Pricing strategies in the e-book market

As mentioned above, the wholesale model implies that a complete control over decisions is in the hands of the retailer. The main competitive concern that arises under this model is that it gives room to use the price of the e-book as a strategic variable to promote the sale of the related device. In this way, by pricing e-books below cost, retailers foster consumption of their e-readers. The problem becomes clear when one takes into account that there exist retailers who do not manufacture e-readers, and hence, cannot afford to follow this strategy as they cannot recoup the losses made by the e- book sales. Eventually, this would lead to marginalization and exclusion of smaller retailers. Furthermore, this could result in a reduction of consumers’ choice since these small retailers are often focused on specific niches, not commonly covered by large booksellers (though elasticity of demand in this segment may be lower).

Moreover, this strategy may have effects on competitors in the e-reader manufacturing sector, specifically on those who also provide e-books (retailers/manufacturers). In this sense, a sort of technological tying is typically practiced because those retailers who supply devices offer only e-books that can be displayed on their own e-readers. Since potential   consumers  take  into  account  this  technological  restriction  when  making purchasing decisions, prices in the aftermarket of e-books become a fundamental factor in order               to determine the               device choice.               Therefore,  if   e-books offered by one retailer/manufacturer are priced below costs, this would affect the market for competing devices, potentially excluding other retailers/manufacturers and limiting consumers’ choice.

3.2.The agency model

On the other hand, under the agency model, retailers become agents, whose main function is to get books from publishers and sell them directly to consumers. Publishers set prices and retailers simply “pass” books to consumers, receiving a commission on sales, and not being allowed to make any sort of discount apart from the previously agreed on with the publisher (typically 5%) and in a given period of time.

As we may well see, the nature of the upstream-downstream relationship (between publisher and retailer) changes completely with the two pricing models.

The agency arrangement is pretty similar to the one that is in place in many European countries for print books (the so called Fix Book Price Agreements or Fix Book Price Laws –  FBPA or FBPL). This, basically, is a Resale Price Maintenance clause, aimed at promoting non-price competition between booksellers in order to foster the sale of little-known books rather than catering only to blockbuster readers. This vertical restriction, by protecting retailers’ margins, provides booksellers with incentives to embark on pre-sale efforts, to carry larger inventories, etc. Under the EU competition law, RPM (Resale Price Maintenance) clauses are considered as hardcore restrictions, nonetheless, agency agreements are a priori excluded.

The agency model basically consists of a Resale Price Maintenance (RPM) clause, which stipulates that a minimum retail price is set by the publisher and the retailer acts as an agent entitled to receive a certain commission (computed as a percentage of the price and typically based on a 30/70 scheme). Consequently, price decisions are completely controlled by publishers.

To clarify how these models work, an example is provided below.

THE WHOLESALE MODEL

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PUBLISHERS

RETAILERS

Publishers sell books to retailers at a RRP less a discount (e.g. $30 and 50%)

Retailer determines the final selling price to consumers

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Retailer buys the e-book from the publisher and pays $15 (of which a given percentage, say,

25%, $3.75, goes to the author as royalties). The retailer may well choose to sell the e-book for less than $15 (i.e. at a loss).

THE AGENCY MODEL

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PUBLISHERS

     RETAILERS

Publishers set the price

Retailers act as agents. They take a 30% commission and pass the remaining 70% to publishers.

The publisher sets the e-book price at $15. Under a 70/30 scheme, the publisher gets $10.50 (the author is credited with $2.625) and the retailer gets $4.50, which is less than what they would earn under the alternative model. However, the retailer would have to sell the e- book for the set price (or at a maximum discount of 5%).

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4. International experience

In conducting the research, it must be borne in mind that it is hard to make a worldwide analysis because there is still no harmonization of policies related to the book industry, neither print nor digital. In some countries, the aforementioned Fixed Book Price Agreements or Laws are in place, so that the introduction of the agency model does not mean a completely different approach. Nevertheless, these agreements/laws cover both printed and electronic books only in some countries (Spain and recently France), while in others the latter are not explicitly included (Portugal). Therefore, the agency model would make a difference in those countries where e-books fall outside the agreements/laws.

