Amazon vs. Hachette

Regular readers will know that I have been following the dispute between Hachette, the French-owned publishing house and Amazon.  The two companies have now signed a deal to end their long-running price dispute.

According to the Daily Telegraph: the two firms had disagreed about the price of ebooks which can be read on Amazon’s market-leading Kindle device.  Amazon believed most new ebooks should be $9.99, which many in the traditional publishing industry said was not financially sustainable.  It also wanted to restructure the way revenues were split between the publisher, author and  itself.  Hachette refused to back down on lowering prices.  The dispute gained public attention earlier this year when hundreds of authors supported Hachette.  They argued that  Amazon’s pricing tactics were damaging writers and high streets around the world. The online retailer responded by increasing shipping times on Hachette books, blocking pre-orders, and redirecting customers to other publishers.  In August a group of 900 writers paid for a full page advert in The New York Times criticising Amazon’s actions: “These sanctions have driven down Hachette’s authors’ sales on Amazon by at least 50%.  Amazon has other negotiating tools at its disposal; it does not need to inflict harm on some of the very authors who have helped it to become one of the largest retailers in the world.”

Under the agreement which has been reached between the two companies, Hachette will have responsibility for setting prices of its ebooks, and “will benefit from better terms when it delivers lower prices for readers,” according to a joint press release.

Hachette said: “This is great news for writers.  The agreement will benefit Hachette authors for years to come.”

David Naggar, vice president of Kindle, said, “We are pleased with this new agreement as it includes specific financial incentives for Hachette to deliver  lower prices, which we believe will be a great win for readers and authors alike.”

How can all three of the statements in quotation marks, above, be true at the same time?

The short answer is, I don’t know.  But I have a theory.  Suppose under the old deal at $9.99, Amazon got 40% and Hachette got 60%: $4 for Amazon and $6 for Hachette, and suppose that Hachette pays its authors a one third royalty from its revenue: $2 per copy.  And suppose, under the new deal, Hachette prices its ebooks at $15 per copy and gets 55% of the selling price, while Amazon gets 45%.  This would give Hachette income of $8.25 per copy, and the author would get $2.75 per copy: a better deal for all three parties assuming that the volume of the ebook is not price sensitive.  But, if for example, only half as many copies are sold at $15 as at $10, everybody is worse off.  This is where Amazon’s obsession comes in: the lower the price the more you sell!  I’ll bet that the deal is structured so that Hachette’s share of the sale increases as the price is lowered.  In this example, for each dollar reduction in price, Hachette would get one percent more of the selling price.

So:

Statement no. 1 is true: Hachette gets better terms as it lowers its price (not better revenue, but better terms)

Statement no. 2 is true: Hachette authors will benefit ($2.75 vs $2 assuming that the volume of sales are not particularly affected at the higher price)

Statement no. 3 is true: lower prices are a win for authors and readers alike (assuming lower prices mean greater sales volumes)

It seems to me that this dispute boils down to different views on the price elasticity of books.  Amazon believes that price is very elastic: the higher the price, the less you sell and the lower the price the more you sell.  Amazon apparently has some data which supports this theory.

Hachette believes that, within a certain price band, the price is inelastic: volume is largely unaffected by price.

My own view is that Hachette is probably right.  They have experience with their authors and their genres to be able to predict volume, and they have a pretty good idea of where the price band should be.  They will be quite sure that if they price a book at a third of its normal price band, it won’t sell four times as many.

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