The Shatzkin Files

Peering into the future and seeing more value in the Random Penguin merger

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So now in addition to the Random House and Penguin merger that is being reviewed by governments far and wide, we have the news that HarperCollins is exploring a tie-up with Simon & Schuster in a deal that hasn’t been made yet. That leaves Hachette and Macmillan, among the so-called Big Six, still on the outside as the general trade publishing behemoths rearrange themselves for whatever is the next stage of book publishing’s existence.

I am not sure we really need an “explanation” for what is the resumption of a perfectly natural phenomenon. Big publishers have been merging with each other for several decades in a process that suddenly stopped after Bertelsmann acquired Random House (to add to its holding of Bantam Doubleday Dell) in 1998. We didn’t know it at the time, but that concluded a long string of mergers that had recently included Penguin’s acquisition of Putnam-Berkley, but which stretched back to the 1970s when pursuit of the paperback-hardover synergy had driven Viking and Penguin; Doubleday and Dell; and Random House-Ballantine and Fawcett into each other’s arms.

(Perhaps HarperCollins should get credit for the resumption of the era of consolidation. Their acquisition of Christian publisher Thomas Nelson, combined with their holding of Zondervan, created a powerful position in one of publishing’s biggest vertical markets shortly before Penguin and Random House announced their plans.)

But consequential events always get an explanation, whether they deserve one or not, and this merger appears to many to be driven by consolidation among the retail intermediaries and the rational concern — amply documented by recent experience — that the retailers would use their leverage to press for more and more margin. This is complicated by the fact that both of the dominant retailers — Amazon in the online world and Barnes & Noble in the brick-and-mortar space — have small publishing operations of their own that are always available to put additional pressure on publishers at the originating end of the value chain.

There is an important asymmetry to take note of here. The retailers publish and are always a threat to acquire manuscripts directly and cut the publishers out but the publishers, particularly the biggest ones, don’t do retail and there is no obvious path for them to enter retailing in any significant way. (That last sentence was written with full cognizance that we await the debut of Bookish, which is an attempt by three of the Big Six to enter retailing in a significant way. Maybe when concrete plans for it are announced there will be some reasons provided to amend that thought.)

In my opinion, the dominant position that Amazon holds in online retailing and that B&N owns in shops are impregnable on their own terms in ways that the positions of each of the big publishers are not.

The threat to Barnes & Noble is that bookstores will become unsustainable: that a retailer trying to exist at scale with books as its primary product offering will, because of ebooks and online purchasing of print, simply become unviable. The threat to Amazon is more nuanced and more distant. One can imagine a world developing where content retailing evolves into niches by subject or tastemaker. But that world is not around the corner (an environment toxic to bookstore chains appears to be much closer) and it would be far easier to imagine how Amazon could adapt to niche online retailing than to see B&N adapting to deliver retail book selections that are only viable at a fraction of their current size.

(I consulted to them a decade ago and suggested that to no interest. They were shutting down their mall stores at the time and the idea seemed totally counterintuitive.  I’ve also written about it.)

I saw recent data (sorry, can’t remember where…) suggesting that something like 38% of the book business is now done online, taking both ebooks and sales of print into account. This seems to be confirmed by a chart built on BookStats data by reporter Laura Owen of PaidContent, if you take “institutional sales” out of the equation and assume that wholesalers sold books to online and store retailers as well as libraries.

Whatever the percentage is, it is almost certainly higher for immersive reading than for illustrated or reference books because immersive works for ebooks and the others mostly don’t. So it would appear that something like 60% of the book business is still a bricks-and-mortar game, with the number being somewhat lower for straight text and higher for illustrated.

That, in a nutshell, explains why the big publishers are still extremely powerful. The 60% sold at retailers is what they’re uniquely skilled at getting and what Amazon is uniquely challenged to penetrate.

