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From some perspectives, we are tipping right now and publishers’ metrics will show it

February 22, 2011 by Mike Shatzkin 85 Comments

Sometimes, and it would seem quite often these days, the future comes faster than you expected it.

Followers of this blog, and of my speeches before there was a blog (this one’s from 2001!), know I’ve long been expecting ebook reading to supplant print book reading for many people. I’ve been wrong about the timing. (Ten years ago I’d have expected to be where we are now three or four years ago.) I’ve been wrong about whether a dedicated device for reading would make much of difference. (I read so comfortably on a phone, and before that on a PDA, that I figured few would want yet another device for reading only.) And I’m rethinking my expectations around enhanced ebooks and the utility of social reading.

But it has seemed clear to me for a long time that ebooks offered compelling advantages over print — portability, ease of purchase, and a lower cost basis that must inexorably lead to lower prices — that would increasingly sway many of the inevitably growing number of people who had a readable handheld screen in reach most of the time. And my long experience dealing with bookstore economics made it clear to me that the consequent sales subtraction from brick-and-mortar stores would lead to closures, which would lead to longer travel times for customers to get to the stores, which in turn would drive more people to purchase print or digital books online. And that would lead to more closures. This is a virtuous circle if you’re in the ebook business or sell print online. Or if you want to see Americans consume less gasoline.

It is a vicious cycle — a death spiral — if you’re a bookstore.

Michael Cader of Publishers Lunch reported (you have to subscribe to use the links) that BookScan numbers show a drop in unit sales of printed books of 4.4 % from 2009 to 2010. But don’t take that number to any bank. It is already out of date. Cader did a further analysis of more recent BookScan data shortly thereafter showing that print book sales have dropped by over 15% compared to the prior year over the first six weeks of 2011! And the share of print sold online keeps rising, so that almost certainly means that print sales in stores has fallen even faster. Could print sales in stores have dropped 20% or 25% from a year ago? They certainly could!

Sales of iPads, Kindles, and Nooks exceeded most expectations for Christmas 2010. Dominique Raccah, the head of independent publisher Sourcebook, a company with a diverse trade list, reported on her blog that dollar sales at her company in January were 35% digital!

No wonder she says, “We may well be at the tipping point. I suspect that we’re going to see some dramatic reassessment when publishers look at their numbers at the end of the first quarter, 2011.”

I have heard the argument from very smart people that ebook adoption will plateau at some point. Since it has been doubling or more for the past three years and was often placed in the mid-teens for new fiction and narrative non-fiction by the last quarter of 2010, we know that it can’t continue to double for the next three years without exceeding 100%. Nonetheless, predictions that ebook sales would achieve 50% in the next five years and that bookstore shelf space would drop by 50% in the next five years — which is what I thought would be the case — seemed pretty aggressive six months ago.

They don’t seem aggressive anymore.

The Borders share of the publishers’ revenue is estimated to be about 8%. They could be 10% or 12% of brick-and-mortar. So if Borders were to completely disappear tomorrow (and they aren’t about to do that) and even if every book they sold in their stores were somehow purchased at somebody else’s store (which won’t happen), the reduction of book sales in stores is so large that all the other stores would still, collectively, be looking at a substantial year-on-year sales decline.

All this means that 2011 that is going to be a real “fasten your seat belts” year for publishers. And Raccah is right that publishers are going to be a bit stunned at what they see when they look at their numbers for the first quarter of this year.

One impact that sophisticated publishers are well aware of but that is not obvious to the untrained eye is that as sales go down, returns percentages, inevitably and inexorably, go up. When a publisher calculates a returns percentage for any period — a week, a month, a quarter, or a year — they are measuring the returns received and credited in that period against the sales made in that period. But the returns actually come from the sales made in prior periods; even in the worst of situations, very few books are returned less than three months following their purchase.

So what’s happening right now is that shipments out are being depressed — no or very little Borders and diminished expectations everywhere else — while returns are rising because they’re coming back from orders placed against the higher expectations of the past six to 12 months. That means that the net sales numbers being created right now — shipments out minus returns — might, for many, be a disappointment verging on devastation.

And returns percentages aren’t the only percentages that are going to be troubling. Two others that publishers look at are also going to get more challenging.

The percentage of a book’s print price that is constituted by the “unit cost of manufacture” is one. The unit cost is extremely run-sensitive. If you’re printing fewer books and if you have to hold the line on retail prices (both of which will almost certainly be true), the percentage of revenue spent on creating the print books is going to rise.

The second trouble spot is that publishers like to think about the cost of “fixed overheads” as a percentage. Many publishers still follow the unwise practice of putting a percentage calculation of overhead into their unit cost calculations for every book. But if sales volume falls faster than overheads can be reduced, that percentage rises too. And you can’t fire your way to rapid overhead reductions very effectively. Shedding staff is often an illusion anyway; we keep hearing about freelancers getting work because publishers have fired the staff that used to do it. But, besides that, warehouse and office space costs and systems investments don’t rise or drop with volume (which is exactly why it is a logical error to calculate them as a percentage of revenue!) Publishers who are using a percent figure for overhead to calculate their margins on each title they acquire to sell are going to find those numbers need to be reconsidered as well.

While Barnes & Noble will be feeling the margin pain of all brick-and-mortar booksellers, they are, no doubt, also very well aware of their growing importance to all publishers in an upcoming Borders-less (or less-Borders) world. B&N will almost certainly be looking for better trading terms and publishers will almost certainly feel the weakness in their negotiating position dealing with those requests. And that’s aside from the fact that publishers really and truly want a healthy Barnes & Noble maintaining its ability to show their wares to the public.

So sales are going down, returns are going up, the cost of goods is going up, margins from sales are going down, and right-sizing overheads is going to be an accelerating problem. The good news is that ebook sales are rising and the margins from them — at least for now — have been pretty well preserved.

But the first significant sign that ebook prices are going to tumble has arrived with the news that 99 cent ebooks are now beginning to appear on the mainstream media’s ebook and combined bestsellers lists which come from The New York Times and USA Today. This creates some nasty problems. It puts previously unknown authors selling 99 cent books before the public as bestseller creators. And it encourages the established publishers to cut prices to register unit sales to get on those lists themselves.

At the very least, I’d expect publishers to start asking The Times and USA Today to consider the total revenue a book generates at retail (price times units) when creating the lists, not base them on unit sales alone. Since the established publishers buy a lot more ads than the 99-cent-book authors do, we should expect them to, at least, get a hearing.

Publishers are going to be scrambling to keep their business profitable and having second thoughts about many of their most time-honored practices in the weeks to come.

Filed Under: eBooks, General Trade Publishing, Publishing, Supply-Chain Tagged With: Barnes & Noble, BookScan, Borders, Dominique Raccah, Michael Cader, New York Times, Publishers Lunch, Sourcebooks, USA Today

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Mike Shatzkin

Mike Shatzkin is the Founder & CEO of The Idea Logical Company and a widely-acknowledged thought leader about digital change in the book publishing industry. Read more.

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