary, Pakman points out. “The seller doesn’t determine the value [of a book] by itself. Value is determined ultimately by the buyer and the seller” agreeing on a price. “There’s no law of economics, no law of physics, that says the value of American literature is $15” versus the $10 cost of an e-book.
Instead, consumers determine the value by deciding to buy a particular book. “If you set the price of an e-book at $1 million … and no one buys it, what’s the value of the book? It’s not $1 million because no one bought it. The clearing price, that’s the value,” Pakman says.
‘Die a Slow Death or Fight’
However, by dismantling the hold of traditional publishers on the industry, Amazon itself essentially becomes a monopoly, Zhang notes. That brings dangers of its own. “In the long run, I think it is very undesirable to have highly concentrated channels of distribution,” Raff adds. “I think that highly centralized control over access to cultural products is quite a bad idea.”
An increasingly dominant Amazon is not good because the retailer could drive prices down to a point where some companies would find it tough to make any money, according to Zhang. Publishers, for instance, need capital to invest in their authors and to develop new technologies. With low sales prices, “not many publishers can survive,” he adds.
Zhang suggests that publishers should fight back by cultivating stronger relationships with alternative distribution channels, such as Walmart, so the companies will be less beholden to Amazon. He adds that the publishing industry’s choice is starkly simple: “Die a slow death or put up a fight.”
As for selling directly to consumers themselves, publishers are not eager to do so. “The publishers on the whole prefer to distribute through [outside channels],” Raff notes.
“In the long run, I think it is very undesirable to have highly concentrated channels of distribution.” –Daniel Raff
Amazon itself is trying to grab more of the publishers’ business, by launching a publishing arm itself and rolling out a platform for authors to self-publish. But Zhang points out that it is not clear Amazon would be a better publisher than the existing options. Indeed, Amazon Publishing had some early stumbles. The retailer reportedly paid $800,000 for the memoir of director Penny Marshall, which sold only 7,000 copies in hardcover in its first month, according to a 2012 story in The Wall Street Journal. It did not help that Amazon’s rivals — Barnes & Noble, Walmart, Target, Apple, Google, Sony and some independent bookstores — did not stock the physical or electronic book.
But Amazon has been gaining ground since then. In the week ending June 7, it had two titles in the top 25 e-books on the Digital Book World best-sellers list. Amazon would have had six, but four were taken off the list because they could be downloaded for free by subscribers to Amazon Prime in a new pilot program. In contrast, Penguin Random House had 13 on the list, Harper Collins had five, Hachette had three and Simon & Schuster had two. Macmillan had none.
While the encroachment of Amazon into publishing worries publishers, Pakman says the idea that publishers themselves would disappear is “hogwash.” He adds that “publishers built for a printed-books world may go away, but their digital native [counterparts] will replace them.”
Traditional publishers provide a valuable service that cannot be simply replaced by technology, however efficient it may be, others argue. According to Raff, a publisher’s tasks include “identifying manuscripts that are worth reading, improving them and seeing to it that the published books come to the attention of potential readers and can be purchased by those people.” He notes that people still browse bookstores to get a sampling of what to read.
Traditional publishers have to play to their strengths as they fight against major booksellers such as Amazon. “In this environment, content is always king,” Zhang says. He urges publishers to “pay attention to quality.” Locking up popular authors will also improve publishers’ clout. “[Publishers] would want to own the copyrights on lots of books and have good working relationships with lots of authors [with books that] Amazon wants to be able to sell,” Raff adds.
Pakman argues that editors who can recognize and recommend good literature will not disappear when the industry is digitized. Instead, “curation becomes very valuable. I might even pay someone with good taste to tell me what to read,” he says. “You can still have people in positions of authority finding good stuff. [Digitalization] doesn’t suppress good work.”
Digital delivery also means authors can self-publish and sell books directly to the public instead of waiting for publishers to choose, nurture and promote them. “If anyone can publish a book, won’t we have more books published? More voices are heard not less, and it doesn’t stop anyone with a strong point of view,” Pakman notes. “I don’t see how that’s bad.”
While Amazon’s strong-arm tactics have inconvenienced customers, Pakman says the overarching impact of the company’s actions could build and expand the e-book industry. “The long-term effects of Amazon fighting for lower e-book prices is likely to make the e-book industry healthier in the long-term,” he predicts. “For that, authors should be supportive.”