But the one thing we know for sure is that the shift to online purchasing — while it has slowed down — will continue to progress for a long time. The increased ubiquity of devices; the always-larger selection from an online merchant; the increase in availability of appealing and useful content that is either too short or too specialized for print; the steadily increasing cost and hassle of shopping by car rather than by computer; the natural results of birth, death, and demography; and the increase in online word-of-mouth and recommendation sources are among the many factors that assure that.

As the percentage of a publishers’ sales that are made through retail stores decreases, the cost of covering them increases. This has already become an issue as the big publishers view their overheads and come to the conclusion that they can’t afford to pay ebook royalties greater than 25% of receipts. Surely, some of the cost basis they see driving that necessity are really print-based (creation and distribution), which makes them calculate what’s affordable differently than a more new-fangled publisher that is planning primarily on digital and online distribution.

The publishers who are merging or thinking about merging are not doing so out of immediate desperation. The financial reports we see from trade publishers are not frightening. Top line sales are challenged — there is little or no growth — but margins have been maintained through the seismic marketplace shifts of the past few years and the pace of change is slowing. So it is probably preparing for a world a few years off that drives publishers to merge today. What will that world look like?

The world of publishing we’re going to see five or ten years from now will probably look quite different. Even if store sales only decline 10% a year against the industry total, what is a 60% share today will be about a third after five years have passed and below 20% in ten. Those are sales well worth having, of course, but they’ll be a lot more expensive to get. And if I were predicting rather than just speculating, I’d expect the erosion of retail sales to be a bit faster than that.

My expectation is that freestanding bookstores will be less and less common, and smaller book sections in other retailers (the way they’re in mass merchants today) will proliferate. We already see this in “specialty” retail: stores stock books that fit alongside their other product offerings. But as bookstores get scarcer, it will probably begin to make sense for general book selections — bestsellers, classics, and the cream of popular categories like cooking and current affairs — to be offered by other merchants. Part of the reason that doesn’t happen now is that it is too hard for the retailer not in the book business to do. A representative selection either requires dealing with many publishers or buying from a wholesaler. And the wholesalers are working on tight margins, not allowing them much room to offer expensive services (like inventory management) unless they really cut into the store’s margin.

But you don’t have to have every book — or even every bestseller — to deliver a compelling consumer offering. Book-of-the-Month Club and The Literary Guild proved that half a century ago when they competed for the general book club market. They demanded exclusives on the bestsellers, so they tended to split them. And they each had enough to pull a very large audience.

Well, the combination of Random House and Penguin has damn near half the bestsellers too. And Random House, at least, has already developed vendor-management capabilities that they can apply at the store level. So as the bookstores disappear from town after town, a Random Penguin combination (they really ought to call it that!) becomes able to offer any local retailer a selection of books that will look pretty good to the average consumer.

In addition, they’ll find that the combined lists give them a great head start on having enough titles to deliver retailers other vertical selections — cooking, crafts, home improvement — that their VMI skills will also help them serve.

Right now the challenge Amazon is having is that they’re trying to publish with a grip on no more than half the market. That’s great, as far as it goes, because that’s where they have a real margin advantage when they cut the publisher out of the chain. But because there is so much Amazon fear-and-loathing around the rest of the industry, they’re not able to build out beyond their proprietary position. (See the recent frustrations expressed by their author, Tim Ferriss, to appreciate how that’s working out in the market today.)

But if Amazon could reach 75% of the market — that is, if store purchasing declined below 25% of the total, which is in the cards for the next ten years — leverage would be reversed. (I’m eliding the format and proprietary reader device issues around ebooks here, but I’m guessing they’ll mostly go away in the next five or ten years.) Then Amazon wouldn’t want or need distribution to the stores or other online outlets. In fact, chances are they’d see it in their best interests to withhold those titles from other retailers and use them as tools to compel shopping with Amazon.

(This would not be a peculiar selfishness of Amazon if they did it. I remember well the battles my friends at Sterling had when they were first acquired by Barnes & Noble trying to convince their new owners that it was necessary to distribute the books as broadly as possible or they would start finding it impossible to sign new titles. B&N’s instinct was to want what they published available only from their stores, an instinct they acted on with SparkNotes.)

