Archive | November 2014

“You’ve got mail”, Amazon, Hachette, and four changes of an entire industry within just a few decades

Tom Hanks and Mag Ryan in “You’ve got mail”, taken from http://romanceeternal.org/REimages/Yougotmail1.jpg

Here we go, Amazon finally sealed a deal with Hachette, one of the big book publishers. What’s interesting about this deal is that special financial incentives were negotiated that may or may not be anti-competitive, and I would like to speculate later how these may look like.

But first some background. I personally find the book industry a super interesting one because so much has happened recently, and keeps happening. My dad still laments that book stores are dying, and that this would be a loss to society–and I keep arguing that the transformation of the book industry is one of the great things that happened in the last ten years. Now we can finally buy ebooks on our Kindles and the like, and can take them with us and read them in a more convenient way than ever. We read newspapers and magazines on those devices, too, and in passing also save loads of paper.

Let’s have a look at the business side. The good old corner bookshop (think Meg Ryan in You’ve got Mail) earned about 40% of the price of every book sold. And this is exactly why there were many such shops around. Their assortment was relatively small, and coordination happened via best seller lists. One could argue that this was some sort of collusive agreement between publishers and bookshops, which resulted in everybody buying the same books at high prices. Then came the bookstore chains (think Tom Hanks in You’ve got Mail). Yes, they were evil, because they offered a broader assortment and discounts on best sellers, making money with the remaining titles. Small bookshops began to disappear (which is why people think they were evil). Now more people read different books, and the bestsellers were sold at lower prices. Overall, this sounds like a welfare improvement to me.

Then came Amazon. Amazon was, and still is, trying to offer its Kindle devices to customers at fairly low prices, such as 100 dollars. The hope is, it seems, that people would move to Amazon and do some sort of one-stop-shopping for books, magazines, music and movies, which would ultimately allow Amazon to earn money. It would be sustainable because Amazon is then able to negotiate good deals with publishers and movie distributors. So Amazon would be a big player with lots of bargaining power, and customers may even benefit from it. But in order to make this attractive to customers already now, Amazon needs to make sure that content, such as e-books, is available at a low price not only in the future, but now–otherwise a Kindle for even a cheap price is nothing consumers would care about. This is why Amazon decided to not earn any money on e-books when it sold them for $9.99. At the same time, publishers were unhappy because the e-book sales cannibalised their sales elsewhere, for which they earned more (for instance because they did not have to give them as much of a discount as they had to give to Amazon). The underlying reason is that they did not set the price themselves anymore. Put differently, a higher price for e-books sold by Amazon would have been in their interest.

Meanwhile, also Apple tried to counter Amazon’s strategy by negotiating a deal with the book publishers. Essentially, Apple came up with contractual arrangements where the publishers set the price of the e-books themselves, but offer the same price on all e-book platforms, including Amazon. This led to prices that were about 30% higher, also on Amazon. Smart move, Steve Jobs! But the US Department of Justice then deemed this anti-competitive (rightly so!), and made publishers negotiate new deals. This ultimately led to lower prices, again, last year.

After that, Amazon started to push for lower wholesale prices, that is: discounts from the publishers, still with the aim of having lower retail prices, so that consumers would still find it attractive to buy e-readers and then content from Amazon. The negotiation phase was quite tough, with Amazon temporarily not shipping hard copies of Hachette and not taking pre-orders.

The new deal now means that Hachette will set the price, but at a level that Amazon finds favourable. How can that be? I can also only speculate, but the following must be more or less true. Suppose Amazon wants to set a price x*, and Hachette prefers a higher price y* (note the stars). Then, it must be that for each Euro that Hachette sets the price higher than x*, Amazon receives one Euro per sold copy from Hachette. In practice, Amazon and Hachette could have a deal saying: Hachette is completely free to set its price, but Amazon would be happy to compensate Hachette one-to-one for price cuts below a certain baseline price, such as for instance y* (other ones would work too). And in the end, it will be hard to argue that this is anti-competitive just like that. After all, it provides an incentive to set lower prices to Hachette. And Hachette will like that too, because it will then sell more books.

However, I would not jump to conclusions yet. I have a feeling that this will sooner or later come back to us, but by then Amazon will probably have gained market share and the industry will have changed further. The big question is whether authors will be better or worse off. For now, it seems that they are better off, but what will happen once Amazon has all the customers and pushes for high prices and/or low royalties? This could be seen as an abuse of a dominant position, and my hope is that other players will keep offering a competitive alternative to Amazon’s services. I’m thinking of Apple and Netflix here. But this may become increasingly hard, because of network effects that lead to a competitive advantage of platforms that are already big. And Amazon offers all the content on one platform, so it’s not clear what will happen. Exciting!