This article originally appeared in TidBITS on 2014-08-11 at 2:35 p.m.
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Untangling the Amazon/Hachette Dispute

by Glenn Fleishman

There’s a special place reserved in literary hell for those who misunderstand George Orwell, as Amazon just did (and as I’ll explain shortly). At 1:30 AM Eastern Time on Saturday, Amazon sent email to authors registered in its Kindle Direct Publishing program [1] with the Subject line, “Important Kindle request.” Rather than being related to account matters, the missive instead detailed Amazon’s dispute with Hachette, and urged bizarre action by KDP participants. Amazon also published the letter on a dedicated Web site [2].

Although only the latest salvo in the Hachette dispute, the letter is part of a larger battle between Amazon and the “Big Five” publishing houses in America. Hachette Book Group may be the smallest of the Big Five, but it’s part of a much larger international conglomerate, Lagardère. In 2012, Hachette and the other big publishers settled a lawsuit with the Department of Justice that maintained the companies had colluded with Apple in 2010 to fix ebook prices. (See “Explaining the Apple Ebook Price Fixing Suit [3],” 10 July 2013, for all the details.) Apple lost in court, is pursuing an appeal, and has agreed to a conditional $450 million settlement pending the outcome of the appeal.

Hachette’s contract with Amazon was apparently the first to come up for renewal, with Simon & Schuster and HarperCollins coming next (so we can likely expect to see more news as those companies move into the hot seat currently occupied by Hachette). In May 2014, presumably to increase negotiating pressure on Hachette, Amazon removed pre-order buttons on Hachette books [4], eliminated discounts on Hachette books, and delayed shipments of Hachette books to purchasers. Amazon did the same with Warner Brothers DVDs around the same time for several weeks, and a few days ago pulled pre-orders for physical versions of Disney movies. Amazon is also engaged in a similar action against Bonnier Media [5] in Germany, where antitrust laws are stronger and more strictly enforced.

The precise details of why Amazon and Hachette are at loggerheads remain unknown, although it appears the primary disagreement — at least according to insiders and public statements by both companies — is that Amazon wants to price all ebooks at no more than $9.99 while still making a profit from them, and Hachette is resisting. Under the antitrust consent degree to which Hachette agreed, Amazon was free to set retail prices for two years. That period is over, and Hachette now wants to set the retail price for ebooks, offering Amazon a percentage of the retail price. In essence, Hachette is looking to use the agency model, which gives pricing control to the publisher, whereas Amazon wants to stick with the wholesale model, in which resellers pay a fixed wholesale price and set whatever retail price they want. In many cases, the agency model provides a higher profit to a bookseller.

Another piece of the background is a public letter [6] that appeared in a recent Sunday New York Times. The letter, signed by over 900 authors, most of whom don’t even write for Hachette, and reportedly paid for by the wealthiest among them, criticized Amazon for harming authors by messing with sales. The text is available at another dedicated Web site at [7].

Amazon’s letter opens by misstating publishing history, asserting that publishers rejected and fought against cheap paperback editions when they were first introduced, and drawing a connection between paperbacks and ebook editions. In fact, paperbacks were initially ignored, became absurdly successful, and were then adopted by the big firms as a way to extend revenue into new outlets (outside bookstores) and reach a new audience. Paperbacks were and remain part of the diversification of the publishing market, which Amazon should know because it, well, sells print books. (Huffington Post has a good summary [8] of accounts from this period.)

Amazon’s letter then contains the odd statement:

The famous author George Orwell came out publicly and said about the new paperback format, if “publishers had any sense, they would combine against them and suppress them.” Yes, George Orwell was suggesting collusion.

One might think the Amazon Books Team, the nominal signatory of the letter, had become unhinged. In the actual event, Orwell loved paperbacks, was committing an act of irony and hyperbole in suggesting a combined effort (impossible in any case), and went on to state that the low price of paperbacks could destroy the economic basis on which authors, booksellers, and publishers functioned.