But if I’m right about where Random Penguin might go, they could play this same game. As the cost of running book departments increases as a percentage of sales, as they surely will as sales in stores decline, the mass merchants will diminish their presence. If Random Penguin has half the bestsellers, they will be able to use VMI to build secondary locations to keep their print books available. Those locations will be theirs and theirs alone. Maybe they’ll only be making 10% or 15% of the total sales this way, but those sales will be unavailable to other publishers (unless they go through RP at diminished margins.)

The proprietary distribution will give RP an advantaged position signing up the biggest books. In time, they might even have enough of the biggest books to pursue one of the current active fantasies of Amazon and a bunch of entrepreneurs: creating a value proposition for big authors that will enable a subscription library with headline titles. And that would be another proprietary distribution channel that this next generation of scale might make possible.

The resistance of the bookstores to doing anything that helps Amazon will make it difficult for Amazon the publisher to build a general trade list of bestsellers until a much bigger chunk of the market has moved online. Barnes & Noble, which had a chance to become the one dominant trade publisher if they’d played their Sterling card differently, seems not to be interested in that role. So it will be one or two of the incumbents that will be left standing ten years from now managing the most commercial titles in the marketplace. The odds are very good that one of them will be Random Penguin.

I (usually) resist the temptation to make political observations on the blog, because that’s not what people come here for. But I have to make an exception because I think one of the most important points to be made about the results of November 6 has not been made anywhere else. And it is, ultimately, a non-partisan point.

Among the many reasons that President Obama convincingly defeated Governor Romney was the superior execution of the Obama campaign around data and operations. They were simply better analysts and managers and they executed better than the Romney campaign.

So can we please put to rest the notion that “getting rich” or “running a business” is a proxy for “management skill”? The most frequently-offered argument from Romney was “I’m a successful businessman so therefore I can run things better than this guy who is community-organizer-turned-public-official.” Actually, Governor, you couldn’t. You didn’t.

The last presidents we had with business experience were (working backwards) George W. Bush, Jimmy Carter, Herbert Hoover, Calvin Coolidge, and Warren Harding. There is no historical evidence in there that shows that business success correlates with the ability to run the United States government. Or even, as we’ve just been shown, an effective national campaign.

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  • The model you propose of Random Penguin acting as the sole vendor for book departments of various retailers mirrors what has been going on in the map business for many years. Every national retailer that carries maps has only one map vendor. It may be a publisher or a distributor. Increasingly it is one of the two top publishers, Rand McNally and Kappa Maps. Every map in B&N is placed there by Rand McNally. As category manager, and working with a B&N buyer, they recognize the need for some titles beyond their own list, so acquire those at a deep discount for inclusion in their program. The same model could be used for books in non-book stores.

    • Precisely. Thanks for the info from the map field.

      Of course, it is “easier” for a map publisher to make sure it has “everything” than it would be for a book publisher. But physical locations won’t *need* to have everything. They never have had everything. If you want to choose from everything, you shop on the Internet.


  • Hey Mike, Nice post as usual. It made me wonder what would happen if Amazon and B&N decided to merge. That ought to shake things up faster than a gallon can in a paint store agitator. What do you think?

    • I think it is really unlikely. I don’t believe Amazon wants to be in the brick-and-mortar store business (despite some misdirection statements by Bezos from time to time.) Their whole existence is about being in businesses that are developing and emerging, not businesses that are disappearing.

      And, in fact, I think even our very lame DoJ — which doesn’t understand the book business at all — would probably see something to oppose here if they tried it.

      But they won’t.


