Thursday, March 15, 2012

My Entirely Too Long, Incredibly Wonkish Book Industry Post: Extravaganza!

With Amazon getting into publishing, removing buy buttons for all the Kindle editions of books distributed by the Independent Publishers Group, and now the suspected or threatened Department of Justice price-fixing lawsuit against Apple and five-major publishers, the book industry has been in the news a fair amount. This is following all the attention caused by Amazon's price check app and the demise of Borders. What's frustrating about all this coverage is that even the articles and reporters sympathetic to the industry, often leave out key aspects of the economics of bookselling. So you (or at least I) read through the comments to see what people think about Amazon, indie bookstores, the price of e-books, etc, and find most of the opinions, again, even those with a positive take on indie bookstores, are based on incorrect assumptions. Part of this is because contemporary American journalism doesn't spend much time on context, part of this is because the most powerful actor in bookselling, Amazon, benefits from these misconceptions (so much more on them later), and part of it is, well, I don't know much about the bikeselling or beerselling, so there's a natural who's-got-the-time ignorance.

This is important because just like bikeselling (fossil fuel free urban transportation and fitness!) and beerselling (beer!), bookselling contributes to the strength and vibrancy of our culture beyond the actions of economic exchange. And these misconceptions, as innocent as most are, will lead to a situation where one entity controls the vast amount of book production and distribution of books in this country, and then, as is typical of super-villains, the world. We all remember how well having monopolies running things worked out in the late 1800s. So, if you already know all this stuff, (because, let's face it, if this goes around on the Twitter, it'll go around the BookGalaxy of the Twitterverse) correct and comment. If you don't, I hope you can just keep some of this in mind when you're clicking or shopping around for your next book, or at least while you're reading book industry news.

Now, you're reading this on the internet, so I know the odds are pretty slim that all of you are going to get all of the way through this post. (Though fans of really, really extended metaphors are in for quite a treat.) So, here my basic points. Read on if you want evidence, nuance, and depth, but I won't be insulted if it gets too wonky and too long for you.
      1. Most retail stores buy their goods from producers and wholesalers for $X per item. Bookstores buy their books at X% of the cover price of the book, regardless of whether or not the actual dollar amount that works out to is profitable for that book at that store in that market. It's like the road not taken, because it makes all the difference.
      2. Amazon's books are cheaper than everyone else's because they lose money on pretty much every new book they sell. Their prices aren't “cheap,” they're subsidized by the other goods they sell as well as by the dozen plus other companies they own.
      3. Using a particular item as a loss leader for a particular time is very different from using an entire industry as a loss leader all the time. One is a long-standing retail technique and the other distorts a market and devalues the products in it.
      4. Initially, the overhead for ebooks is not significantly less than the overhead for print books and so, initially, ebooks should not be priced significantly lower than print books. (Notice the adverbs.)
      5. (I know, five points, but I warned you.) If books are important to you and/or you believe books are important to culture in general, don't buy all of your books from Amazon. No problem with buying some. Even buying most is acceptable. Shifting 10% of your Amazon purchases will save the entire world.

The Biggest Most Significant Difference Between Selling Books and Selling Just About Everything Else.

Bookstores purchase books for retail from wholesalers and publishers at a discount of the cover price. Most retail stores buy their goods from wholesalers or producers at a set per-unit price. For example a grocery store might buy bananas at $.23 per pound from a produce wholesaler. Then, they are free to charge whatever they want for those bananas, marking them up really high if there is a lot of demand in their store for bananas, using them as a loss leader by setting the price low, or something in the middle. In calculating their mark up, they'll figure in all the overhead that goes in to getting those bananas from the wholesaler to the buyer, most of which is staff time, but there's also transportation, utilities, meeting health and safety standards, etc. Then they'll add something on top of that, representing their profit.

This model allows for a lot of price flexibility. This is why bananas at the convenience store tend to cost more than at the grocery store. If you're buying bananas at the convenience store, there is probably some reason why you're not buying them at the grocery store, it's closed or not on the way home, whatever, and so, because of a difference in the market, the convenience store price is different from the grocery store price. Anyone who shops around knows that prices often vary from grocery store to grocery store as well, as every grocery store has its own particular micro-market. Who knows, maybe you live in a town with a crippling potassium deficiency. Well if so, your bananas are going to be way more expensive than my bananas. Or maybe the nearest grocery store just happens to be one of the busiest on the East cost, so you're going to pay more (more than the nearest Co-Op, Shaws in Porter Square!) for everything.

