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Amazon explains digital pricing elasticity

August 4, 2014

Many budding writers claim to major in English because they hate math. But Amazon used a bit of math to explain its side in its prolonged contract dispute with publisher Hachette.

In a brief blog post from last week, the "Amazon Books Team" explained that it wants reduced e-book pricing primarily because "the total pie is bigger" with benefits falling to all parties involved — authors, publishers, consumers and Amazon.

The main point was that e-books are "highly price-elastic," meaning the lower the price, the higher the sales and vice versa. Quantified measurements inside Amazon show that for every e-book sold at $14.99, it would sell 1.74 copies if priced at $9.99. For 100,000 units offered, therefore, the haul would be $1.5 million at $14.99 and $1.74 million at $9.99.

As such, the benefits of the $9.99 price in the Amazon study includes:

  • The customer paying a third less;
  • The author receiving a royalty check that's 16 percent larger and being read by an audience 74 percent larger (potentially then landing on bestseller lists);
  • The publisher and the retailer both generate higher revenue.

While agreeing that a "small number" of specialized titles could be priced over $9.99, Amazon contends that e-books at $14.99 are "unjustifiably high" given that they're digital (no printing, no warehousing, no secondary market, etc.).

Books also compete against mobile games, television, movies, Facebook, blogs, free news sites and more. Wrote Amazon, "If we want a healthy reading culture, we have to work hard to be sure books actually are competitive against these other media types, and a big part of that is working hard to make books less expensive."

Finally, Amazon surprised many by claiming to be willing to continue accepting 30 percent of e-book sales, its current take, if Hachette stopped pricing titles at $12.99 and $14.99. Amazon has been feared to be looking for a 50 percent cut.

The primary criticism of Amazon's analysis was that lower uniform e-book pricing would cannibalize print book sales. The other was that while the theory may work on average, popular authors and books longer in length could command a higher price and still see the volume. Sampling and the methodology of the study were also questioned.

In the Bits column in The New York Times, Farhad Manjoo pointed out that while iTunes had set a uniform price when it first arrived around a decade ago, subscription-based music services, games funded by in-app purchases, and ad-supported social networks are showing new payment mechanisms continue to arrive for digital media. He wrote, "Creating a single, typical price for e-books would stifle that potentially glorious future."

As part of the spat that began in May, Amazon has delayed shipment and prevented pre-orders of some books published by Hachette.

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Discussion Questions:

Does Amazon's price elasticity analysis around e-books make sense? How does supply/demand theory differ for virtual goods and how does it affect comparable physical goods such as printed books? Should authors be swayed?

While we value unfettered opinion, we urge you to show respect and courtesy for people or companies about whom you comment. Keep in mind that this is a public, professional business discussion. RetailWire reserves the right to edit or refuse the publication of remarks that we deem unsuitable. We may also correct for unintended spelling and grammatical errors.

Instant Poll:

Do you believe the writer community would benefit from lowering e-book prices from $12.99 and $14.99 to $9.99?

Comments:

Amazon has no credibility here. The end.

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Cathy Hotka, Principal, Cathy Hotka & Associates

Based on past experience, the Amazon argument makes sense. Pricing an item on sale at a "magic" price point (say, $99.99 instead of $109.99) often drives enough additional unit volume to generate incremental gross margin dollars, even at a lower percentage. There's an old argument about whether dollars or percent pays the bills, but there isn't much doubt about the results.

Amazon is also trying to use demand-based pricing models, which are using increasingly sophisticated algorithms to forecast the effect of pricing on unit sales. In a way, it's no different from your local baseball team using demand-based pricing to drive higher unit sales of a weeknight game in April against a second-tier competitor.

This is not to justify Amazon's hardball tactics in the Hachette dispute. In this case, it's unfortunately the writers and readers getting caught in the middle.

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Dick Seesel, Principal, Retailing In Focus LLC

In order to evaluate the effect of Amazon's pricing, it is essential to model the cross-elasticity with print books of the same title. That is, quantify what the article's author states as: "The primary criticism of Amazon's analysis was that lower uniform e-book pricing would cannibalize print book sales."

One would expect the pricing of an e-book title to affect the decision of whether to purchase it instead of the print book of the same title at least as much as the decision of whether to instead purchase a different e-book. After all, book content really isn't interchangeable, is it?

Amazon is disingenuous if it attempts to argue that their e-book pricing is good for the author without reporting this cross-elasticity. With knowledge of this quantity, and knowledge of what royalty the author makes from each of the two different types of formats his or her creation is delivered in, one can assess who the e-book pricing is good for. I think that we can assume that Amazon's e-book pricing is good for Amazon.

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Dr. Paul Helman, Chief Science Officer, KSS Retail

Consumers don't understand why e-books cost so much. Nothing needs to be printed, there are no warehousing and distribution costs. And you cannot pass the book to a friend, unless you also want to lend your reading device. In explaining their math, whether others agree with it or not, Amazon has taken a consumer-friendly position. Publishers and authors can complain all they want. Amazon has positioned itself on the side of readers.

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Max Goldberg, President, Max Goldberg & Associates

Regardless of the merit of the argument, the strong-arm tactics are not creating a positive image for authors. If the argument is so persuasive, why the strong-arm tactics? Is holding a publisher hostage a good negotiation strategy? I think not. It gives the impression of trying to fix and control prices.

