This post is likely to be unpopular.

In April of 2012, I wrote “Why Should eBooks Cost $15” in response to the news that the Justice Department was suing Apple over price collusion with the book publishers. In it, I discussed eBook pricing…

Readers of this blog are familiar with my many discussions on digital good pricing and price elasticity. There’s “Weighing In On the Amazon/Macmillan Pricing Debate” where I detail that the market can tell you your optimal (i.e., highest profit producing) price for digital goods. Each incremental digital good has no additional cost. The marginal cost of distributing it is zero. So you really want to maximize total profit by finding the price that produces the most number of copies sold. In these markets, you make a mistake when you set your price by looking at your legacy costs (which were designed for a physical goods market in pre-digital times). Digital markets produce much lower profit per item, since digital markets tend to have lower prices for goods. (See “As Big Media Goes Digital, Markets Shrink“.) In all the discussions about why book publishers demand that eBooks should be $15 and not $10, they say it is because they cannot afford to sell books at $10. That is, they cannot cover their legacy cost models on that number. Right. Which is why you must rebuild your cost structure for a digital goods industry with far lower prices. You start by paying your top execs much less than millions of dollars a year. Then you move your offices out of fancy midtown office buildings. Why should eBooks cost $15? Amazon is far more of an expert on optimal book pricing. They have far more data than publishers, since they experiment with pricing hundreds of thousands of times a day across millions of titles. Amazon can tell you the exact price for a title that will produce the most number of copies sold. Amazon is pretty sure that number is closer to $10 than to $15. Yes, they want to sell more Kindles. And they believe that lower eBook prices mean more eBooks sold which means more demand for Kindle. The negative coverage of Amazon is centered on them selling eBooks below cost in order to reach the $10 price point. But that is a function of publishers setting the cost higher than $10. If the profit-maximizing price for an eBook is $10, then publishers must adapt to set a wholesale price lower than that, even if it means your legacy cost structure doesn’t allow it. And that’s the rub.

Now, more than two years later, we find ourselves having the same discussion. The Amazon/Hachette dispute (most of the journalists covering it have been sympathetic with Hachette) is largely over the retail price Amazon believes it should charge for eBooks. Hachette wants this price higher, Amazon wants it lower. Hachette seems to want to try to keep eBooks priced about the same as physical books. But why should it? eBooks have no marginal costs, and consumers therefore expect the pricing to be lower. Amazon agrees.

While the hardball tactics Amazon has used to force Hachette to lower prices have, somewhat uncharacteristically, inconvenienced Amazon’s customers, I believe their larger point is the right one. Many legacy industries who’s models were built in the analog world have trouble adapting to the lower prices of digital markets. (See the music industry.) Amazon’s pricing data likely shows they will sell more eBooks at lower prices. They want Hachette to price eBooks lower. In this new world, more copies can be sold, for lower retail prices, but with no physical costs. The profit might well be close to the same amount, or it may even be less per unit. But adapting to the increased competition for consumers’ attention/spend and the inevitable price erosion of digital goods compared to their physical peers requires prices to fall. Amazon is attempting to force the publishers’ hands.

Most of the emotion around this debate has centered on the effects of Amazon’s tactics on authors. I understand how a dominant retailer can hurt sales by temporarily refusing to stock titles or make them hard to buy. But the long term effects of Amazon fighting for lower eBook prices is likely to make the eBook industry healthier in the long-term. For that, authors should be supportive.

Source: http://www.pakman.com