What's Your Consumer Surplus? (Part IV of the French Study Trip)

So for the past couple years I’ve been taking business classes at the University of Rochester’s Simon School. Slowly (and I mean really slowly) working my way towards a M.B.A. (And making interesting friends along the way. If you want a lesson in perspective, try explaining the publishing world to future stockbrokers and number crunchers—we seem totally back-assward and mental.) Right now, I’m in an Intro to Marketing class, and on this past Monday, we talked a lot about pricing.

I’m no pricing expert (hell, I’m not an expert in anything, really), but there are a few basic concepts that I think add a little something to the discussion of what people should pay for eBooks.

OK, so in an ideal world ruled by the pseudo-science of supply and demand curves, products would be priced at a level to give just a little bit more consumer surplus than the best alternative. I don’t want to dwell here, but basically, you as a consumer assign a particular benefit value to a product. (This toothpaste is world $5 to me!) And in theory (assuming that people acted rationally, which is bullshit and all, but bear with me, I swear this will go somewhere), in deciding what to buy in a supermarket you evaluate the benefit minus the cost and purchase that option which leaves you with the largest “consumer surplus.” So if the alternative to toothpaste A referenced parenthetically above has a benefit of $4 and a cost of $2, then toothpaste A should retail for $2.50 . . . Or whatever.

It’s all much more complicated, and in the world of normal products, these prices can be shifted on a weekly, no daily, no hourly basis and you can slowly figure out the ideal price point that takes into account demand curves, your costs, channel profits, etc. etc., etc.

But let’s leave all that to people who actually wear ties to work and believe in the American dream. This is a blog about books. And books aren’t a product like any other.

Where do book prices come from? If you really want to know, and want to read a very survey on the topic, you have to visit Literary Kicks and this report that Levi Asher put together a couple years ago. Very interesting, very informative.

Different presses use different methods to come to their prices (a lot use the “what do other people charge” method, some use complicated cost formulas, some use trial-error and randomness), but there are a few important things worth pointing out:

1) The current big publishing business model relies on a two-tier model of very expensive hardcovers followed by a much cheaper paperback. Granted, there are other revenue streams—subrights sales being the most obvious—but if you were just publishing a book and wanted to breakdown the costs, you would evaluate your sales income on X sales of the $25 hardcover followed by Y sales of the $14 paperback.

2) Because it’s impossible (I assume, but again, no M.B.A.) to figure out a demand-curve for a particular book (publishers hate readers, remember), more analytical pricing decisions are based on covering costs. For example, if a Press has $X of operating costs, is paying a $Y advance, $Z to a translator, $M in marketing, $P in printing, wants $$ profit, and assumes sales of H hardcovers and P paperbooks, you can math that up and figure out what the prices should be to cover your costs. Done and done.

3) Even if you wanted to do some sort of technical customer surplus undercutting price war thing, what would the best alternative for a specific book even be? (A: A movie and a six-pack.)

But thanks to technology, there is a way of comparing best alternatives for a specific book: the print version versus the eBook. And this is where things start getting complicated. . . .

Corporate Publishing is premised upon earning 10-15% profits on an annual basis, and a good portion of its revenues come from sales of hardcovers, paperbacks, and now eBooks. Although I don’t work at a publisher of this sort—and never have—from my conversations with other people, it seems that looking to the future, Corporate Publishing wants to retain its current scheme—use expensive hardcovers to cover upfront costs, profit off of paperbacks—while realizing that the world is changing and that it’s perfectly logical to believe that in ten years, eBooks will make up 50% of sales.

So what? Well, so, a couple of things. First off, we all know that eBooks reduce a huge number of costs for publishers (hold up there, HarperStudio, I’ll get to your bit in a minute), such as printing, shipping, warehousing, pulping/remaindering, and other distribution related costs. (And, in a radical position moment—I’d say marketing is reduced as well, because you can reach customers more efficiently and more directly. Not that marketing is free, but if you shift the way you look at everything, you can find new ways of doing things that you used to solve simply by throwing money at them.) Chopping with a dull axe, there are two main possible outcomes: keep the prices of eBooks equivalent to hardcover/paperback and make more money for the corporation and author, or reduce the price of eBooks since readers believe you’re screwing them.