But most books are sold on a discount schedule. Book stores usually pay between 45-60% of the cover price, no matter what the cover price is. This means, that their profit margin is based on a price set by the publishers. Regardless of what it costs the bookstore to get the book from the publisher to the reader, and whether or not that particular price is best for that particular bookstore in that particular market, the margin is the margin. With the bananas, the grocery store gets to figure out their overhead and then tack on a little bit more for profit. Bookstores don't have that luxury. Some books, like The Girl Who Kicked the Hornets Nest, which was a bestseller in hardcover for months and months, will work out that there is profit for the bookstores from its sales. Others won't. (Many, many, many others won't.) The grocery store can decide what their profit margin on bananas is, bookstores have to hope (and work like hell) the volume of sales across their entire selection will work out to keeping the lights on and the bills paid.  (And me fed!)

What this works out to a radical absence of flexibility in pricing. For example, maybe a museum in your town hosts a big old retrospective of some artist. The book store in the town can't really take advantage of that market change by tacking on an fifty cents or whatever to the price of the book. (Or dropping it, if they think they'll make it up in volume.) Nor, can bookstores take advantage (like everybody else) of tourist markets by raising the price on their souvenir books. Because, the profit margin has to work out over their entire selection, nor can bookstore really lower the price on particular books. If they do, that lost profit margin is gone.

This is why so many bookstores are filling their stores with cards, gifts, toys, and other “sidelines.” These tend to be per unit priced rather than discounted, so have the price flexibility of those bananas.

This is the most under-reported aspect of bookselling and it leads to most of the misconceptions I've seen in the public. For pretty good reason, people assume books are sold like everything else, and so can be forgiven for using terms like the “indie mark-up” (by the way, has you ever heard anybody talk about the “talented chef mark-up?” I mean, unless you're at a restaurant using organic local produce, the restaurant paid the same thing for those delicious delicious green beans as the crappy restaurant with its wilted flavorless green sticks of vegetable matter. The contribution of a person made them more valuable and so you were totally fine paying more for them. Anyway.) or wondering why books from Amazon are so much cheaper.

Hey, Now that You Mention It, If Books Don't Have Much Retail Price Flexibility, How Come They're So Cheap on Amazon?

I'm glad I made you ask. First of all I do believe there is a reasonable “business model discount” that Amazon can offer. Their national volume of sales, online-only business does have some lower overhead, and they have done a good job of occasionally finding ethical ways of shaving that overhead (like paying a little bit extra to have a particular model folding chair boxed at the factory instead of at the warehouse). I'm sure someone could do some rigorous calculations about this, but just from my own anecdotal experience working in a store, I would estimate, that the Amazon business model could offer a 10-20% discount to its customers.  (Not bad at all, really.) But that's not the discount Amazon tends to offer.

The next chunk of percentage comes from the fact that their warehouse workers are overworked and underpaid as has been reported in a number of recent articles. (Which is a pretty generous statement. Circlesof Hell, was implied.) To get the next percentage point, they use their market share and volume of sales to coerce publishers into giving them better discounts, basically saying, if you don't give us a better discount than you give other retailers, we will not buy your books. You don't hear about this too much from the big publishers, but Denis Johnson, of the totally kickass Melville House Books, and other smaller publishers have chronicled this.

But I'm going to spend the bulk of my time talking about two restaurants that specialize in wine. (Told you there'd be extended metaphors.)

There are two mid-scale restaurants in Metaphortown; Bob's and Robert's. At Bob's there is always a sommelier on duty to suggest pairings, explain specials, answer wine questions, and in general help patrons pick out wine. Though it has an extensive wine list, Robert's doesn't. Because Bob's business model has more overhead, wine at Bob's is a little more expensive. If you just want a decent glass of wine for $8, Robert's is your place. But if you're looking for the best wine possible for your taste and your meal, you'll only get it at Bob's, and it'll probably be $12. But the owner of Robert's is also the owner of Robert's Cars, a very profitable car dealership and so, because the car dealership is making tons of money, Robert's starts selling wine at $5 a glass. Essentially, Robert's is subsidizing his wine, with profits from the car dealership. Bob's is obviously in trouble. Sure, a sommelier selected wine is worth more, but $7 more? Since wine was Bob's thing, Bob's goes out of business. This means that Robert's now has a significantly higher percentage of the wine market and, Robert, being a shrewd businessman, can now go to the wine wholesaler and negotiate for better net prices. Which he uses to lower the still-subsidized-by-car-sales price to $4 a glass, which puts Roberta's out of business and causes some of the other restaurants in the area to just stop offering wine, which increases Robert's share of the market. Since a higher percentage of their sales are going to the super discounted Robert's, the wholesalers' margins are cut, so they have to find a way to make up the difference, which means they have to renegotiate their deals with the vineyards themselves, which will force the vineyards to cut costs, which is mostly likely going to come out of the workers salaries and Ta Da! author advances decline for a decade.

