Macmillan

I was extremely fortunate in my “choice” of parents. I had both admiration and affection for them, and I always had a great time just shooting the bull with my dad, Leonard Shatzkin. He was a real visionary about the publishing business and was also very witty and cogent. A great deal of what passes for my insight is really just a recycling of his.

He died in May of 2002. Until the last six months or so of his life when the heart failure that killed him so weakened him that he couldn’t really think anymore, he was still working hard on what he always considered to be the most important commercial challenge for book publishers: how to manage the inventory in retail locations. In fact, he was developing a system he hoped to commercialize as a solution for independent stores. I didn’t want to say “what independent stores?” to him back then, even though it was already obvious to me that their existence was seriously threatened. Dad had shaped his view of publishing during the 1950s, when the industry was near the front end of what was nearly half-a-century of unfettered growth.

That period of growth was over by 2000, and those of us who were trying to measure the trajectory of digital change in the early 2000s couldn’t avoid seeing it. Dad might have seen it 10 or 20 years earlier, but he was intellectually and emotionally incapable of accepting it in the last few years of his life. In fact, while taking control of the inventory in independent bookstores had been the key to the growth Dad fostered at Doubleday in the 1950s and in building the Collier Books imprint, which he created, for what we now call Macmillan I in the 1960s, it didn’t present the same level of opportunity in the 2000s. He had been right for many years about this, but he wasn’t anymore.

Another immutable truth in my father’s picture of book publishing which also turned out not to be permanent was his belief that book publishers should just keep expanding their lists, pretty much without limits. When Dad launched Collier Books by doing 600 titles a year in 1962, the entire industry only produced about 10,000 titles. In Dad’s time, it was probably true that most books big houses did contributed to profits, so the more titles you did, the more profits you made. Tom McCormack, who was a protege of Dad’s in the late 1950s and then went on to a long and successful career as CEO of St. Martin’s Press (now part of Macmillan II), attributed much of his success and St. Martin’s to Tom’s own recycling of Dad’s insight.

There is this beast in publishing known as the “title P&L.” The “title P&L” proceeds from the mistaken premise that titles, standing alone, deliver profits or make losses. In fact, that’s not true, because a substantial chunk of a publishing house’s costs are not title-specific; some costs are not really attributable in any sensible way.

The way “title P&L”s normally work is that “overhead” — rent, salaries, etc. — is figured as a percentage of sales (which, if you look back to last year, is, indeed, a calculable number across any company.) By “distributing” the unattributable costs that way, the logic says, you make sure that each book covers its “share” of the costs of keeping the doors open. But, as McCormack pointed out many times over his career, the rent didn’t go up because he signed a new title and it was nonsensical to charge each title, let alone each sale, for the rent.

Dad had a very succinct and persuasive way to explain the folly of the “title P&L” logic. What he suggested is that every house do a recalculation of their overall P&L at the end of each year. To do it, they should take out every title that failed to earn back the overhead charge (usually somewhere between 35% and 45%) because those had, by the internal logic, “lost money.” Surely, if you take out all the titles that lost money, you would see your overall calculation of profits rise. Right?

But it never does, it always falls. Why is that? Because most of the titles deemed to have lost money by “title P&L” logic actually made a contribution to overhead. That is, the direct revenues attributable to that title were greater than the direct expenses charged to it; they just weren’t sufficient to be scored as profitable when the overhead tax was deducted. But if you subtract all the books that earned 6% or 10% or 19% or 34% margin on sales, you subtract actual dollar contributions to overhead and profit.

Important point: overhead and profit are both produced by gross margin on sales. When enough margin has been generated to cover all the overheads, the margin becomes profit. So titles don’t earn profits or losses, they contribute more money or less to overhead and, in some cases, actually don’t recover their direct costs. The titles that don’t recover their costs clearly have lost money; all other titles contribute to overhead and, if it is covered, to profits, but they aren’t, strictly speaking, profitable in and of themselves.

All that was true in Dad’s day and is still true today. What has changed (I think; I haven’t actually done the analysis with a real house’s numbers) is that the percentage of titles that don’t even recover their direct costs is rising. It is actually getting harder and harder to publish new titles successfully, even if the standard of success is lowered to “recovered all costs” from “delivered its pro rata contribution to overhead.”

That’s because each title published today is facing a much more challenging commercial environment than each title published two, three, four, or five decades ago. Each title competes with more titles in the marketplace and more new titles coming into the marketplace: print-on-demand and online used books have snared a great deal of market share that used to be available only to new titles and backlist kept alive in print-run quantities by publishers. And, for the past 10 years, each new title is coming into a marketplace that has less shelf space available for books overall than it had for the last title.

So the “keep publishing more and more” paradigm that Dad believed in and that McCormack credited with St. Martin’s growth may not actually work anymore. In fact, any sentient publisher today would have to look at their output regularly to recalibrate what new title publishing is actually profitable. I expect that analysts in every major house are slicing and dicing their lists, trying to figure out whether they can discern — by level of advance or subject matter or by imprint or editor or agent — which bets will return the cash invested and bring profit to the house.

We can assume those analyses are being done, but can we assume they’re being done right? Without any inside view of the details (and I don’t have one), we’ll assume (hope) that the crude application of a single overhead percentage to each title is not the standard for analysis. If it is, the house doing that will almost certainly be led to erroneous conclusions, just as Dad and Tom pointed out they were if they saw a book that contributed 30% margin as “unprofitable” and would think they’d be better off not publishing it.

The big publisher of 2010 has another problem besides the reality that new titles are harder and harder to launch to any standard of acceptable return. They also have to feed a machine built to handle a certain volume of printed books when the decline of print book sales is being accelerated by the shift to digital. The additional margins in digital (which are being produced as long as prices can be maintained) are not very helpful if they need to be diverted to pay for warehouse space, field sales forces, and higher unit printing costs because there is less print “throughput” to support them.