That’s crass, I know, but in France all the talk from big publishers (on both sides of the Atlantic) was how the acceptance of a $10 price for eBooks would DESTROY FOR TIME ETERNAL the business model for publishing. A publisher absolutely can not survive if people are paying so little for their product. As Bob Miller will explain over and again, publishers still have some fixed costs: editorial salaries, marketing, office costs, etc. EBooks cost money to make. OK, we all get that.

(One quick long interlude: the complaints about Amazon.com and its influence on this price point are very interesting to listen to. As you’ve probably read about, Amazon.com is selling a lot of eBooks for a loss. Check The Lost Symbol: the retail list price for the Kindle version is $29.95, but you can buy it wirelessly for only $9.99. Typically, publishers give retailers a 50% discount, so for every Kindle version purchased, Amazon.com owes Doubleday $15. So they lose $5 on every sale. Why? Capture market share. We all can agree on that. But the long-term impact of this strategy is more complicated.

Big Publishers believe that this will crush them in the future in one of two ways: either they’ll have to reduce the price of their e-offerings, or Amazon.com will start demanding a larger discount so that they can start making money on these sales as well. Either way, the fear is that Amazon.com will find a way to screw with the publisher’s revenue streams. But the fear is abstracted beyond these specifics—as someone said last week, “it’s never good for the market when a retailer is selling your product for at a loss.”

What’s interesting to me as a former indie bookstore employee is there wasn’t nearly the same level of strident complaints from Big Publishers when Costco & Co. decided to sell Harry Potter at a loss and really decimated (more than decimated) sales and potential revenue for the independents trying to compete.

And really, I think Amazon.com’s long-term strategy is more nuanced than people want to believe. Most likely, future pricing for Kindle versions will follow the pricing for print books: best-sellers will be heavily discounted, long-tail titles that don’t sell a lot of copies won’t be. And if you have enough of these long-tail eBooks available, you can offset your losses from the top sellers. This assumes a more stable eBook market and all sorts of things, but still. Digression over.)

Let’s flip over to the customer: First off, readers don’t care who’s losing money on eBook sales. They want to pay as little as possible, and, I’d argue, they actually have a price ceiling that has been created via a decade of purchasing other digital goods. We pay $10 for a CD, why pay more for a product that’s not as fun, not as immediate, not as culturally cherished? And more importantly, where’s the customer surplus equation? I can buy the print version of a book for $18 let’s say, and that gives me a certain amount of satisfaction. What would the eBook have to be priced at to give me an equal amount of satisfaction?

And once again, in broad strokes, we have two camps: that the eBook is inferior to the printed book or that it’s actually worth more.

I fall into the inferior camp. With Kindle, you don’t technically own your eBooks, which is a bit of a drawback. But that aside, you can’t share them, you can’t display them (showing off my bookshelves is how I pick up chicks, er, well, yeah, that never works, but I can dream, right?), you can’t hand them down to your kids, drop them in a bathtub, read them as easily on the beach, buy first editions with cool covers, etc., etc.

On the other side of the argument people point to the fact that you can click on any word and get the dictionary definition (which is super-cool, I’ll admit), that you don’t have to carry so many heavy books (having just moved more than 30 boxes of print books, again, I’ll concede), that you can embed multimedia attributes, and that your books won’t get lost or damaged or misplace or loaned out and never returned, etc., etc.

Recapping: the Corporate Publishers need revenue to remain the same as it was in the days of only print books. They’re afraid that eBooks could cannibalize sales of print versions. They know people don’t want to pay more than $10 for an e-version. So what to do?

Again, big broad strokes to be finely detailed tomorrow (always tomorrow), but there are once again, two main paths. Molly Barton from Penguin (who does, like everything for Penguin and is extremely bright) was the best at articulating the one that seems to be driving most corporations—the idea of adding value to eBooks through the addition of various multimedia things. Like video. Audio. Etc. If you can create a cool product, people will pay $16 and Penguin remains profitable.

Although she’s focusing on the coffee, there’s a way of talking about the cup that sort of fits this same idea. I wrote about this presentation at TOC Frankfurt that focused on doing things to the eBook itself to make it more valuable. Like, for an additional $1, you can share it with a friend. For $2 you can “merge bookshelves” with your life partner. Etc.

The other, more radical approach, is to realize that your business model is flawed. That readers who want eBooks want them for $10 or less. That they can now communicate directly with authors (remember them?). That we’re entering a new world in which old square pegs don’t fit round holes. That you have to find a new business model.

That was really the point of our Study Trip, and the topic of tomorrow’s post.