Wednesday, December 31, 2014

The Year Amazon Failed Calculus

In August, Amazon sent me a remarkable email containing a treatise on ebook pricing. I quote from it:
... e-books are highly price elastic. This means that when the price goes down, customers buy much more. We've quantified the price elasticity of e-books from repeated measurements across many titles. For every copy an e-book would sell at $14.99, it would sell 1.74 copies if priced at $9.99. So, for example, if customers would buy 100,000 copies of a particular e-book at $14.99, then customers would buy 174,000 copies of that same e-book at $9.99. Total revenue at $14.99 would be $1,499,000. Total revenue at $9.99 is $1,738,000. The important thing to note here is that the lower price is good for all parties involved: the customer is paying 33% less and the author is getting a royalty check 16% larger and being read by an audience that’s 74% larger. The pie is simply bigger.
As you probably know, I'm an engineer, so when I read that paragraph, my reaction was not to write an angry letter to Hachette or to Amazon - my reaction was to start a graph. And I have a third data point to add to the graph. At Unglue.it, I've been working on a rather different price point, $0.  Our "sales" rate is currently about 100,000 copies per year. Our total "sales" revenue for all these books adds up to zero dollars and zero cents. It's even less if you convert to bitcoin.

($0 is terrible for sales revenue, but it's a great price for ebooks that want to accomplish something other than generate sales revenue. Some books want more than anything to make the world a better place, and $0 can help them do that, which is why Unglue.it is trying so hard to support free ebooks.)

So here's my graph of the revenue curve combining "repeated and careful measurements" from Amazon and Unglue.it:

I've added a fit to the simplest sensible algebraic equation possible that fits the data, Ax/(1+Bx2), which suggests that the optimum price point is $8.25. Below $8.25,  the increase in unit sales won't make up for the drop in price, and even if the price drops to zero, only twice as many books are sold as at $8.25 - the market for the book saturates.

But Amazon seems to have quit calculus after the first semester, because the real problem has a lot more variables that the one Amazon has solved for. This is because they've ignored the effect of changing a book's price on sales of ALL THE OTHER BOOKS. For you math nerds out there, Amazon has measured a partial derivative when the quantity of interest is the total derivative of revenue. Sales are higher at $10 than at $15 mostly because consumers perceive $15 as expensive for an ebook when most other ebooks are $10. So maybe your pie is bigger, but everyone else is stuck with pop-tarts.

While any individual publisher will find it advantageous to price their books slightly below the prevailing price, the advantage will go away when every publisher lowers its price.

Some price-sensitive readers will read more ebooks if the price is lowered. These are the readers who spend the most on ebooks and are the same readers who patronize libraries. Amazon wants the loyalty of customers so much that they introduced the Kindle Unlimited service. Yes, Amazon is trying to help its customers spend less on their reading obsessions. And yes, Amazon is doing their best to win these customers away from those awful libraries.

But I'm pretty sure that Jeff Bezos passed calculus. He was an EECS major at Princeton (I was, too). So maybe the calculation he's doing is a different one. Maybe his price optimization for ebooks is not maximizing publisher revenue, but rather Amazon's TOTAL revenue. Supposing someone spends less to feed their book habit, doesn't that mean they'll just spend it on something else? And where are they going to spend it? Maybe the best price for Amazon is the price that keeps the customer glued to their Kindle tablet, away from the library and away from the bookstore. The best price for Amazon might be a terrible price for a publisher that wants to sell books.

Read Shatzkin on Publishers vs. Amazon. Then read Hoffelder on the impact of Kindle Unlimited. The last Amazon article you should read this year is Benedict Evans on profits.

It's too late to buy Champagne on Amazon - this New Year's at least.

3 comments:

  1. Hm. An author friend of mine has noted he actually makes more money when people read the same title on Kindle Unlimited than when they buy it conventionally. Point in your favor, there.

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  2. They will if a book is usually priced at $1.99 or less, not if it's priced higher. Higher-priced books will lose money each read versus an outright sale.

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    Replies
    1. ...which will encourage the serialization of longer works. And because of the way payment networks work, Amazon has a big advantage over any other retailer except maybe Apple at the lower price points. Payment networks eat $0.33 of the first dollar.

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