  • As always, a multi-thought-provoking, terrific piece!
    Since it looks like S & S will be the final pillar in American trade book-publishing to fall to foreign ownership (and it took so long to get S & S back from the Japanese!), perhaps it is time our American retail tech wunderkinds start learning about content, editors and the cultivation of new writers. We all keep talking about the staggering of brick and mortar bookstores but we rarely if ever speak of the editorial bloodbath in New York under foreign ownership, the demise of new-author cultivation and the resulting “product” shift in American bookstores. If I wasn’t an American I wouldn’t care about American culture either and I’d probably publish an increasingly narrow swath of brand-names, too (even after they’re dead–God bless you, Robert Ludlum). The thing is, between foreign ownership and our American techies (manufacturing in Asia and Eastern Europe), our industry has been—and is—being systematically destroyed. WHEN do we reinvest in American book editors? WHEN do we reinvest in the nurture of new American writers? WHEN do we invest in American eBook manufacturing jobs? WHEN do we see in retailing an evolving shift toward an American sensibility of book content?Okay, tantrum over!

    • Laura, I don’t see it that way. Of the leadership of the Big Six houses actually in New York, only two aren’t American: Markus Dohle of Random House and David Young of Hachette. In both cases, the rest of their management is overwhelmingly American. The editors at all the big houses are overwhelmingly American. There really has been no cultural takeover by non-Americans of these publishing houses.

      So whatever you think of the quality of the Big Six output, I don’t think we can blame (or credit) it to foreign influence.


      • It is the ownership issue that gets to me, Mike, when all the American executives fly to Munich or London or Paris or Toronto to report to their owners, and then come back to fire editors, keep their bestsellers, cancel the rest of their contracts and consolidate whatever imprint they were editing for into another.
        Thirty years ago Doubleday published 600 titles a year and had 54 editors and an in-print backlist of 2,000 titles. Now Doubleday scarcely exists and the backlist reassigned to new imprint names,creating the illusion of a long American literary tradition under that new name.
        You don’t think this scenario, that has occurred to over 32 publishing houses in the past three decades, has impacted American bookstore content? If foreign ownership issues orders to fire older American editors, keep their bestsellers and cancel their other author contracts? Over and over? I mean, who has been bringing along the new American authors? Or did I miss something and there IS a new Danielle Steele, and a new Stephen King, and a new Nora Roberts, James Peterson, John Grisham, Nelson DeMille, Sue Grafton and Tom Wolfe and on and on?
        The editorial void created by foreign acquisition over the past two decades has made the American author under the age of 60 practically extinct! And nowhere does this show up more than in eBooks, with 100,000 titles offered by book publishers drowning in 1,400,000 self-published eBooks.This is the American literary landscape of the new tech-genius retail system???

      • Golly, Mike, I’m sorry, this isn’t even the place to get into this.

      • Laura, I hear what you’re saying, but I don’t think foreign or not has anything at all to do with it. It is corporatization, pure and simple.

      • Thanks! I promise I’ll go away, MIke!

      • Now having you do that was never my intent! There is no requirement that people in this comment string agree with my opinions.


  • Personally, I far prefer ‘Random Penguin’ too! Nice job, Mike. Everyone in my writing group were talking about the big 6 becoming the big 4, and the implications. Now, I have more to add to the conversation 🙂

  • The record labels could have set up something along the lines of iTunes and Spotify, if they had been able to reach agreement amongst themselves. Could the trade publishers protect themselves from Amazon by setting up an online retail store in which all their publications would be available?

    • John, I think what you’re suggesting might be part of the thinking behind Bookish, which three of the Big Six (Penguin, Hachette, S&S) have been funding and trying to get started for two years or more. The problem is that Amazon has moved bookselling beyond books (their business stands on a much broader base than books) and B&N and Kobo and Apple have moved it beyond the US with global offerings. The question, which perhaps Bookish will answer, is what the publishers would have to bring to the party. Of course, if they cut off the other retailers from having the books, they’d force the consumers to come to them. But that would do such violent damage to the books’ sales that it would cause far more problems than it would be worth.


      • Let’s hope so, but Publishers’ Weekly reported in 2011that the main aim of Bookish was ‘ to make recommendations about books that will appeal to a reader’s particular taste’ (as well as retailing books). Personally, I think the Big 6 would do better to allow the recommendations side of the activity to rest with small retailers who, on an affiliate basis, could sell books and rely on a Bookish-style operation, to fulfil the orders with speed and efficiency. It was their failure to do this which led Jeff Bezos to establish his own warehouses and scoop the market.

