The ebook value chain is still sorting itself out, and so are the splits
The division of the consumer’s dollar across the publishing value chain has a history of change. When I came into the business 50 years ago, discounts from publishers to retailers often topped out at 44% and even wholesalers seldom got more than 48% off the retail price on hardcover books. Today discounts into the mid-50s for big retailers and for wholesalers are common.
The top royalty for authors was, as it is now, 15% of the retail price, but there were fewer exceptions allowing the royalty to be cut, contractually or in practice. Today “high discount” clauses, calling for a royalty of something less that 15% of retail (and sometimes a lot less than 15% of retail) will often apply to more than half of the sales the publisher makes. (It is also true that in those days the agent’s standard cut was 10%. The 50% increase they’ve achieved to 15% is the single biggest change in share in the past 50 years.)
Lower royalties subsidize higher discounts and higher discounts have subsidized price cuts to the consumer. Discounting off the publishers’ suggested price by the retailer was rare until the Crown Books chain, which had a meteoric tenure as a major retailer from the mid-1980s until the mid-1990s, made it a core component of their offering. The Barnes & Noble and Borders chains, which rose to prominence during the Crown decade, used the tactic, although less aggressively than Crown.
All of these numbers: the discount determining what the retailer will pay; the royalty calculated either as a percentage of the stated retail price (usually printed on the book) or of the net paid by the retailer on a high-discount sale; and the ultimate consumer price (whether what the publisher printed or lower if the retailer wants it lower) are based on the price the publisher sets and prints on the book in the first place. The informal internal formulas for setting the price have changed over the years too and, although it is a bit hard to really compare, it would appear that the markup over manufacturing cost has also risen steadily over the past 50 years.
So we had reached a point, somewhat before we had the Internet and Amazon.com, where, on big books at least, the publisher would charge a price higher than they expected the consumer to be charged, give the retailer a discount larger than many retailers would keep as margin, and state a percentage as the per-copy royalty in the main body of the contract that didn’t apply to most of the sales. One could say there was a “virtual” world in trade book publishing’s value chain before the term was applied to our new digital reality.
The core underlying point here — obvious but often ignored — is that the division of revenue across the value chain is never fixed. That’s important to remember as we consider how the ebook chain is shaping up. One hears authors and publishers arguing about what is the “fair” division of the ebook consumer’s dollar (as if “fair” had anything to do with it, which it doesn’t) and we have a very unsettled picture of what the retailer’s share of that dollar will be (even though Apple is doing its best to be definitive about it.)
Right now for ebooks we have two “standards” for the publisher-retailer division of revenue. For agency publishers across all retailers and for all publishers selling to (or perhaps we should, with respect for the agency logic, say “through”) Apple, the retailer share is 30% of the purchasing customer’s payment for the ebook, or the publisher’s “digital retail price”. For non-agency publishers selling to everybody else but Apple, the normal offer is 50% off the publishers “suggested retail price”. The DRP is set within boundaries basically set by Apple, primarily based on the price marked on the print version of the book. The SRP is the publisher’s own creation and has been at or close to the lowest-priced print version. The non-agency publishers who sell to Apple are obliged to have both: their DRP is the price Apple will charge (until and unless they’re undercut) and the SRP is the price that forms the basis of discounts to wholesale customers. I haven’t studied this but I think most publishers set SRPs higher than the break-even point because they want wholesale customers to go agency and would trade less revenue to achieve that, as they did when they switched over in the first place. (The publishers could set the SRP at a point where 50% of it equals 70% of the DRP, so their take is the same either way.) Theoretically, the publisher can count on the wholesale-purchasing retailer to discount the book to match the DRP, reducing their own margin and being competitive with the DRP in the consumer’s eyes.
This pricing strategy depends on the retailer discounting from the SRP to keep the pricing of the ebook from looking ridiculous. Not discounting is a way for the retailer to push the publisher to lower the SRP, which could start a cascade of price-cutting. That discounting has usually started with Amazon; others then follow suit. There are anecdotal claims that Amazon is starting to foil this strategy by letting publishers who set high prices live with the prices they set more often than they once did, but nobody but Amazon knows that for sure.
During the period when Random House stayed out of agency pricing, one thing they said was they thought the 30% agency standard was high and they didn’t want to memorialize a retailer cut that rich. Either other considerations prevailed or Random came to the conclusion that they couldn’t singlehandedly change that standard cut.