We all know that Amazon sells lots of stuff besides books, but the full reach of their business doesn't usually get reported. Did you know about Amazon Web Services, that sells a whole bunch of internet and data services? Or that Amazon owns, PlanetAll, Junglee,, IMDB, Alexa Internet,,, CD Now,, BookSurge, Mobipocket,, Shopbop,, Brilliance Audio,,, Box Office Mojo, AbeBooks, Shelfari,,, Reflexive Entertainment, Zappos, Lexcycle, SnapTell, Toucho, Woot, Quidsi, BuyVIP, Amie Street, Lovefilm, The Book Depository, and Pushbutton? And has investments in English Yard and Living Social? And has hosted internet services for Borders and Target and still operates retail websites for Sears Canada, bebe Stores, Timex, Marks & Spencer, Mothercare and Lacoste?  

So the short answer as to why Amazon's books are so much cheaper while Amazon is still profitable; because they intentionally lose money on books and make up those losses in other industries. Amazon's prices aren't “cheap,” they're “subsidized.”

To be honest, I'm not sure Amazon is actually profitable. For a publicly traded company it is pretty secretive about its sales. How many Kindle Fires did Amazon sell over the holiday? We're told “millions” but there is a big difference between 3 million and 9 million. And each and every one of those, just like everything else in their books division, was sold at a loss. The company didn't officially turn a profit until the fourth quarter of 2001, seven years after they were incorporated. And their business model is based on market share. They're using predatory pricing to become the only store on the internet, but, if I were an investor, I'd wonder how long and in how many different industries are they willing to lose money to get there. Then I'd ask, what happens if they don't?

But, Josh, Aren't They Just Using Books as a Loss Leader?

A lot of people argue that Amazon's book pricing structure is just a loss leader. Using a loss leader is almost traditional in retail. A loss leader is an item sold at a loss in order to bring customers into the store to buy regularly priced or slightly marked up other items. Let's go back to the bananas. Knowing how popular bananas are (the most popular fruit in America) a grocery store that normally sells bananas for $.99 a pound sells them for $.50 a pound for a week. Maybe they display some hot fudge nearby. The store loses money on every pound of bananas they sell, but they make it up when the people who came in for bananas buy other stuff, like the fixings for a banana split. You see this all the time. (Lots of indie bookstores use bestsellers as a loss leader.) But you never see a grocery store use the entire produce department as a loss leader all the time. If they did, not only would it put whatever produce only stores there might be in the area out of business, just like the subsidized wine, it would put downward price pressure on every point in the produce industry.  (And I'm pretty sure said grocery store would go out of business as well, like Borders.)  But, perhaps, more importantly, it would make customers believe produce actually costs less than it does. This isn't about booksellers laughing all the way their private villas in Tuscany on the backs of their wildly profitable bookstores (as some commenters seem to believe), it's about making sure there's enough money in the book economy to fund the process of getting a book out of a writer's head and into a reader's hands.

People Are Always the Most Expensive Expense

To be honest, the persistence in the belief that ebooks should cost radically less than books is a little baffling, given that most of the articles that touch on the issue of ebooks point out that ebooksdo not cost significantly less to produce than books. I'll read an article mentioning that the material overhead of production represents about 10% a books' overhead and sure enough someone in the comments field will argue that $9.99 ebooks are a publisher wide conspiracy. But what really baffles me about the persistence of this belief is how it also manages to fly directly in the face of conventional business wisdom.

No matter what a business does or sells the biggest chunk of its overhead is almost always going to be salaries for employees. This is practically a business axiom. And yet people seem to (or want to) believe that this axiom doesn't apply to ebooks. All of the people who produce an ebook are the same people who produce a book. Same staff, same amount of staff hours, same amount of employee overhead. Why should their prices be radically different? The problem is, of course, (I bet you can guess what I'm going to say,) is that early in ebooks Amazon sold ebooks at dramatic, one might even say “predatory,” losses in order to encourage sales of their Kindle and “secure” ebooks market share. They created a price expectation completely disconnected from the actual cost of production.  (Self-published authors is a totally different market, that, you'll be relieved to know, I'm not going to discuss here.)