4.1 The United States e-book market

Though e-books and e-readers were in use back at the very beginning of the 2000s (iLiad, 2006; Sony Reader PRS-500, 2006), this market really took off in the U.S. in 2009. The main player in the market was Amazon, which already had developed its Kindle, set prices under the wholesale model. Most retail prices were set equal to $9.99, regardless of the novelty or genre of the e-book. As publishers noted in many occasions, this strategy implied losses for Amazon in many titles. A justification of this tactic carried out by Amazon is the fact that being aggressive in the e-book market would enhance the demand of Kindles. This can be seen as part of a more comprehensive business strategy, which Amazon intended to use to build a strong position in the growing market. In this sense, it is worth mentioning that during 2009 Amazon developed several free applications that allowed other devices (not e-readers themselves) to display the titles, which formerly could only be read on Kindles.

It must also be noted that discomfort among publishers was arising because valuation and willingness to pay for e- books on the part of consumers was being damaged. This is particularly dangerous when a product is being established in the market since it would probably set “precedents” of a low cost/value good.

This scenario completely changed when Apple started setting the terms for e-books for its forthcoming iPad (the closest non-e-reader competitor of Kindle) in early 2010. From the very beginning, Apple negotiated  with  the main publishers in U.S. a wholly different pricing model to supply e-books to iPad users through the iBookstore, the agency model. Macmillan was the first publisher with whom Apple reached an agreement, which led to some kind of retaliation on the part of Amazon, which temporally removed the “buy” buttons for Macmillan’s titles from its website. However, major publishers agreed with Apple into the agency model (the Agency Five: Macmillan, Simon & Schuster, HarperCollins, Penguin, and Hachette; later on,  in March 2011, Random House also switched to the agency model) and pressured Amazon into undertaking the same arrangement, which was effected in February 2010. It needs to be stressed here that this contract model, which implied prices of $12.99 to $14.99 for most fiction and non-fiction titles (including best-sellers), yielded lower revenues for publishers, who received a 70% of the final price. This “sacrifice” was supposedly accepted by publishers to prevent Amazon from gaining a stronger position and more bargaining power and to preserve e-book value.

Furthermore, this agreement extended to commercial relationships between the main publishers and retailers. It resulted in a great similarity in prices for different titles, thereby raising competitive concerns.

In fact, five of the six publishers involved held around 60% of the overall sales in the market in 2009 according to different sources.

4.2 European Union e-book market

In Europe, the adoption of the agency model took place at quite an early stage of the European e-book market development. And was simultaneous with the introduction of iPad and its associated agency model.

In early 2011, this model gave rise to competitive concerns in the Office of Fair Trading, which started an investigation working closely with the EC. The concern was related to the suspicion that e-books prices were fixed by publishers, given that they were twice as expensive as their printed version. This fact triggered a European wide investigation in which the EC is still working with national competition  authorities. However, which publishers are raided  is unknown.  The involvement of the EC does not necessarily mean that a pan-European cartel is being suspected (among publishers present in several countries), but the fact that e-books are sold across borders.

In this sense, parallelism with the case of U.S. is not straightforward. There are several elements that differentiate the European e-book market, making the analysis more difficult.

As regards intra-brand competition, it must be noted that, as it was mentioned before, there are countries in which prices of books are allowed to be fixed by law (e.g. France and Spain), which means that price fixing, and thus the agency model, is legal. Of course, this does not imply that coordinating on prices among publishers is permitted but it is just simpler to reach. On the other hand, in some countries in which such laws are not in place, the agency model is also present (e.g. UK).

This limited, or null, downstream competition enhances the likelihood of a collusive agreement among publishers.

With respect to upstream competition, a common practice among publishers is the establishment of platforms through which an individual publisher, or even a group, sells books directly to final  consumers or retailers. This, together with the existence of associations of publishers, increases transparency and observability in the market, leading to fast detection of deviations from the agreement and to a timely punishment.

On the overall, it seems highly plausible for publishers to reach collusive agreements on prices of e-books.

4.3 Comparison of the US and EU e-book markets

As we can see from the subchapters above, the United States and the European Union e-book markets are different in nature and activities. Below there comes a comparative analysis of the two markets.

According to statistics, e-books currently make between 15 and 20 percent of the overall book sales in the United States. It is obviously a dramatic and quick rise since 2010. In the rest of the world, however, the situation is entirely different. In the UK, e-books account for about six percent of sales which makes the UK second in the list after the US.  In Germany, Spain, France, and Sweden, e-books make only 1 percent of total book sales. Apparently, we can characterize European e-book markets as still nascent.

