The Pervasive Data Center

We've all heard the rant. With e-books, there's no paper, printing, transportation, and so forth. So why should an e-book still cost $9.99 (typical for Kindle) or even more?

The idea of e-books being cheaper makes a lot of intuitive sense. If everything you physically hold in your hand and everything it took to deliver that physical good to your hand can be converted to a few megabytes worth of electrons, surely the cost of the book must be dramatically lower than a typical hardcover--and the price should reflect that fact.

The problem is that the costs aren't nearly as much lower as you might believe. Here's one breakdown from Money magazine for a hardcover bestseller by way of Scott Laming of BookFinder.com Journal:

Based on a list price of $27.95

$3.55 - Pre-production - This amount covers editors, graphic designers, and the like
$2.83 - Printing - Ink, glue, paper, etc
$2.00 - Marketing - Book tour, NYT Book Review ad, printing and shipping galleys to journalists
$2.80 - Wholesaler - The take of the middlemen who handle distribution for publishers
$4.19 - Author Royalties - A bestseller like (John) Grisham will net about 15% in royalties, lesser known authors get less. Also the author will be paying a slice of this pie piece to his agent, publicist, etc.

This leaves $12.58, Money magazine calls this the profit margin for the retailer, however, when was the last time you saw a bestselling novel sold at its cover price.

One way to look at this is to look at the percentage of the list price that printing represents. That's 10 percent--plus at least a chunk of the wholesaler line item. So let's call it 20 percent in all.

But, as noted, given that books generally sell at a discount off list, I find it more intuitive to look at this the other way. Start at zero and add cost and profit line items. In the example, the typical volume retailer is often making far less than the $12.58 figure would suggest. A 40 percent discount brings it down to only $1.11; hardcover bestsellers are a sort of loss-leader for retailers.

Pre-production. Other things being the same, there's no reason this goes down with an e-book. Arguably it's a bit lower if something is sold solely as an e-book--perhaps a bit less design work and proofing related specifically to the physical nature of a book--but it's actually likely a bit higher if we're talking about having both physical and digital versions--as would be the typical case today.

Now some, such as blogger Aaronchua, argue that this just shows that traditional publishers "have not changed their operating structure to leverage on the new economics brought on by the Web."

However, as noted in discussion of the prior piece, these functions are not just costly overhead. "After the book's in the publishing house, it is usually reviewed by like up to 5 editors who give their opinion before it's handed over to one editor who they believe is the best for it. You then get an editor, who through multiple revisions helps the author get the book to a better standard and quite often to more closely resemble the author's original idea."

Now, perhaps the whole process is too heavyweight. But how many of us have read a book and thought to ourselves that "it really needed an editor." Most of us, I'd say. You can skimp here but the results often show it.

Marketing. Again, there's no inherent reason why the dollar amount changes. Many aspects of the marketing process probably change if we posit an all-digital world. But social media and other forms of viral promotion are not a panacea that magically replaces book tours, professional publicity work, and so forth. Sure, you don't need to do any of this but you don't need to sell many books either.

Profits. Let's be generous and cap the costs there. In practice, there are going to be some costs related to digital delivery that someone is going to have to shoulder along the line, but ignore that.

If we're going to sell the book for $9.99 net of any discounts, that leaves us with $4.44 to split between the retailer and the author. Compare that to $4.19 for the author in the printed book example and something between about $1 and $10 for the retailer. So a $9.99 e-book in this example leaves less money after costs than the hardcover does.

This may be made up by higher volumes to some degree. However, as Tim O'Reilly noted in a 2007 post:

I think that the idea that there's sufficient unmet demand to justify radical price cuts is totally wrongheaded. Unlike music, which is quickly consumed (a song takes 3 to 4 minutes to listen to, and price elasticity does have an impact on whether you try a new song or listen to an old one again), many types of books require a substantial time commitment, and having more books available more cheaply doesn't mean any more books read. Regular readers already often have huge piles of unread books, as we end up buying more than we have time for. Time, not price, is the limiting factor.

The economics of selling back-catalogs may also be different. Pre-production costs are, almost by definition, fixed. They're incurred before the first book can go out the door. Marketing is also primarily a fixed advance cost. (Although the size of budgets will be tuned to expected sales--unknown authors with no track record shouldn't expect massive advertising and publicity campaigns.)

So once those costs have been incurred--and hopefully recouped--in more or less the usual way through the first couple of years of a book's life, it may make sense to offer a discounted digital edition given that it doesn't incur the cost overhead associated with lower volume "long tail" sales.

(In principle, you could argue that the same logic applies to the pricing of digital editions at any time in a book's lifecycle. However, in practice, a $5 e-book of a new release would cannibalize the more profitable print edition.)

I know this post went into a lot of detail, but when you're talking about business models and pricing, it is important to actually run the numbers. One can dispute fundamental assumptions behind those numbers of course, but at least they give a starting point.

In this case, they show that--if you want the same level of professional preparation and promotion associated with a typical printed book--the $9.99 e-book price that a lot of people grumble about is probably pretty near the floor.