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Camille P. Schuster, Ph.D., President, Global Collaborations, Inc.

The concept is correct. The logic is correct. If the numbers are true, Amazon is correct. However, there is a problem with averages. If an author experiences a 100 percent plus increase he/she will be very happy. But many may experience increases considerably less than the 74 percent quoted. They won't be happy at all.

The upside of course is that we aren't really dealing with reading. We are dealing with buying. And in this case, the cheaper price will stimulate the purchasing of more books that will never be read. I believe I can load over 1,000 books on my Kindle. That's easy. There is no way I could load 1,000 books in my home. It makes the decision to buy so much easier.

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Gene Detroyer, Professor, Independent

"The lady (i.e., Amazon) doth protest too much, methinks." Amazon makes a good argument about pricing, but it doesn't wash in the whole picture here. I'm an author, and I'll certainly never see enough volume to justify the lower pricing vs. anticipated profit.

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Naomi K. Shapiro, Strategic Market Communications, Upstream Commerce

Simple answer; no, it does not make sense. Great argument but no meat. Amazon had something to prove and went out to prove it.

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Mel Kleiman, President, Humetrics

First off, Cathy has it right. Amazon makes decisions on what's good for Amazon. I don't know of a more self-centric organization.

As the author of seven books and one who still marvels at the feel of a great paper, creative layout, addictive fonts and superb book construction and who is a master underliner, nothing at any price will replace a physical book. Truth is, you look smarter when your shelves are lined with amazing books.

I do wonder: 1.) why an author needs a publisher at all; 2.) why a digital book needs to be $15 when a real one cost just $5 or so more; 3.) if the number of sales would go up even further if the e-book was $5 or $7.

On a pastoral note, Amazon needs a reminder that greed and ego have destroyed more businesses than pretty much anything else.

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Ian Percy, President, The Ian Percy Corporation

In a word, "No."

Most people will just read the headlines about Hachette and authors fighting Amazon and skip the extended argument on digital economics.

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Ryan Mathews, Founder, ceo, Black Monk Consulting

Amazon is the expert on eBooks. For all practical purposes they invented the media and the medium. The old line booksellers haven't been able to compete and by the time they catch up, habits will be established that will prohibit success.

From a consumer's perspective, I would never pay over $9.99 for an ebook. I buy about 10 books per month and if I buy hardback, I buy used and save from 50% to 95%. In my case, I would NOT buy a new book, but would buy a new ebook.

Hachette doesn't seem to be familiar with the 21st century. Today's business isn't about margin, it's about profit. If I am a writer, money in my pocket means a lot more to me than my publisher's margin. I believe this may be the beginning of direct sales of books by writers, directly to consumers using Amazon's portal. That should discourage the sales of printed books and maximize profits for the writer and Amazon. Publishers should look on Amazon as a savior, appreciate the volume and get with the program.

Ed Dennis, Sales, Dennis Enterprises

Price elasticity is not the only relevant factor when it comes to understanding consumers' response to a lower price for an e-book. There is also the very practical limit on people's reading time. At $9.99 or even at $.99, there's little point in purchasing more e-books than you'll have time to read.

I'd call this an "external rule" that constrains the elasticity model. Combine this with the very cogent observations about cross-elasticity here by Dr. Helman and the problem starts to become more interesting: There is an upper limit on demand for any title that has much less to do with the price and more to do with the readers' capacity to read and the large selection available.

Another consideration regarding e-book pricing is the "price gap" problem. As the absolute difference in price between the hard-bound book and an e-book widens, we may anticipate a consumer response with significant consequences.

No wonder publishers fret about the shrinking top line that would seem to result when Amazon proposes to lower e-book prices. The incremental soft copies sold on Amazon may be highly profitable, but their sales may boost some titles at the expense of others and alter the economic model for book publishing yet again.

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James Tenser, Principal, VSN Strategies

Whole lot o' thinkin' to do early on a Monday morning! But the answer to the question — very narrowly defined — is "no". Each book has its own demand curve, so it makes little sense to make generalized remarks about an appropriate price. (Amazon admits as much with its concession on specialized titles. The real question is whether/not this is truly a "small number".)

But the answer to the more important general question — are e-books too expensive? — is harder to know. This is an empirical issue, and since Amazon has the most data, it's largely a question of whether you trust them or not.

'notcom'

A couple of retailers have stayed in business selling all products at the same price. However, grocers do not sell everything at the same price. There is a big difference between e-books. They should be priced at what the owner, the copyright holder, wants to price them at. Currently, many authors get a flat percentage of revenue. They would rather sell print. Perhaps Amazon should pay authors directly to produce $9.99 ebooks. Wonder if those books would sell?

'Ron'

Doesn't the Amazon blog oversimplify things? Does it not paint one side of the picture or a complete and true picture? I wonder.

If the books were at $4.99, would we buy more? Would we have the time to consume what we bought? Or say we did buy lots of books because we felt they were well-priced, would that not slow down our future purchases?

I am not sure if authors should be swayed. But all I can say is that they must be worried.

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Mihir Kittur, Co-founder and Chief Innovation Officer, Ugam

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