The thing is, the ebook price of a book should be able to come down over time. Once the overhead of the author's advance, editors' salaries, administrative assistants, janitors, publicity and the like, have been made back, the material cost difference becomes meaningful. Older ebooks, backlist ebooks, or even ebook editions of very popular books could end up in the price range people seem to want. And we already accept this idea of falling prices of books. The first hardcover edition of a book is more expensive, not just because of the cost of materials, but because it is the first opportunity for a publisher to make back all that people based overhead. When it comes out in paperback, the price difference (often about $10-12) doesn't just come from cheaper materials, but from having less of the initial overhead to cover. A fair ebook price would start out at 10-15% off the least expensive print edition (and most retailers would probably add an additional discount on top of that, given how little overhead they cost book stores), drop with each new cheaper print edition, and then, once the initial investment has been made up, drop a little bit further. In this model, they won't hit $.99, but this isn't a pack of gum we're talking about. This is the product of thousands and thousands of hours of work, that you can enjoy over and over again. For readers who put price first, it really isn't any different than waiting for the paperback or mass market edition, or, if you're really stingy, waiting for copies to enter the used book market, or, if you're really really stingy (or have run out of room in apartment), getting the book for free out of the library.

And there's just a little bit of cognitive dissonance that I want to mention before I stable this particular high horse. Ebooks prices are portrayed by many commenters (and some journalists) as an act of betrayal by the publishers. A scam to squeeze more money out of the downtrodden book buyer. But in these articles there are almost always some mention of financial struggles of publishers. (And bookstores and everybody else trying to pay the rent with books.) How could book production be so unprofitable while ebooks are squeezing vast amounts of profit from readers? And while we're on the topic, doesn't it seem like there's a connection between a radical drop in what buyers expect books to cost, and the profitability of every aspect of the book market?

So What Do We Do Now?

The book industry is in a weird place. Most of the technological advances that are affecting it, aren't being driven by book people. They're being driven by Apple, Sony, Samsung, and Amazon. And frankly, the industry would go from today's terrifying precipice to long term stability if Amazon would just charge fair prices for the books they sell. (And pay their goddamn sales tax!)

But what is most interesting, and in some ways, encouraging, is that it really wouldn't take that big of a change in consumer behavior to stabilize the book industry. One of the interesting things the American Booksellers Association discovered is that the difference between a store that stays in business and a store that goes out of business is about 2%. A 2% decrease in profits and the store goes out of business. A 2% increase in profits and the store is sustainable. Just a little change, and the bookstore in your town stays open And, studies have also shown that physical bookstores (physical stores of any kind) encourage sales. More bookstores, more book sales, which stabilizes the entire industry and let's take this brief moment for some fancy flying to imagine we eventually start buying and selling enough for most authors to make a living on the work they poured their hearts, souls, and probably some other body parts and fluids, into. Furthermore, other studies on spending in general have found that shifting as little as 10% of your spending from national chains to locally owned businesses has dramatic benefits for your local economy.

So if you just shifted 10% of your Amazon shopping to your local bookstore, you would improve the local economy, and ensure the long term sustainability of books in America. Just one out of every ten books you buy. Don't have a local bookstore? (Use'sstore finder just to be sure.) Powell's, The Strand, and BetterWorld Books are good alternatives. If you're reading ebooks, hundreds of indie bookstores sell ebooks through their websites. Poke around on the internet, find one you think is cool and buy ebooks from them. (Might I personally suggest Porter Square Books. (OK, I'm a little biased about that one, but there's also Harvard Book Store, Brookline Booksmith, Word, McNally Jackson, SkylightBooks...))

Books are important. (Remember those monopolies from the late 1890s? Those guys assuaged their guilt by building libraries.) They still do things for us that nothing else can do. But they're also an economic entity. They are bought and sold. Just like anything else bought and sold, consumers need information in order to make the best decision. Hopefully, this (holy crap, is it really this long?) incredibly long blog post will provide, at least some people some of the information they need to make good book decisions.

Because right now, how we buy books today, might irreparably damage how we read books tomorrow.