Tuesday, December 15, 2009

When Amazon and Kindle Win

Last week, I went to a talk given by Mike Shatzkin, who has been doing a good job preparing book publishers for their future. One of his points was that the growing market power of Amazon.com has the potential to disrupt the way that book publishers do business.

After the talk, I was inspired to go home and do a tiny bit of math. It occurred to me that it should be possible to write an equation to describe the point at which authors would find it to their advantage to sell directly through Amazon and Kindle rather than working through publishers. After filling up a spreadsheet, I boiled everything down to one equation that defines the moment that Amazon wins, and the Big 6 publishing houses (Hachette, HarperCollins, Macmillan, Penguin, Random House, and Simon & Schuster) would lose.

Let k be the Kindle's maximum market share for a book's market. In other words, if Going Rogue: An American Life sells a million copies, and 200,000 of those could be Kindle e-books, then k=20%.

Let d be the fraction of the list price that Amazon has to pay publishers for the right to sell a Kindle version. This number is currently 50%. For front-list titles, Amazon is currently subsidizing the Kindle pricing. That means that Amazon pays the publisher $15 to be able to offer a book with a retail price of $30 for $10 on the Kindle. (for Going Rogue the Kindle edition has a pre-order pricing of $8, and the publisher will get $14)

Let r be the author's gross royalty rate from a publisher. In other words, if Going Rogue lists at $28, sells a million, and Sarah gets $2.8 million, the r=10%. It's not uncommon for authors to receive net royalties of 5-10% on print and 25% on e-books; the corresponding gross royalties would be 2.5-5% for print and 12.5% on ebooks, if you assume a 50% wholesale discount.

Finally, let f be the percentage of the book's list price that goes to production cost. For blockbuster books, f can be quite small, because fixed cost are amortized over a very large number of books. It goes without saying that reproduction costs for the Kindle are close to zero.

d*k > r+f,
then it is advantageous for Amazon and Sarah to deal directly, cutting out the publisher completely.

I should note that this ignores the possible profit Amazon might be able to derive from print versions. Do you think they have the logistics expertise to do that?

Its also worth considering the effect of fixed costs. Publishers who specialize in producing many titles that sell only moderately well (i.e. f is large) are probably less at risk of Amazonian disintermediation than those who rely on blockbuster books.

Upon sharing this with a group of people with more experience in the book publishing world, I got the following reactions:
  • Sarah Palin would never go direct with Amazon because what she really wants is a big media campaign.
    Is there a law that prevents Amazon from doing a big media campaign?

  • What about advances? How would authors manage without advances?

    If you put some private equity together with unemployed publishers and bankers, the advances problem might have a solution.

  • Amazon woud never want to become a publisher. Think of the headaches of handling idiosyncratic authors.
    Author agents may play a useful role in easing Amazon's difficulties here. And agents will have lots of fun playing off Amazon against Apple and Google.

  • Amazon might be able to win authors that are already their own brand, but how will new authors be discovered and developed?
    Oprah, I have a business idea for you!
As if to prove my point, it came out yesterday that Steven Covey, author of The 7 Habits of Highly Effective People, is moving his electronic rights to Amazon, which is going to heavily promote his books.

Give me a few more days and I'll have the differential equation. It won't look linear.


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