Big publishing management is aware of this challenge; it is part of what drives up the value (and prices) of big brand franchise authors. The big authors are still the fastest way to guarantee the volume of print output and sales necessary to fill those volume-guarantee contracts with the printers, absorb the warehouse space, and cover the cost of calling on accounts that sell print only. And look at the irony. With less volume, unit costs per book go up, which reduces total gross margin. And if warehouse and sales organization costs are fixed (they aren’t but it is hard to adjust them quickly, the way you can cut a press run or a marketing spend), then the percentage of sales they will consume will go up. So much for calculations of overhead as a percentage!

The big variable publishers have to deal with today is marketing cost. The most common rationale for list-cutting is that it will allow a greater amount of marketing attention to the books that are published. But that articulation actually begs the question, because marketing resources are variable. If you add more, you increase the overhead nut you have to cover before you get to profits. And if you reduce those resources, then you’ll be chasing your tail trying to put more marketing effort behind each title.

The analysis of how to cut has to be done; it is pure insanity for publishers to keep cranking out new titles if they are losing on many of them. Some of the ones they lose on have the potential to be big but just don’t make it; some aren’t even seen to have that potential. But the ultimate answer is not in how or how much a publisher can reduce title output, but in how they focus it. That’s the secret to reducing marketing costs and it is something we will certainly explore in another post someday.

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Michael Cader did a brilliant analysis of Thursday’s New York Times piece on ebook pricing, published exclusively for paid subscribers to Publishers Lunch. The Times piece’s shortcoming was that it tended to sensationalize the news that the prices the public will pay for current brand-name ebooks will be going up. If you observe the book business for fun, you can perhaps afford not to have access to content like Michael’s analysis. But if you’re in it for a living and you want to seriously keep up with what’s going on, I suggest you save $20 somehow on other publications each month and reinvest it in a Publishers Marketplace membership. I am not the only blogger moved to make this suggestion by this piece.

I am working under the rash assumption that Cader will not sue me for quoting his remarks without regard to fair use limitations (particularly after the commercial in that first paragraph.) Of course, I do my best to add some Shatzkin Files value to my quotes and paraphrases as well.

Michael’s overall point, as I read it (and these are my words, not his): “we in the business know what’s going on with ebook pricing; apparently reporters outside the business do not. And therefore a great deal of misunderstanding is circulated among the book-buying public and it behooves the trade publishing community to get the word out to make sure that the public understands what’s really behind what they pay for ebooks.”

His device to illustrate this point is to describe some common misunderstandings fostered by the Times piece — all of which are real misunderstandings and none of which are just convenient straw horses — and knock them down.

Frankly, it is only the overall point on which I’m not sure I agree. I am not convinced it makes much difference whether we push the “truth” out or not. Amazon’s recent “concession” statement over the Macmillan dust-up tried to channel potential consumer anger at Macmillan and away from them. That’s an effort that is bound to fail. Everybody who buys from Amazon knows that they’re buying from Amazon. On the other hand, “Macmillan” is not an active book imprint at the moment in the United States. The books the corporation called Macmillan puts out are under the imprints St. Martin’s, Farrar Straus, and Holt, and their subsidiary imprints. My wife found the Macmillan Dictionary for Children online and that book is published by Simon & Schuster! So good luck to Amazon trying to get the consumer to punish a corporate entity whose name isn’t on the cover of its books.

But the myths Cader describes are ubiquitous misunderstandings and they were clearly promoted in the Times piece. As Michael describes them (in italics):

* $9.99 never was the top e-book price; people pay more than that every day.

The Times piece makes a big deal out of consumer expectations of the $9.99 price. Cader points out that recent data from the ebook retailer Kobo described at Digital Book World — which shows that at Kobo they sell as many books for more than $9.99 as they do for exactly $9.99 — and Amazon’s own data undercut that notion. Cader says surveys of Amazon data have shown that 30% of the SKUs are priced higher than $9.99.

I have been told directly by a responsible person at Amazon that 4% of the titles they sell are deep-discounted to $9.99 and those represent 25% of the total sales. Of the other 75% of the sales, many (most) are less than $9.99 without necessarily deep-discounting, according to Cader, 30% are more. I have personally bought many Kindle books for more than $9.99 and some for more than $14.99.

But what I’d see as the biggest fallacy in this whole “customer expectations” meme was not mentioned by Cader. So far we have a relatively small percentage of book readers who have ever purchased an ebook at all! General consumer expectations can not be set by a sliver of the group who are early adapters. In fact, publishers are being smart precisely because they are tackling this consumer pricing problem before the market really does become general and a large population of book readers do have experience with the current price structure.

* The implicit, false promise of cheap e-books was made by the people who profit, at very nice margins, from selling the devices, not from publishers.

This is true for the $9.99 books offered by Amazon and Sony and, now, Barnes & Noble. Other etailers, like Kobo or B&N before the Nook, were offering that same price to keep up with (keep down with?) Amazon. But the central point is right. Amazon created the expectation of $9.99 pricing to sell readers; publishers didn’t create it to sell books!

The two companies most likely to save publishers from an Amazon stranglehold on their future general readership, Apple and Google, would also place “margin from ebook sales” very low on their list of objectives for participation in the ebook supply chain.

If the market really could stabilize with three or more reliable paths to the general ebook consumer, with price competition among the content,  but not price-competition driven by external forces, it would be one of the most important strategic accomplishments of the current generation of publishing management, to whatever degree their policies enabled it to happen.

* Brand-new ebooks sold at $9.99 are generally sold at a loss by the retailer.

And, as Cader goes on to point out, this is led by a retailer with a $50 billion market cap with an implicit expectation that it will drive smaller retailers out of the game. Publishers are taking the steps they are explicitly to encourage a more diverse marketplace. So, Mr. and Ms. Consumer, whose side are you on?