This open letter contains escalated and abbreviated versions of previous economic claims by Amazon, and advises bizarrely that KDP authors (the email) and average readers (the Web site) should send nastygrams to the head of Hachette accusing him of collusion, among other slightly off-kilter talking points. This may be because the ad paid for by authors suggests people email Jeff Bezos directly. It smacks of a temper tantrum.

The trouble is that in this and previous efforts, Amazon misstates and misleads on the numbers. Two weeks ago, the same Amazon Books Team posted a note on its Kindle forums [9] that tried to establish why a $9.99 book price made more sense than $14.99: the same ebook priced lower supposedly sells 1.74 times as many copies. Amazon claims it has done this analysis across many titles, even though that makes little sense since it’s in a position to know that no arbitrary book will automatically sell more copies because it is priced lower. Many particular books may exhibit changes, but in order to test this, Amazon must have engaged in presenting different prices to different customers, changing prices for periods of time, and so forth. No two books are identical, so their testing had to be using the same book and exposing different prices. This yields some broad information, but isn’t applicable in every case.

More broadly, Amazon’s erratic response ignores most of the realities of publishing. The publishers in question, and most publishers, continue to print books as well as issue them in ebook editions. TidBITS Publishing, with its Take Control series, is one of a relatively small number of publishers (across fiction, non-fiction, textbooks, and more) that delivers books solely in electronic form.

As a result, publishers have to deal with the cost of production across multiple media: ebooks are not magically free to make once you have a print book. (I’ve experienced this first hand, as have many other Take Control authors.) Plus, any potential profit from a single book has to be spread across the various formats in which it appears. Conventional publishers who produce hardcover editions want to keep the initial ebook price high — though low relative to the print equivalent — to avoid eroding the lucrative margins on hardcover sales. When hardcover sales ebb, publishers then typically produce a paperback edition, and cut the ebook price, often to below $10, if it was above that price to begin with. Over time, ebook prices for the same title tend to drop as demand lags.

The science-fiction author John Scalzi offers some first-hand insight [10] across his many titles, which are issued in hardcover, paperback, and ebook versions, and points out that the $14.99 and $19.99 ebook prices that Amazon claims are demanded by publishers are rare in practice.

Publishers aren’t all happiness and light: the big ones are following the money to varying degrees of success. But it is abundantly true that most books from most publishers make very little profit after overhead, production costs, and author royalties are subtracted. A number of books lose money, but hopefully not too many, lest the publisher perish. Importantly, a handful of books each season are blockbusters that, combined with evergreen titles that recouped their costs in previous years, account for the majority of whatever profits are recorded. One shouldn’t pity the poor Big Five publishers, but it’s not all peaches and cream even at the top of the market.

Hachette’s CEO responded [11] to people who followed Amazon’s advice to write him, and the details he provided are more in line with what is publicly observable and which those of us in publishing know to be true. Among other things he notes that 80 percent of Hachette’s titles are priced at $9.99 or less; most of its more expensive books are $11.99 or $12.99; and the publisher's cost differential for print books is about $2 to $3. That last point is disarming: by admitting the actual difference, he also reveals the economics of pricing across both formats and time.

So it’s not really about pricing in general, but timing. To be more precise, it seems that Amazon is proposing that readers don’t need to wait for the market to reflect the price Amazon wants to charge immediately. What Hachette is saying (and is the truth) is that pricing is based on demand: some people are willing to pay more to have a book sooner. Readers know that a paperback costing 40 to 60 percent of the hardcover price will eventually appear, and that used copies will eventually become available (on Amazon, no less) at 5 to 20 percent of the new hardcover price. And yet people persist in buying expensive hardcover editions to be able to read the latest and greatest right away. That, my friends, is the market: publishers are not delivering penicillin to the Arctic; buyers are not heroin addicts who have no control over their actions.