But if we maintain a competitive landscape of retailers, there is a way it could come down. What if one retailer (B&N? Kobo? Google?) were to offer publishers a deal where a discounted version of an ebook were offered through them on a temporary exclusive — say, the first 60 days the ebook was out — during which they would help subsidize the discount by taking a smaller percentage themselves during the promotion. Would publishers find it tempting to accept such an arrangement to poke a hole in the 30% standard? I think they might. (They would certanly enjoy the conversation with a competing retailer inquiring about how that happened, in which the publisher could offer a “matching” deal for some other equally appealing book and leave that retailer to think about whether to hold the line on the 30%.)
Another value chain segment the industry is still trying to value and price is the percentage a distributor can charge in the digital world. There’s wide variation here already, as there is in the print world, where the same bundle of services (sales, warehousing, shipping and returns processing, collecting receivables) can cost anywhere from around 20% to around 33% (fully loaded.) In ebook distribution, we see BookBaby willing to set up for a fixed fee (with no percentage deducted), BookMasters and Smashwords and some agent services like Knight charging about 15% of the revenue, and then offers from various publishers, distributors, and literary agents that go as high as 30% of the revenue.
Usually those offers are framed as “we pay 70% of revenue” which, I think, some hope will be confused with the 70% the agency retailer pays of the consumer dollar. Of course, if they are paying 70% of the revenue on a wholesale account buying at 50% off and the account doesn’t discount to the consumer, the distributor is actually paying 35% of the consumer dollar to its client.
The challenge for distributors is to offer services which don’t commoditize. Many authors already manage their own digital publishing affairs and sneer at the idea that a distributor or publisher has anything to offer that is worth even a token payment, let alone a substantial share. Over time, one can imagine information dashboards, metadata enhancement, dynamic pricing, and marketing assistance capabilities that will give ample justification for a distributor’s presence in the value chain for many authors and small publishers. It would be premature to predict how much value can be added and how much margin it could command. Most of these roads aren’t paved yet. What the distributors are offering at the moment is their ability to navigate unpaved roads and constant marketplace change which, despite the skeptics, is service many of us can see the need for.
What gets perhaps the most attention in the industry’s conversation about dividing the digital swag, but which is dependent on the upstream divisions of revenue, is the author’s royalty from the publisher. The majors have held the line for a year or two at 25% royalty, which means 25% of the 70% they get from the retailer, or 17.5% of the consumer’s dollar. That’s a quarter of what the author can get from Amazon or Kobo, and just a bit more than a quarter of what they can get from Barnes & Noble. Aside from publishers’ significant efforts to build marketing capabilities that will grow sales and their ability to charge a retail price often four times higher than an author would on his/her own, the publishers are offering guaranteed payments (advances against royalties) and a print revenue stream to sugar-coat the 25% digital royalty. Still, as the percentage of books sold digitally rises, it is likely to pull up the percentage of the sale authors will get along with it.
Everything happens faster with digital than it did with physical. And so it will be with changes in the revenue distribution along the value chain. My hunch (all hunch, no data) is that in the long run (5 or 10 years?) retailers will find it hard to keep 30% of the consumer’s dollar, publishers will find it nearly impossible to keep 75% of what the retailers pay, and that any author who wants to compete seriously will have a cost structure that will often make a royalty rate taking even as much as half of it away worth considering. Right now putting an ebook into Amazon and having them sell it on autopilot can get a lot more of the total market than will be the case over time as a more fully articulated and global ebook infrastructure builds out.
If I’m right, retailers should want longer contracts than publishers in their agreements; publishers should want longer contracts than authors, or at least longer terms for the stipulated ebook payout percentages; every author or publisher wants as short a contract as they can get with their distributor; and every author giving an ebook exclusive to a retail channel for longer than an introductory period should think twice about what that might cost in years to come.
Michael Cader did an absolutely fabulous reporting job on the distribution alternatives available today for our eBooks for Everyone Else conference in San Francisco. We’re doing an eBEE track at Digital Book World in January, and Michael’s doing a reprise of that presentation, with time for q&a, at a breakout session there. The distribution piece is by far the most complex of the three moving parts (the retail function and the royalty rate being much more straightforward components that don’t vary much in their definition) and a lot of DBW attendees will benefit from Michael’s reporting.