* People who can afford an ereading device can afford all proposed ebook prices.

Cader is making the point that conscientious reporters should make put price complaints into context. I’d personally dwell more on the “dog bites man” aspect of reporting that people favor lower prices. Has anybody ever found a consumer who favored higher prices? Has anybody ever found anybody who would prefer to pay more for anything they buy? From here it would seem that all reports of what people say they want to pay or say they would pay in some hypothetical circumstances are pretty much meaningless. Michael says “put them in context.” I really wonder whether this kind of senselessly speculative commentary ought to be reported at all!

* Publishers are lowering [my emphasis] their ebook prices.

Cader captures the massive irony of what is going on here with this one. From reading this piece or from reading Amazon’s note to Macmillan, you’d get the impression that “greedy” publishers are “raising” ebook prices. That’s not actually the case. The publishers going to the Agency model are actually reducing their price per unit sold; they’re just insisting that booksellers not sell those books as loss leaders. As Cader put it, “we in the trade know that publishers are preparing to lower their ebook prices by 50 percent or more, and reduce their own profit margins. But customers don’t; they hear that publishers are raising prices.”

* The new “top price” is going to be $12.99 more often than not.

The public reporting is that the Agency-priced books from Apple will be $12.99 and $14.99, with no additional detail. Cader seems to know that most, or at least a large number, of those books will be at the lower of those two prices. Undoubtedly, some people will refuse a book they want to read on a device they paid over $200 for because of a $5 difference in price ($14.99) from their prior expectation ($9.99). But somewhat fewer will be reluctant at $12.99, which is where the price will apparently be a great deal of the time. Certainly, nobody writing for a newspaper knows the future balance between those two price points.

* Surveys show many people will pay more than $9.99 for ebooks.

Cader points out (and my personal repeated experience confirms) that people often do pay more than $9.99 now, even according to the stats we’ve seen. But what he doesn’t point out, so I will, is that those stats are stacked!  Amazon prices all the hottest and most desireable books at $9.99, and therefore so does Kobo and other Amazon competitors. So the clustering of consumer purchasing around that price is largely driven by the appeal of the product at that price point.

That is: people bought the book, not the price!

* Goldman Sachs says ebook prices are not the biggest factor in purchasing a device–but expensive devices are an obstacle.

This is from a survey that Cader has seen and I have not. But the point is that portability is the main benefit consumers see in ebook devices, with price running second and ease of purchase nearly even with price as a perceived benefit. Ebook purchase decisions are not made on price alone.

What this data also would tell us is that ebook reading is going to spread because the price of devices is coming down and the circulation of ebook-able devices, smartphones and iPads, is increasing regardless of dedicated reader prices.

* Publishers have rewarded and honored early ereader adopters with a lot of free book giveaways, and some very inexpensive price promotions.

Much has been made in other places (not in the Times piece and not in Cader’s report) of the fact that the Kindle “bestseller list” contains a lot of free or almost-free books. Some of those are public domain titles, but many are not. Those that aren’t are provided by publishers as promotions, usually an offer of an older book by a multi-title author who has a new one just out. Does any retailer billboard the publishers who “have made books available for you for free?” Not that I’ve ever seen.

I do believe that the price of content will be driven down over time because of the laws of supply and demand. The amount of content being made available every day is staggering. However, the established publishing companies still have pretty much a monopoly position on curating and branding it. Curating and branding save consumers an enormous amount of time and effort; that’s why they are willing to pay for them. Publishers and the authors whose brands they are enhancing and maxmizing are operating in an increasingly competitive world, but they are both totally sensible and totally unremarkable in trying to maximize the rewards for their efforts.

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Now I swear all this is true. As everybody knows, a very serious food fight broke out between Amazon and Macmillan late Friday night. All weekend Michael Cader led the way in ferreting out additional useful information and I spent most of today (Sunday) trying to write an analytical blogpost. I got it just about finished in the early afternoon, and the bottom line to what I’d written was “Amazon will not be able to sustain this.”

I decided to hold the post until after going to see Crazy Heart this afternoon and, when I came home, Amazon had already folded. But I had written a post that provided a lot of useful information, even if events had stolen my punchline.

So I’m giving it the once-over to edit it for the reality that Amazon has already announced that they will not continue to boycott Macmillan books.

It is received wisdom in Washington that when you have news you have to release but would prefer to have minimum impact, you release it on Friday afternoon. The latest tiff in the Amazon versus Big Publisher brouhaha went that idea one better; it appears to have broken in the middle of the Friday-to-Saturday night.

About midnight that evening, David Wilk alerted the Brantley list to a VentureBeat post that indicated that Macmillan titles were no longer available at Amazon.

By noon the following day, Brad Stone had posted a further explanation to the NY Times blog.

The VentureBeat post had no clue as to what was going on and even carried a link to a post from author John Scalzi suspecting a “glitch.” But Stone pinned down that the disappearance of the Macmillan titles was, indeed, retaliation for Macmillan’s move to the agency pricing model, first revealed by Michael Cader in Publishers Lunch and discussed on this blog last week.

Sometime late Saturday afternoon, Lunch posted a narrative explaining what was going on and including a paid insertion from Macmillan: a letter from Chairman and CEO John Sargent giving Macmillan’s account of what had transpired.

Which, as many people who care know by now (as I write this on Sunday morning and afternoon) is that Macmillan told Amazon about the new agency model, by which Amazon would actually get ebooks at lower prices than now but also by which Macmillan would set the prices to consumers. Amazon retaliated with what is, more or less, a “nuclear option.” Macmillan books are no longer on sale except through third party vendors (extending the ban to those dealers would open up yet another big can of worms for Amazon and they hardly need any more) and that includes Kindle. Most of the third party vendors are selling used books and no Macmillan books are being transacted directly by Amazon at all.

