e-book contracting

The Wall Street Journal has an interesting article, "E-Book Readers Face Sticker Shock ," (gated) about pricing of e-books versus physical book. It seems that publishers are preventing retailer discounting of e-books even though they cannot do so for physical books. As a result, the discount for the electronic version is shrinking considerably.

Under the old book arrangement, major publishers charged the same wholesale price for e-books as they received for hardcovers. For a new novel priced at $25, for example, they received $12.50 for the e-book and $12.50 for the hardcover. When Amazon.com discounted the e-book at $9.99, Amazon took the loss.

But under the new pricing model, a $25 hardcover is often priced at $12.99 for the e-book. And because publishers receive 70% of the e-book retail price -- while retailers retain 30% -- that means publishers receive only $9.09. Publishers were willing to accept the lower profits because they felt the new arrangement preserved the value of books and encouraged other retailers to enter the e-book market.

I have a possible explanation after spending only 30 minutes thinking about this (meaning I very well could be wrong).

The publisher/retailer contract includes a different sort of sharing arrangement than before. With a fixed wholesale price, it would seem that, previously, retailers bore more risk but I believe that they were not charged for unsold physical books. This means that publishers bore a a substantial risk of eating the costs of a poor selling book. This gave them an incentive to exercise quality control in order to publish books that would sell well. With e-books, there are less costs to publishing a poor seller. To have similar quality control incentives, the new contract must make publisher payment a fraction of sales rather than a fixed wholesale price. But if it is a fraction, then retailers may want to discount too much. To solve this problem, publishers have prohibit e-book discounting.

Unfortunately, this may be illegal.

The Justice Department confirmed last week that it was investigating whether there was improper collusion between the publishers and Apple to prevent discounting. Publishers last week either disagreed with the allegations, said they were cooperating with regulators or declined to comment. Random House said it isn't part of the probe and otherwise declined to comment. Apple declined to comment at the time.

Hat tip to Dr. Jane