The best analysis I’ve seen of the clash between Macmillan and Amazon over setting the prices for e-books comes from Paul Carr at TechCrunch. He provides some necessary publishing-industry background:

In the UK, way back in 1900, publishers corralled retailers into the Net Book Agreement (NBA); an agreement between British publishers and booksellers that books would be sold at the price specified on the cover. If a bookseller offered so much as a penny discount, then the publisher would simply withdraw all of their books from that bookseller and encourage other publishers to do the same. The arrangement suited everyone; book shops were the only place to buy new books and the NBA meant they didn’t have to worry about rivals undercutting them; this particularly benefited independent bookshops. For their part, publishers knew exactly how much they’d be getting for each title and authors knew how much of that would form their royalty.

All of that, however, changed in 1997, when a British court ruled the NBA anti-competitive. Discounting bookstores like Borders then opened in the UK, a great many independent bookstores closed, and both authors and publishers had to change their approach to selling books — no longer could all parties take their profits for granted:

Authors learned to adjust pretty quickly, especially as fewer than 20% of titles actually ever earn back their advance and start paying royalties. But publishers have remained annoyed. Deep discounting cuts directly into their profits. There was one area, though, where publishers could still make a killing on every sale: hardback books. The fact is that printing a hardback book, as opposed to a paperback, costs a matter of pennies more. But there is a perception amongst book buyers that they are far more expensive, a perception that it has been in no one’s interest to correct as it allows them to be sold for twice the price of paperbacks. Even with booksellers demanding deep discounts, the publishers still make a ton of profit on each hardback sale. By releasing the hardback book months before the paperback, publishers can subsidise a huge amount of their business from hardback sales, while booksellers can still discount highly to get people through the door.

But now, as Carr explains, the popularity of e-readers has raised demand for e-books to the point where the latter are cutting into hardcover sales, depriving publishers of their highest mark-ups. You can infer from this by, the way, something of just how small the difference in production costs is between e-books and pulp. You might think that publishers would be content with the lower production costs of e-books offsetting the production costs of pulp; but the latter are actually low enough that this isn’t the silver lining one might expect. Most of the money that goes into publishing a book doesn’t go for printing, it goes into profits and creative work (that it is, not just the author’s creative work, but also the editor’s and the various graphic designers and whatnot whose contributions go a long way toward making what we read more attractive on all levels).

Since e-books pose a threat to profit-rich hardcovers, old-fashioned publishers would like to kill the new technology by harboring what is, after all, in many respects an inferior product (you can’t sell or loan an e-book, or impress your friends with it by putting it on the bookshelf) with a higher price. Carr believes that the upshot of this will be to drive piracy, much as the ineptitude of record companies in the 1990s drove illegal file sharing. Carr is probably wrong, or at best half-right, about that — some kinds of books, especially vastly overpriced textbooks, might be electronically pirated. But most book readers are older and wealthier than music consumers were in the 1990s; they’re not going to try to learn their way around BitTorrent for the sake of saving $30 on on the latest Dan Brown. Those who have already made the switch to e-readers will probably just pay the higher price, though the inconvenience of having to wait longer for a release that’s delayed so as not to coincide with the hardcover may be a greater incentive for some to return to hardcover books. The dirty secret here is that even without being able to re-sell, loan, or display them, e-books are in many ways a superior product to bulky pulp products.

Macmillan’s move might retard the adoption of e-readers among people who have yet to embrace them. But even that is open to doubt: wasn’t Kindle the most popular Christmas gift for middle class families last year? Won’t the Kindle and iPad be the hot gifts for 2010, too? Discounted prices for e-books were an additional incentive, especially when e-reader technology was new, but now e-readers have momentum of their own. To kill that momentum, one would have to charge more for e-books than for hardcovers.

If Macmillan realizes this, what they might be hoping for is not to kill the e-book, but to turn the e-book into the new compact disc. When CD’s debuted in the 1980s, they were quite expensive but everyone was assured prices would come down as the technology proliferated and manufacturing costs decreased. Except for the effects of inflation, that never really happened: at the height of the CD market in the 1990s, they were still retailing for much closer to their debut price than to the price of bygone LP’s and cassettes. Record companies locked in high profits on what was first seen a premium product and eventually became the industry standard. They never had to cut prices significantly. Of course, the upshot of that was when an alternative medium, file sharing, arose, CD’s took a massive hit. But the record companies got at least a decade of high profits out of medium.