We have said on this blog, repeatedly, that publishers’ discounts to retailers would have to come down and that the windowing tactic (delaying ebooks from being available when the hardcover first comes out) was all about pricing control and nothing else.

What I want to accomplish in this post is to lay out clearly what is happening and then enumerate some key points about what’s going on: paradoxes and prospects.

Before the Agency Model (like “now”), publishers sell ebooks at about 50 off an often ridiculously high established price (”parity” is common; same price as a hardcover on a new book) to retailers who were setting the prices to the consumer themselves and, following Amazon’s lead, always discounting. The publishers are paying the authors royalties that are frequently 25% of net, which amounts to 12.5% of publisher declared retail. Some publishers pay 15% of retail; Sargent, in a previous letter to agents, indicated a desire to move from 25% of net to 20% of net, which would be 10% of retail.

The proposed Agency Model will have publishers setting a price lower than the established retail they had before but higher than the deep discounts Amazon led retailers to sell at. The publisher intends to  pay 30% of that established price to the retailer and 25% of either the full consumer price or of the 70% “net” (still to be determined) to the author. This means that the retailer will get a higher price from the consumer and a better margin than they realize now (even though a lower percentage of the “established” price). The author’s cut per copy could actually be reduced!

The wholesalers, Ingram and Content Reserve, often get the same discount as publishers. They handle the stores and libraries publishers serve don’t want to deal with directly. So those stores and libraries get less margin than the big ones publishers handle without an intermediary. One thing that was new to me that came out on the Ebook Supply Chain panel at Digital Book World is that publishers insisted on vetting the accounts that would be selling their books to make sure they didn’t violate territorial restrictions. So Ingram (and presumably Content Reserve) has to manage a granular control by title by publisher by account.

It is not at all clear how the Agency and price maintenance protocols get applied through wholesalers. Perhaps this means that smaller accounts and libraries just won’t have the newer titles that will only be released on the Agency basis (assuming that the scenario Sargent describes is what is also followed by other big publishers.)

This is a bizarre paradox, really. Macmillan actually proposed to sell Amazon the ebooks at what is, in effect, a lower wholesale price than Amazon gets now and their enforcement of a retail price puts more margin into Amazon’s pocket on every sale made than they earn now! And Amazon is fighting it.

Sargent’s note makes clear that the discount-off-retail pricing that has existed all along will still be offered, but that newer books wouldn’t be included in that offering. Those would be available only on Agency terms. What is not clear is whether Macmillan intends to continue the Agency terms past the nine-month “window” for new books. We’d guess they will for some accounts.

But that leads to another paradox because publishers unambiguously benefit if retailers sacrifice their own margin and discount when hardcover price maintenance and NY Times Bestseller list rankings are not at stake. Lower prices to consumers sell more copies. Presumably retailers will continue to want to compete on price and will do so when sales terms allow. But what does that do to the publishers’ challenge of “setting” prices for those accounts that want that done across the entire list?

Yet another paradox is the position of the agents. On the one hand, we have seen that many of those representing big authors see the same danger the big publishers do of inexpensive ebooks undercutting valuable hardcover sales and Times Bestseller rankings. On the other hand, publishers lowering established ebook prices and reducing their take from their intermediaries could often mean lower royalties for authors. But not necessarily.

If publishers are paying on “net receipts” (and many are) and if a) retail prices aren’t cut by as much as half (which they often won’t be) and b) if the publisher doesn’t deduct the Agency “commission” from its computation of net (sure to be debated), then the basis of the author’s royalty wouldn’t go down.

Quick summary: if you have a $25 list price ebook on which the author’s royalty is 25% of net, the author is now getting 25% of $12.50, or $3.125. If that book becomes a $15 ebook with a 30% commission, the author would get $3.75 (a nice increase) if the commission is not deducted first and $2.625 if it is (a sharp cut.) Of course, the $25 and $15 prices described here are notional and with different prices (as they say) “your results will vary.” If that notional book had been priced at $30 in hardcover, the author’s share would have been $4.50 and the ebook price change would clearly cost them something on every copy.

Author Charles Stross had a very insightful post on his blog, speaking from the perspective a gored ox (he has books published by Macmillan which have been taken down.) Stross makes clear that Amazon is miffed because their competitive strategy of driving away ebook competition through aggressive discounting will be foiled by publisher price-setting. Stross says:

Amazon are going to fight this one ruthlessly because if the publishers win, it destroys the profitability of their business and pushes prices down.

I’m not sure it “pushes prices down”; I think it actually pushes (ebook) prices up, at least temporarily. But the points Stross makes about Amazon wanting to achieve ebook hegemony and the Agency model being part of the publishers’ plan to beat that back and strengthen other players seem right to me.

We had a lot of this conversation last Spring before Sourcebooks’s windowing move with Bran Hambric, followed by Hachette with True Compass and HarperCollins with Going Rogue, pushed this tussle between Amazon and publishers to the forefront. In his analysis at that time, Cader made the point that publishers were actually helping Amazon undercut other retailers with their “parity” pricing; making the ebook retail the same price as the hardcover print retail. His logic was that the high prices increased Amazon’s advantage over other retailers because they could better afford to sell high-profile titles at a loss than their competition. Meanwhile, the publishers (and authors working on “net”) continue to get higher ebook revenues than the consumer spending would really entitle them to.

My first question when all this arose overnight on Friday was “why Macmillan?” Sargent’s note may have answered that question: because John was in Seattle on Thursday officially delivering Amazon the Agency Model news that we only assume is going to come to them from other publishers as well. One presumes that Amazon thinks that taking such drastic action as this might discourage the other publishers thinking about doing the same thing (and the iPad announcement on Wednesday would lead us to think that four of the remaining five Big Six players are indeed working out the details of a similar consumer-price-controlling sales model.)

