Consumer Market (Business To Consumer)

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This is an amazing turn of events.
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Amazon's Self-Defeating War on Publishers

By Marion Maneker
Sunday, January 31, 2010

From Slate
The Big Money

http://www.thebigmoney.com/blogs/goodnight-gutenberg/2010/01/31/amazons-self-defeating-war-publishers?page=full

Two days after Apple (AAPL) announced its new iBooks store--featuring a deal with booksellers called the “agency model,” in which Apple acts as the publisher’s agent in exchange for a 30% distribution fee--Amazon (AMZN) declared war on publishers.

The Seattle Internet behemoth began by shooting the messenger. Macmillan’s CEO, John Sargent, had travelled to Amazon’s headquarters the day after Apple’s announcement to deliver something of an ultimatum: accept the same terms as Apple--including a maximum price of $14.99 for e-books, not Amazon’s preferred $9.99 price point--or wait seven months after publication for e-books to be released.

Amazon, perhaps panicked by the degree of old-media collusion with its Cupertino rival, Amazon shut down the sales of all Macmillan titles--electronic and physical--on Friday. How that blatant act of bullying will advance Amazon’s agenda remains difficult to see. The lost sales will be significant for Macmillan but the revelation that Amazon is willing to abuse its market position will be a greater blow to the internet retailer.

No one likes a bully. Economies like dumpers even less. Amazon (and Wal-mart (WMT), Target (TGT) and others during the Christmas season) has been engaging in dumping--selling a product at below cost to steal market share. Dumping caused enormous trade friction between the U.S. and Japan in the 1980s. It’s no surprise that the practice has caused friction with publishers today. (And Amazon might give thought to what the Justice Department’s reaction will be to Friday’s retaliatory act.)

To see just how important the issue is to publishers, you have to look at the economics of Macmillan’s offer. Under the agency model, at either $14.99, $12.99 or $9.99, Macmillan makes less money than allowing Amazon to dump its titles at $9.99. Let me repeat that: Macmillan is offering to take less revenue from its e-book sales if Amazon will respect its preferred prices!

That’s because publishers don’t want their physical books devalued by the direct competition from e-books being sold at 40% of the list price. Can you blame them? At the price points Apple has accepted, publishers are setting the floor price at the wholesale level. They’re willing to offer the e-book retailers a 30% discount (that agency fee) to help them honor the floor and be fair to the publisher’s other customers: physical bookstores, big box retailers, newsstands and others.

At the center of this is a new problem created by widespread digital distribution. Is the item for sale a function of its physical properties and distribution channel costs (this has been the traditional view) or is the item the cultural product, the book, magazine or newspaper? Should digital retailers have cost advantage that allows them to undercut even the wholesale price of physical retailers?

There’s no easy answer to that question. By subsidizing the dumping of e-books, Amazon has put publishers in a terrible position with their other customers. Amazon recognized this, in part, when it offered agency terms to publishers and self-publishers a week before the Apple iPad was announced. That was Amazon’s last-ditch effort to support the $9.99 price. Shutting down Macmillan would appear to be an admission of defeat.

There is, however, a compromise that might benefit all parties. Amazon has been pushing the Kindle to heavy users of frontlist books. But the agency terms offer an opportunity for backlist books that gives everybody a win. With the agency model, a backlist book becomes a goldmine for publishers, authors, Amazon and Apple. Priced at $9.99, the publisher receives pretty much the same amount of money under agency terms as it would have for the wholesale book. Still protecting their preferred terms for electronic books, the publishers could maintain their 20-25% of net receipts formula for author royalties because the author would be getting more money ($1.75 vs. $1.05 in paperback royalties on a $13.95 physical paperback). Leaving the publisher with $5.25 in margin, more than they’d get from the physical paperback. When you include the savings in paper, printing and binding, freight and warehousing, the margin jumps even more.

This detente would flood the book market with titles that have stood the test of time where demand remains strong--a good incentive for Kindle and iPad buyers--while protecting the physical book distribution business. It would also buy publishers some time to divest the distribution assets that will inevitably erode as e-book selling takes off.

By Sunday evening, Amazon had decided that no good could come of its attack on Macmillan. In a rather ill-mannered announcement on the site, they tried to spin Macmillan as an overbearing entity: “We want you to know that ultimately, however, we will have to capitulate and accept Macmillan's terms because Macmillan has a monopoly over their own titles, and we will want to offer them to you even at prices we believe are needlessly high for e-books.”

Petulance is unbecoming in a $54 billion company, as is the attempt by Amazon to clothe its attempts to expand its e-books business as something other than a grab for market share. “Kindle is a business for Amazon,” they closed their latest statement with, “and it is also a mission. We never expected it to be easy!”

Marion Maneker is a regular contributor to The Big Money.