      • They are attempting to employ technology at a scale indies couldn’t match to do the recommendations, I think. I’m skeptical of the approach, but I believe (with very little said by them) that’s the logic behind it.

        I don’t agree they would have stopped Amazon with the tactics you’re suggesting. Ingram tried to get the indies into the game with I2S2 (Ingram Internet Support Services: use the searchbox on the blog and I think you’ll find pieces I’ve written about it). The indies ran for the hills when Amazon started discounting. At the time, doing business for no margin that was at most 1% of the volume didn’t look sensible to anybody. And they would never have had the deep pockets to compete with Amazon on price in a sustained way, which was absolutely necessary.

        Part of the genius of what Bezos and Amazon did was that there really was no defense against it that would have made sense, except possibly for B&N and, even there, perhaps impossible given that they were a public company whose investors had a different view of these investments than Amazon stockholders did.


      • I entirely see your point about the ferocity of Amazon’s competition on price. Yet a small guy with a website and an interest in a specialist genre ( Martian porn?) could have added a margin to the wholesale price which might have been larger than an affiliate payment from Amazon. This would not work, of course, with Amazon selling at loss-leader prices.

      • The only way to prevent Amazon from undercutting you on price is not to sell to them. And the problem with that strategy is that they have most of the ebook market which will then be out of reach for you. So I’m afraid they’re a fact of life. It is fashionable to think that big companies control their fates and that all these big publishers and retailers (Borders as well as B&N was mammoth when Amazon started) could surely have done *something *to stop Amazon from becoming so dominant.

        In fact, I don’t think they could have.


      • Yes. It is like arguing that the Czars and the Bourbons could have retained their power by giving way to reform. Had they done so, the Russian and French monarchies might well have survived (like the Dutch, British and Scandinavian monarchies) but their power could not have survived. The people, however, surely gained from their loss of power. Do you think authors and readers will gain or lose by the shift of power from physical publishers to online retailers? Maybe this is a topic for a future blog post!
        Consumers like low prices, high quality and diversity. Authors like high income – preferably from selling large numbers of high quality products (for which they need editorial, design and marketing help). A book generates the same gross return from selling 100,000 copies @ $5 as from selling 10,000 copies @ $50. The author’s profit depends on the % age royalty. The reader benefits from lower prices. Sales volumes must always be influenced by prices.

      • The answer to that question — benefit of readers and authors — is “it depends” on exactly which readers and authors you’re talking about!


      • So readers and authors wanting thousands of shades of grey benefit but those who want to write and read Pulitzer Prize books lose out?

      • Among other things. Yes.


  • Arjun_Basu

    So the big publishers become the “land of best sellers” only? Oh, how far Penguin will have gone…..

    • That’s not what I’m suggesting. Not bestsellers only by any means. But bestsellers are what drive the consumer to shop with you so the entity with control of bestsellers has enormous power.


      • Arjun_Basu

        More and more, the opportunity for the smaller publishers to push the culture (not necessarily the profits, mind you) is becoming apparent. The next great discovery will scarcely come from the Big 4 or 3 or 2 or 1. If they are risk adverse now (while admitting that the entire book publishing industry is about risk), they will be even more so in the near future.

      • Not sure what “the next great discovery” will be. If an author, it might be “self-published” but then discovered by a big house. (Watch for an announcement around something like that soon…) If it is a new kind of book, it might not come from a publishing company at all. If it is a new distribution channel, it is hard to see how it could be truly tested without the books from a big house.


      • Arjun_Basu

        Yes, i was speaking of author, not form(s) or distribution. Agree on two and three. Let’s just admit that the big publishing houses used to make the big writing discoveries. Heck, they used to edit books. Remember that?

      • They still do edit books. And they still do make writer discoveries. But there are other paths to the reader for writers and the monopoly on access is over.


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