And Amazon apparently figured out, as I was writing these words, that the only brand blown to smithereens by the nuclear option would be theirs. It is hard to imagine how extensive the brand damage could have been if Amazon delisted even one more major publisher along with Macmillan for even a couple of weeks. For a brand whose principal attributes are dependability and dedication to the consumer, it would have been catastrophic.

Amazon says now that the boycott is temporary and they were candid about the fact that they have no choice but to yield. They take a swipe at the publishers’ copyright-based “monopoly” on titles. But this was a really bungled response on every level. Amazon deserves credit for being smart enough to walk this thing back within 48 hours. Amazon may have to learn something new for them in the ebook space: how to be one of a number of players, not the only game in town.

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I wrote about piracy in my prior post and suggested that I had some ideas. These are those.

Brian Napack will be presenting Macmillan’s Seven Point Program for fighting piracy at Digital Book World. Today I want to expose The Shatzkin Files THREE Point Program for doing the same. I don’t know whether my three points will be covered by Brian’s program, but I do believe these — in concert — would yield beneficial effects (although nothing will “stamp out” digital piracy.)

1. Flood the sources of pirate ebooks with “frustrating” files. Publishers can use all sorts of sophisticated tricks to find pirated ebooks, like searching for particular strings of words in the text. (You’d be shocked at how few words it takes to uniquely identify a file!) But people looking for a file to read will probably search by title and author. So publishers can find the sources of pirated files most likely to be used by searching the same way, the simple way.

But, then, when publishers find those illicit files, instead of take-down notices, which is the antidote du jour, we’d suggest uploading 10 or 20 or 50 files for every one you find, except each of them should be deficient in a way that will be obvious if you try to read them but not if you just take a quick look. Repeat Chapter One four times before you go directly to Chapter Six. Give us a chapter or two with the words in alphabetical order. Just keep the file size the same as the “real” ebook would be.

For peer-to-peer file sharing, the publisher would have to put a computer or five to work, not just “upload” the crap files to a central site. But the effect to be achieved is to make illicit file downloading frustrating for the consumer and a sufficiently widespread effort of this kind should certainly do that.

One digitally sophisticated publisher reacted to this suggestion saying “too much work.” Maybe, but if this became a standardized component of each publisher’s response, the pirate marketplace would sure have a lot of sludge in it. There is also the concern that we’re punishing the end user, the reader. But (while I’m not defending them), far more Draconian remedies, such as suing consumers and denying them Internet use for repeated offenses, have been proposed. Giving them a dose of frustration (and that’s all we’re suggesting here: not malicious code or anything like that) to discourage use of pirated content seems a proportionate response.

2. Form a publisher group or authorize a trusted third party to put a “seal of authenticity” on the web sites that are totally reliable to be hosting only publisher-approved and legitimately-trafficked files. To make this most effective, publishers should “stand behind” the file distribution from authenticated sites, guaranteeing replacements for defective files, for example. We believe that, to date, publishers have been willing to complain loudly and point fingers at sites that distribute illicit files, but they have done nothing to help the honest consumer know what are legitimate distribution points. Of course, some like Amazon and BN.com and Powells.com are obvious (which doesn’t mean they shouldn’t want, and get, the “seal”), but as sources of ebooks proliferate (and they will), publishers will want to help steer consumers to the sources of ebooks that the publishers trust and believe the consumers should trust as well.

3. Promote like crazy to a) point people toward “seal of authenticity” sites and b) both scare and shame people from downloading from sites that do not have the seal. Promotion should be pretty easy: the authenticated sites can help, and so can a strong and forthright message with every ebook downloaded. Ebook readers should be constantly reminded that authors don’t get paid from pirated books, that pirated books can contain viruses or other undesireable code and that there is nobody to complain to if something untoward happens as a result of downloading one.

At the same time that publishers should be doing these things, they should also be trying hard to understand what the actual commercial impact of piracy is. The fact that there is a pirated copy of every book out there doesn’t actually tell us much; nor does the experience of the record business. We need to understand what real heavy book purchasers and readers are doing as the society moves from reading on paper to reading on screens. And, right now, we don’t have a clue.

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As part of the program-creation process for Digital Book World, I had a round of conversations with the top executives of the Big Six companies to discuss the agenda, mostly with the CEOs. The purpose of the check-ins was to find out what topics the CEOs wanted their companies to speak about and, of course, which they wanted to avoid for reasons of diplomacy, commercial politics, or legality.

One topic I had left out of our program initially was “piracy”. Some of the executives I met with found this a very troubling omission. My first reaction was “what’s there to discuss? We’re all against piracy and there isn’t much we can do about it. So what else do we say?” Although there are two of the big houses where that view is, to some extent, shared, most of the others disagree, some vehemently. In fact, Macmillan has a “seven point program” to confront and combat piracy, which will now be the topic of a presentation by Macmillan president Brian Napack on the first morning of Digital Book World.

The topic of piracy is a part of the conversation about “digital rights management”, software that manages how a file can be used. DRM is a pretty standard aspect of software and DVD distribution but it comes in for a lot of complaint and criticism from very knowledgeable observers and participants in the ebook scene.

There is a “first sale” doctrine in copyright law that gives the purchaser of a book (or sound recording or DVD) the right to give away or re-sell that good. It does not give the right to sell or give away a copy, but it does allow you to “share” your book or CD or DVD with your mother, your sister, and your aunt and then to sell the used copy on eBay. Those rights have never really extended to software, which often knows if you’re trying to load it onto a second computer and won’t let you. Attempts to control sharing of music through DRM are commonly blamed for the piracy that became rampant in that sphere (although I don’t buy that; there are other explanations I find more compelling.)