The youthful music market, however, was driven by celebrities and a few rather restrictive promotional outlets — radio, mostly, and at one time MTV, when MTV still played the occasional music video. There was also a high barrier to entry for independent record labels because of the limited physical channels of distribution. You could start a record label in your basement, you might even put out some good music, but you weren’t going to get, say, Camelot Music in your local mall to sell what you were putting out. And you certainly weren’t going to get Wal-Mart to carry your stuff.

None of that applies to books in the Internet age. The organs of publicity are things like blogs, which can take a liking to a book from a small publisher as readily as they can to some Macmillan product. And a small publisher offering e-books for significantly less than Macmillan does could cut into the big boys’ sales, although there are several complications to that strategy, among them the cut of profits demanded by Amazon and Apple for including a product in the Kindle Store or iBookstore. With higher profits on more expensive e-books (as well as the capital they already have from the traditional book market), the big publishers will be able to pay authors better, and thus attract bigger names, than the smaller publishers can. But lower prices mean more sales; in other words, it will become easier for new authors to have breakout bestsellers with publishers (small or large) that charge less for their e-books, while established authors may be chagrined to see their sales limited by the old-fashioned price models of Macmillan and its ilk. My guess is that, over time — but maybe quite quickly — the smarter or smaller publishers offering less expensive e-books will win. Consider what already happens with paperbacks: they’re much less profitable for the big companies, and they have less prestige among readers, but they sell vastly better than hardcovers. E-books eliminate the distinction between “cheap softcover” and “pricey, prestige hardcover” for readers, so why not choose cheaper e-books over Macmillan’s? Even some authors will be tempted to forgo higher profits at the major publishers if they can sell significantly better through a cheaper publisher — and since the cheaper publishers might cut down on costs for the middle men (i.e., Macmillan executives), authors might not wind up with much worse deals anyway. Advances would be smaller for authors — vastly so — but percentages on sales could be quite a bit higher.

The authors who are really hurt by the transformation e-books are wreaking are not the Dan Browns, who will sell very well regardless of what channels are used, and who may in fact claim higher percentages on profits through e-books, nor the toiling would-be authors who can hardly get a break from the publishing industry as it exists now — e-publishing should make getting published much easier, even if you might not get an advance. No, the authors who are really hurt are the second-tier types, like those who produced the spate of Freakonomics knock-offs a few years ago. To understand why this is, you just have to know the cardinal rule of modern publishing: publishers are extremely risk-averse and prefer to produce variations on books that have already sold well rather than put their money behind an uncertain venture. When authors pitch a proposal to a publisher, they’re usually expected to suggest a few “similar” books that have sold well. So if you can write well for a mass audience and you want to publish something, you pitch a knock-off on Twilight, maybe with werewolves instead of vampires. Publishers now are willing to pay big advances for such rubbish, on the accounting logic that by paying healthy advances to a handful of such authors each season, one is guaranteed a reasonable profit if even one of them succeeds in becoming the next Stephanie Meyer. If there are three or four failures for every success, well, one big success can still pay for them all.

Needless to say, I don’t think the quality of our literature would be harmed in the least by the absence from the Kindle store of Twilight With Werewolves or More Economics for Hipsters. The only worry I have is that I’m not sure just how much the midlist will be affected — a proliferation of new authors and unsaleable books is good, since a few will be worthwhile; the sustained power of big-name, low-quality authors will be the same under any model; but what happens to authors who have published a couple of good books who want to make more money in order to continue writing? The largesse of the publishing industry has sometimes been good for them, although there’s been a lot less largesse in recent years. My guess is that we’ll see some inventive financial models arise — perhaps even a return in part to the old traditions of patronage and subscription.

We’ll see. But in all this, there’s a general rule to keep in mind: what’s good for readers, including lower prices and wider channels of distribution, should ultimately be good for writers, at least in purely commercial terms. Whether we would all be better off without the printing press, let alone e-readers, is a question a few great minds have taken up, but I won’t get into that here.

Filed under: Books, Culture, economics