The new report from O’Reilly Media, “The Global eBook Market: Current Conditions & Future Projections” and discussions at the Frankfurt Book Fair suggest that foreign countries won’t necessarily follow an identical but delayed path to the widespread e-book adoption.

The fact that the e-book business has been slow to develop in Europe and other international markets has important ramifications for publishers there. In the U.S., the quick growth of e-book sales has been something of a lifeline for publishers facing a declining print book business. E-books have allowed publishers to reach new readers, and studies show that owners of e-readers buy and read more books overall. The absence of a vibrant e-book business in most foreign countries is depriving publishers there of the same advantages.

In Europe, Amazon, the most famous retailer of e-books, will clearly be the key to helping e-book markets to develop. Its Kindle has recently entered into Europe and been welcomed by many publishers and readers who are looking for easy ways to sell and buy e-books. Yet, some European publishers are wary about Amazon’s deep impact on shaping e-book emergence there. Their main fear is that Amazon might bypass or override traditional practices like price regulation.

In terms of a timeline for growth in Europe, big European publishers believe that it will take at least three years before e-books are close to 10 percent of sales there. It may take even longer in other parts of the world and the reasons for that are as follows:

       Relatively few affordable e-readers

Affordable e-readers are one of the main drivers of e-book growth, and until recently they’ve been virtually non-existent in much of Europe. It was only in 2011 that Amazon finally brought the Kindle to Germany and France. At the same time, Spain and Italy aren’t expected to get the device until at least the end of 2012.

       Not enough e-books

Lack of e-book titles is also keeping the digital book business from growing faster in Europe. Publishers in many markets have only recently begun releasing new local-language e-books simultaneously with print books. Moreover, they are still in the very early stages of digitizing their backlists. Simultaneously, there is also a dearth of foreign-language titles in digital form. Geographic restrictions limit where e-books from other countries can be sold, and what is also important is that the copyright law for e-books complicates relationships between authors, agents, publishers and distributors.

       E-books are expensive

E-books cost more in foreign countries than in the U.S., even without taking the VAT into account.[11] The recent research by Italy’s Bookrepublic and AT Kearney found that the average price for a newly published e-book across the world is currently €10.50, ($14.5/£9.19), not including taxes, whereas the average price in the UK is €10.80, ($14.91/£9.45) and the average in the U.S. is €9.30. ($12.84/£8.14).

       VAT

Most countries in the European Union and Scandinavia have a value-added tax (VAT) on print books and e-books, with the tax being much higher on e-books than on print books. The main reason for this is that under the definition of the European Commission, books are considered products, while e-books are considered licensed services. The VAT on e-books in Italy, for example, is 25 percent, compared to 4 percent for print books there. This undoubtedly contributes to higher e-book prices.

The above-said allows us to conclude that the e-book adoption is not going to follow the same path in every country. It is determined by numerous parties, including governments, publishers, producers and, certainly, readers.

4.4 Russian e-book market

Though the major focus of our research has been on the United States and European Union, we feel it necessary to take at least a brief look at the state of things in the Russian e-book market.

As the number of available e-book titles continues to increase and prices fall, Russians are exhibiting an increasing affinity for reading on screens. However, market players caution that it will be a long time before e-books replace printed titles.

Moscow Times reported, that the “size of the Russian e-book market is currently $2.2 million, with e-books accounting for less than 1% of total book sales.”

The Russian e-book market is dominated by two players: LitRes, the biggest copyright holder on Russian-language books, which controls 54 percent of the market, and Imobilco with 20 percent. E-book prices on LitRes, for example, range from 10 rubles (33 cents) for Tolstoy’s novel «Childhood» to 250 rubles ($8.50) for the Russian translation of Walter Isaacson’s «Steve Jobs». RBK Research estimates that in the best-case scenario, e-books’ share of the Russian book market could hit 30% by 2015.

Mikhail Osin, director of the digital sales department for Ozon.ru–which has been called “Russia’s Amazon”–said, “Sales of e-books are rising at a fast rate, and this trend will continue in the future. New technologies are occupying a segment of the market, which of course is a concern to publishers, making them adapt their business model and even switch to the production of electronic books.” Ozon.ru had a 40% increase in e-book sales in 2011, with e-reader purchases rising 250%.