The question of DRM-or-not in the ebook world is a very complicated one, although opponents of DRM often paint it as very simple. O’Reilly Media sells its ebooks “DRM-free”, as do some upstart ebook first publishers. The ebook self-publishing site, Smashwords, also sells only DRM free from their own site, although Smashwords-originated files might have DRM added by intermediary resellers, with which it is making more and more deals.

The opponents of DRM point to the incontrovertible fact that its existence does not stamp out piracy, which is transparent at a time when you can type just about any book title into Google with the word “file” after it and be directed to sites that offer you a free pirated download. In fact, even not publishing the book digitally is insufficent DRM to keep it from pirate distribution.

Mark Coker of Smashwords, despite the fact that he sells onlyDRM-free ebooks from his site, is an avowed opponent of piracy, and even of sharing. He suggests a boilerplate notice in his ebooks that tell you that you should go buy another copy of this book you’re about to read if you didn’t buy this one, or else you’re cheating the author. Mark believes the key to combating piracy is education; he admits to an unusually strong faith in consumer integrity.

But despite the lengthy introduction, this post is not about DRM; it’s to propose what is the ultimate defense against piracy: ebooks that aren’t static; ebooks that change.

The secret sauce behind O’Reilly’s DRM-free policy is that when you buy an ebook from them, you are entitled to the updates to that ebook…forever. The implicit message there is there will be updates.

There is no better antidote to piracy than this. If the pirated or peer-to-peer edition of a book is yesterday’s, or last week’s, and the book is changing, then it’s yesterday’s paper (which the Rolling Stones noted long ago, “nobody in the world” wants.)

This is beyond wrenching to publishers; it completely changes the workflow and it completely changes the business model. The rhythm of a publishing house is based on the fact that books are, at some point, finished. There is a Henry Ford assembly line aspect to how things have always worked. Whether you’re an editor, a marketer, or a sales person, new books have a pretty reliable “cycle” for you: their existence in your life has a beginning, a middle, and an end. The conveyor belt moves the book away from you so you can’t spend too much time on it and can move on to the next one. Having authors not stop adding to or changing a book, even after it’s published, is totally disruptive. And what would we do about the ISBN numbers?

Yet, the possibility for ebooks to be totally up-to-date is one publishers can’t ignore. The Little, Brown division at Hachette has just announced that on December 1 it is publishing a 2,000 word update on the H1N1 (swine flu) virus in the ebook edition of “The Vaccine Book”, which was originally published in 2007. If something startling happened that should change that text on February 1, wouldn’t it make sense for them to update the book again? In October, Wiley published, as an ebook only, “The Swine Flu: The New Pandemic” because they wanted to get the most up-to-date information out quickly. By that logic, wouldn’t they also want to update their ebook if what was up-to-date in October isn’t in March?

And if they did that, what possible value would a pirated edition of yesterday’s ebook have?

Of course, swine flu is a dynamic subject. It isn’t a novel; it isn’t history. It isn’t even programming or software development or technology, the subjects O’Reilly publishes (and often updates.) But every editor knows plenty of authors of non-fiction books that wanted to keep writing and changing and adding past every deadline the house presented. Let the new process start with those; there will be plenty of candidates.

Furthermore, the biggest threat from pirated ebooks is to the most established franchise authors. I believe Tim O’Reilly is responsible for two cogent and pithy observations about piracy: that obscurity is a greater threat to most authors than piracy, and that piracy is “progressive taxation.” Both express the reality that the marketing for most books fails to reach most of the book’s potential audience. That Henry Ford assembly line conveys the book away from the marketers before the task of informing the entire potentially-interested public is anywhere near complete. So piracy, or file-sharing that may fall short of actual piracy, can serve the purpose of spreading the word about a book and triggering more sales. Except there are some authors, and those are the ones that sell the most books for the biggest publishers, who don’t need marketing to inform their audience; their audience, in effect, informs their audience! And those are the ones who would surely lose sales if there were no DRM and books could be freely shared or are made available through illicit channels.

But those authors are also the ones who have the biggest personal followings. They are the most capable of adding material: notes about what they’re working on, correspondence with fans or critics, even observations about other people’s books, that would add some value for many of the readers of their stories. In fact, a regular “update to my readers” from a top-flight author that is available only in their ebooks, or to purchasers of their ebooks, would be an attraction to many and could serve as a constant reminder that downloading their books from illegitimate sources is cheating them.

I’m not against DRM in principle and I’m all for combating piracy any way we can (and I have a couple of thoughts on that subject I’ll save for a subsequent post.) But I am far from certain that piracy represents the same existential threat to book publishers that it did to record companies, although we have others: the music business isn’t nearly so threatened by the shift to vertical.

One of my favorite people in the digital book business, who once worked in the music business said to me: “I don’t worry about piracy. I did in the music business because music was bought by kids. My customers are 53-year old ladies. They don’t go to pirate sites. They’d be afraid of getting a virus!” She’s right about that, at least for today. But for those who are concerned about piracy, I am not sure this problem can be attacked with toughness and muscle as effectively as it would be with creativity and delivering to the market something the pirates just can’t keep up with.

We have observed previously that the day will likely come when Big Authors will go straight to electronic distribution for some ebooks, bypassing the publishers to collect bigger royalties. What could be the first shot of that battle, and a reflection of the ideas in this post as well, may have been fired in the UK where Sony has announced a special edition James Patterson ebook which will contain the new book, “Cross Country”, a month before its general release plus other excerpts and a special letter from James Patterson. Of course, that deal was probably made by the publisher with Patterson’s cooperation, but it points to possibilities that should make publishers nervous.