Amazon wants to brand this all as beneficial to the book buyer: a $9.99 ebook is cheaper than one that costs more. It’s also trying to pretend to be the authors’ friend by suggesting that publishers are cheating authors by not giving them a bigger split of the proceeds. (That latter point may be true, but see above: only some books make money, and better-known authors who have reliable sales already get percentages closer to what Amazon suggests every author should receive. It’s more reasonable to say that most publishers are inefficient, and that better use of money could produce more sales or a greater share to authors.)

Shouldn’t we applaud lower prices? After all, as consumers shouldn’t we want to pay the lowest possible price for any fungible item: all ebooks being exact digital copies, price is the only differentiation. However, Amazon wouldn’t actually be lowering the price of many books and, for all we know, it would set $9.99 as a new target to which it would push formerly cheaper books. Meeting the demands of a firm that already has a dominant share of the market in a way that cedes it more control and likely market share is a great way to put it in the position of becoming a monopsony (the only or primary buyer in a market) and monopolist. Historically speaking, that’s unlikely to benefit consumers.

Amazon remains mostly concerned about Amazon, a reflexive behavior engaged in by most businesses. The trouble is that, as a market, ebooks took off thanks to the introduction of the Kindle, and Amazon grabbed a large share of the market. But growth in ebooks as a percentage of revenue has slowed very quickly — probably much more quickly than Amazon had anticipated.

Ebooks were once a negligible part of book sales, but in 2013, they comprised about 27 percent of the roughly $15 billion of American adult consumer book sales [12] (fiction and non-fiction). Across all categories, the U.S. book industry grossed about $27 billion in 2013. As a percentage of children’s book sales, the ebook share actually dropped because a Hunger Games book was released in 2012, and no similar blockbuster appeared in 2013.

While ebooks now represent billions in sales, the stagnation in growth means that the majority of profit for most books remains in print editions, which is bad for Amazon, which heavily discounts mass-market print books to drive a high volume of sales. Amazon was betting in part on a greater shift to selling Kindle ebooks — typically with digital rights management (DRM) that locks readers to its Kindle ecosystem — to drive increases in profit, and steal both revenue and profit from remaining brick-and-mortar bookstores.

Amazon has already hit bumps in the road on its strategy to trade profit for growth, something it has pursued for its entire 20-year history, and which investors were willing to buy into until recently. Amazon lost $127 million in the last quarter [13], and projects a loss of $800 million in the current one. It has only sporadically been mildly profitable. But you can’t be a startup forever. Amazon’s business problems and stock market drop (about $320 per share now, down 20 percent from over $400 at the start of 2014) have also likely emboldened publishers to take a stronger stance.

Publishers could pursue a more sensible strategy that would reduce Amazon’s power by taking a page from the music industry. When Apple dominated digital song downloads, the industry broke the power of iTunes by removing DRM. This had previously been seen as inconceivable, but books are even easier to copy (through retyping, OCR, or simple encryption breaking) than music. Amazon was one of the main firms to leap into the fray and sell music at competitive prices; Apple was forced to rejigger its pricing scheme, and it lost ownership of the digital music market, though it still maintains a huge share thanks to its early dominance and insanely popular hardware ecosystem.

To break Amazon’s lock on ebooks, publishers could insist that DRM-free EPUB become the format of choice, eliminating the connection between reading on a Kindle and purchasing from Amazon. (It’s possible, but not easy, to read EPUBs on at least some Kindle models; see “How to Download EPUB, PDF, and Mobipocket to the Kindle Fire [14],” 22 April 2012.) Amazon would likely be able to update Kindles to use EPUB easily, as the KF8 format it uses for devices released in the last few years is already essentially EPUB [15]. Since all other ebook reading devices and apps already support EPUB, readers would be free to choose from whom to buy and on what device to read without Amazon’s DRM-bolstered link between its store and Kindle ecosystem.

By switching to a model in which any ebook could be purchased from any reseller and read on any device, publishers wouldn’t find themselves beholden to Amazon as they are today, and the bully pulpit that Amazon uses to spread its message (and bully authors) would disappear.