As for e-reading devices, their prices have dropped about 30% over the past two years. Yevgeny Militsa, director of e-reader retailer PocketBook Russia–whose e-readers range in price from 3,400 rubles ($115) to 15,000 rubles ($507)–said his company sold approximately 400,000 devices in 2011, which doubled 2010 sales. He expects the market to grow another 50% in 2012.

And yet, as Alexander Bobrowski of LitRes observed: “For many Russians, the value of a book still lies in its tangibility. For this reason paper still prevails.”[12]

Conclusion

On the basis of the work carried out we have come to the following conclusion.

The development of the e-book market needs to be cautiously monitored. International experience, particularly in the US, has shown that both pricing models give room to different strategic anti-competitive behaviors and hence, competition concerns. Specifically, the wholesale model is widely used to predate in the e-book retail market, cross-subsidizing the losses with the sales of e-readers (which could be done owing to the existence of a technological tying). As regards the agency model, the main competitive concern here is that it facilitates collusive agreements among publishers.

These issues are even more complicated in the EU since countries have different policies regarding pricing and taxing books in general and e-books in particular. A higher degree of harmonization is necessary in order to prevent potential arbitrage and to promote market integration.

It also needs to be stressed that this is a new market and available information is still scarce enough.

References

       Adams, D.; The Agency Model. Not a bad idea, only illegal (in Australia) in The Digital Reader - 03/04/11 (http://www.the-digital-reader.com/2012/02/01/the-agency-model-not-a- bad-idea-only-illegal-in-australia/)

       The Global eBook Market: Current Conditions & Future Projections; By Rüdiger Wischenbart, additional research by Sabine Kaldonek

       Allen, K.L.; The Agency Model Redux: An Analysis After Six Months in the Diesel eBook

       Store Blog - 12/02/10 (http://blog.diesel-ebooks.com/?p=704)

    Angier, M.; Top Ten Reasons Why eBooks Are Better than Printed Books in Power Home

       http://www.powerhomebiz.com/vol127/ebooks.htm

       Basten, A.; More raids in price-fixing probe. Publishers “explain” high ebook pricing in TeleRead – 03/04/12 (http://www.teleread.com/paul-biba/more-raids-in-price-fixing-probe- publishers-explain-high-ebook-pricing/)

       Bradbeer, M.; Why the agency model is flawed in FutureBook - 09/21/11 (http://www.futurebook.net/content/why-agency-model-flawed)

       Jones, P. and Casassus, B.; European publishers offices raided by EC inspectors in The Bookseller.com –(http://www.thebookseller.com/news/european-publishers- offices-raided-ec-inspectors.html)

       Jones, P.; Ten things about the agency model in the UK in FutureBook - (http://www.futurebook.net/content/ten-things-about-agency-model-uk)

       www.wikipedia.org

       Kindle claims 45% of eReader market, Sony claims 30% in the Best Tablet Review -

       09/01/09 (http://besttabletreview.com/kindle-claims-45-percent-of-ereader-market-sony- claims-30-percent/)

       Kindle vs. iPad Review in the iReader Review -01/27/10 (http://ireaderreview.com/2010/01/27/kindle-vs-ipad-review/)

       Koleva, G.; Apple, Amazon targets of eBook price fixing probe in Wallet Pop – 08/04/2010 (http://www.walletpop.com/2010/08/04/apple-amazon-targets-of-ebook-price-fixing-probe)

       Kunhardt, J.; eBook Pricing Deals May Violate Antitrust Laws; CT Attorney General Launches Investigation in HuffPost – Books – 03/08/10 (http://www.huffingtonpost.com/2010/08/03/ebook-pricing-deals-may-v_n_667919.html)

       LeCharles Gonzalez, G.; eBook Market Needs Transparency, and Fast in the Digital Book World - 06/09/10 (http://www.digitalbookworld.com/2010/ebook-market-needs- transparency-and-fast/)

       Lowe, S.; The Advantage of an Ebook Agency Model in Publishing Bits - 06/03/10

       (http://publishingbits.com/ebook-strategy/30-advantage-of-an-ebook-agency-model.html)

       www.fep-fee.be

       www.publishers.org

Appendix

A.1: Main e-readers