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There is considerable concern among the trade publishing establishment about the future of brick-and-mortar stores. As well there should be. Retail stores provide the most efficient promotion opportunities for books: putting them in front of people poised to buy. They give clear signals about sales appeal by positioning and piles of stock of varying sizes; they make it possible to “look inside” of illustrated books in ways that no online presentation can match; they enable discovery through serendipity; and they put more different book choices in front of any person faster and more efficiently than any web page or smart phone screen possibly can.

But they’re troubled. Same store sales, or what the Brits call “like-for-like”, have been declining. That may be partly due to the recession, but it is also due to factors that won’t go away: shifts of sales to the Internet, to ebooks, and perhaps to substitutes in other media and the Web.

The magic that grew Barnes & Noble and Borders into behemoths was large store size and title selection. My first experience with this effect was a lesson from my father, Leonard Shatzkin. He took over executive responsibility for the Brentano’s bookstore chain as a vice-president of Crowell-Collier (later called Macmillan, a company subsequently bought by Simon & Schuster and not connected to the company now called Macmillan) in the early 1960s. The store in that chain that was doing least well was in Short Hills, New Jersey. They doubled the number of titles the store carried and it soon was the best-performing store in the chain.

But the “size as a magnet” concept took a back seat to mall store expansion by Walden and B. Dalton in the 1970s. As shopping centers were built across the country, the mall developers favored national chains, which were “bankable”, for their leases. Walden and Dalton rode that wave and added hundreds of stores. Meanwhile, partly assisted by the expanding wholesaling services offered by Ingram, independent stores thrived and grew their title selections beyond what the space-challenged mall stores could offer.

In the late 1980s, Bookstop, a discount chain in Texas, pioneered the “superstore” concept: a massive selection of 100,000 or more titles under one roof. This was the Brentano’s Short Hills effect writ large. By that time, Borders and Barnes & Noble, which already had larger stores than the mall stores, had bought Walden and B. Dalton, respectively, giving them critical mass to support robust central operations and provide leverage in their relationships with publishers. The new superstore concept suited Wall Street, and the two big chains were bankrolled to roll out superstores nationwide.

This was great for everybody except some of the larger independents which, up to that time, had the large title selection field to themselves. For publishers, it meant lots of additional shelf space for their backlist. For consumers, it meant a large increase in choice at hundreds of locations around the country. The attraction of 100,000 or more titles under one roof was compelling; these superstores didn’t need malls to bring them traffic. They were destinations worth traveling to on their own.

But then came the Internet, and Amazon. As we used to remind ourselves quite often ten years ago, “the Internet changes everything.”

And what the Internet did was to seriously dilute the attraction of so many titles under one roof. Now “unlimited” choice was available online: not a hundred thousand titles, but millions. Not just the books presented by active publishers and chosen by buyers, but all the books, in or out of print.

By the turn of the 21st century, it seemed to me that the powerful attraction inherent in the massive superstore selection was muted. I advised a client to “leverage your infrastructure to figure out how to make the small store work.”

But, by that time, both the big chains were phasing out their mall stores. This was not entirely a matter of store size, although it might have been seen that way. The malls the stores were in were often in suburbs from which prosperity had moved on. The effect of the Internet wasn’t just being felt by bookstores, but also by department stores, which were the “anchors” that brought traffic to the malls. So footfall at the mall stores fell, quite aside from any negative impact of a limited title selection.

In 2009, the mall store era has officially come to an end. First Barnes & Noble announced it was closing all the remaining B. Dalton stores. Then, this week, Borders announced it is shuttering more than half of the remaining Walden stores, which will leave only 130 operating, in January.

Meanwhile, it only takes a visit to a B&N or Borders store today to see that they are hardly stuffed with books; the ones I’ve been in lately appear to have more space than they need, and this is when stores are relatively full of merchandise.

Of course, larger stores can be more cost-effective than smaller ones for other reasons beyond the attraction of the title selection, even if that attraction is working well. There are per-store costs, of store management and central management attention, that don’t readily reduce with store size. And while the effect of a massive title selection at a retail location might not be what it was 20 or 40 years ago, more titles will certainly attract more traffic than fewer.

Meanwhile, the other big change in the book retailing scene in the past 20 years has been the growth in sales at mass merchants: Wal-mart, Costco, and the price clubs and supermarkets. These stores leverage existing traffic (one would think that few, if any, customers go there for the books) and deep discounting to make significant book sales with a very limited selection of titles, usually well under 5,000. They’ve been part of the problem for full line book retailers. Their pricing and ubiquity bleed off sales of the highest-profile bestsellers. In the 1970s, bestsellers pulled people into bookstores where they might buy lower-profile books. Today bestsellers are presented to the public at cut prices where people buy their groceries or school supplies, leaving the bookstores with the customers who still consider them a “destination.”

Both of the big bookstore chains, but particularly Barnes & Noble, own unmatched infrastructures to deliver a curated selection of books to dispersed retail locations. They found it impossible to make the small stores they owned in the mall locations profitable, even with those capabilities. (In fact, Borders, which doesn’t have a supply chain to match B&N’s, outsourced some of its shelf-stocking at Walden to wholesalers in recent years. It is inconceivable that B&N would ever do something like that.)

But bookstores are going to be getting smaller; we know that intuitively and the stock we see in the current superstores confirms it. And smaller bookstores, if they were planned to be smaller, would require less space, less traffic, and less sales to be viable.

Of course, smaller stores wouldn’t be a magnet for traffic; that’s what turned the Short Hills Brentano’s around and that’s what fed the whole superstore revolution.

So it would seem the combination for the future might be a B&N or Borders mini-store inside another large retailer. Remember, many other retailers are going to be having the same problem; figuring out to deal with having too much space, so there should be potential collaborators on the other side of the partnership. This will require a different kind of inventory management than the chains exercise now; more of a rack-jobbing approach. But their capabilities: to source books, select books, organize books for presentation, and to deliver books all over the United States, will have more consumer demand than they’ll be able to satisfy with only their own very large stores.

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Here’s how we’ve been putting together the program for Digital Book World.

First, I dreamed up a list of panel “topics” that I thought touched the key issues and concerns facing general trade publishers today as a result of digital change. Then we ran that list past our illustrious and helpful Board of Advisors, who pointed out some places where consolidation would be appropriate and dismissed a couple of ideas as klunkers.

That left us with a list of topics longer than we can use: we have between 18 and 24 panel slots and well over 40 ideas in hand. We figured that some would be harder to fill than others and things would sort themselves out as we recruited panelists.

In the process of discussing things with our Advisors, new ideas also surfaced. One of them is now looking prescient.

At a meeting at Macmillan with Advisory Board member Ami Greko and a couple of her colleagues, an interesting topic arose. What happens when the entry level employee knows more than the manager about how to use digital tools or play in a digital space?

After all, the top marketers in trade publishing houses honed their skills in a different era. They don’t necessarily know how to use Twitter or Facebook or Ning. But the people they’re hiring to fill entry level jobs have been on Facebook for years and they have probably already used it to organize something. Who would tell whom what to do here? Who would be in charge? And how do we apply the content-and-market knowledge that is developed through years of book experience to promotional venues that are best managed by green marketers (and we don’t mean “green” in the environmental sense!)

Although that panel figured to go on the list of those likely to be “harder to fill”, it seemed to us like an important topic.

And we got evidence this weekend that we’re not the only ones with that thought in mind, although perhaps publishers are seeing it a bit differently. The Bookseller reports that a survey by an organization called “Skillset” has revealed knowledge gaps in UK publishing houses.

Suzanne Ashley, Skillset publishing sector manager, said the report had revealed specific problem areas within training and recruitment.

She said: “There are those who know the business really well—often those who are more experienced, middle-management types—who are very uncomfortable with the wholly changing digital landscape.”

The question not being answered is whether those who “know the business really well” might actually be uncomfortable with the young people new to their team who live in, and are quite comfortable with, the changing digital landscape. That’s the question I hope we’ll explore constructively at Digital Book World. If any managers or recent recruits have thoughts to offer on this question, we want to hear from you.

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As the reality of the shrinking marketing opportunities for general trade books and the continuing verticalization of audiences through the Internet takes hold, we can expect to see some unusual changes (by historical standards) in trade publishing over the next few years.

It seems inevitable that retail shelf space for books is going to be diminishing. This, in and of itself, doesn’t have to mean a reduction in title exposure to the public; Indigo in Canada has said that they’ve cut store inventory but increased title selection by going to more frequent replenishment. That’s a good strategy. The problem in this country is that Barnes & Noble has already been employing it for years, so they don’t have the same opportunity to create further improvement by doing it going forward. They already replenish every store from their DCs every day! And since B&N’s share of the retail book shelf space is likely to be growing since their competition is more challenged than they are, in the US we must expect a declining opportunity to promote books through bookstores.

This is a major problem for the Big Six (in alpha order: Hachette, HarperCollins, Macmillan, Penguin, Random House, and Simon & Schuster) because they require, and plan for, continued sales growth. If overall industry sales of books in stores is going to go down, and it is, then all of the Big Six can’t see their sales go up.

That signals consolidation going forward. We should expect to see at least one get sold to another in the next two or three years. But the traditional method of consolidation — one company acquiring another — will probably not be the only way these companies respond to the increasingly difficult market conditions they’ll face.

Two types of commercial transaction that have been almost unknown in consumer publishing will be pretty common by the middle of the next decade, both of them coming under the overall heading of “publishing portfolio rationalization” which I think all the big houses will engage in.

These changes I’m expecting will start when trade publishers recognize that marketing effectiveness and controlling marketing costs are both dependent on niche focus. Costs which have been traditionally associated with “imprints” will increasingly be seen to be sensitive to subject niches. As marketing activity shifts increasingly to the web, it becomes more and more expensive to market a book that is directed to a different audience than previous books the company has published.

So what happens then? Publishers figure out how to “trade lists.” Look at the situation now with a number of players in the sci-fi arena. Macmillan (Tor) and Hachette (Orbit) are trying hard to build online communities; Macmillan just took the heretofore unusual step of setting up to sell the sci-fi books of all publishers to its audience.

The history of the online world suggests that one of these communities will “win”. In fact, the likelihood is that we’ll see the day when the leading sci-fi site has twice as much traffic as the one in second place, which will in turn have twice as much traffic as the one in third place. Why would the one in third or fourth place keep trying then? Their books would sell better and be marketed more effectively through a competitor’s site. So why wouldn’t they sell off their list to the competitor in that case? I think they would.

Perhaps there will be symmetry and the publisher in first place with sci-fi will be in third place with romance, so they’ll be a buyer in one genre and a seller in the other.

The bottom line is that we can expect to see reshuffling as publishers trade off areas they can’t afford to market to for others where they’re going to expend the marketing effort and want to have the most possible content to dominate the niche and from which to extract a payoff for their efforts.

The second kind of reshuffle we’ll see will involve smaller publishers or third party aggregators taking content off the Big Six’s hands. Each of the big publishers has a few titles in niches such as interior design, health and nutrition, or gardening that they don’t have the critical mass or bandwidth to do anything significant with. Many will be in niche areas that others, often smaller publishers, are developing aggressively. Since the Big Six are going to be financially challenged in the new environment and looking for ways to become more “focused”, selling off clusters of a dozen or two dozen titles will seem sensible. And from the niche players’ point of view, they’ll see the opportunity to sell copies to their growing web communities, or to use the content to make those communities grow even faster.

Horizontal lists that were built for the 20th century publishing ecosystem will not prove to be the right mix for the marketing machines for content that will be evolving in the 21st.

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