Amazon/Macmillan: Price discrimination and demand elasticity

My latest Publishers Weekly column, "The Price Is Right," looks at the Amazon-Macmillan price dispute as a fight between two strategies for maximizing profit: price discrimination (getting the most out of each customer) and demand elasticity (sacrificing some per-customer revenue to sell to more people) and how these two strategies are challenged by the nature of digital goods and complexified by proprietary formats and DRM:
Everyone with a product to sell practices both price discrimination and demand elasticity in varying degrees. But when the product you're selling is digital, the correct ratio of one to the other becomes a lot harder to calculate. If you're selling hard goods, whether books, shovels, or coffee beans, the math is easy: you can't make money if you drop your price below the marginal cost of production. But digital goods, like e-books, have almost no marginal costs. Things like credit card processing fees, electricity and bandwidth, and a few other considerations keep the cost from truly falling to $0, but the low marginal cost of selling digital copies opens up some very exciting possibilities for publishers. Could the pool of people willing to buy books--the total number of regular readers--be increased by dropping the price? And could that increase in new customers be large enough to offset losses from smaller margins? Amazon clearly thinks so.

But pricing and profit-maximizing strategies aren't the whole story. Consumer electronics buyer demographics tilt heavily to the coveted 18-34-year-old who'll buy anything slim with an eggshell finish. Turning those big spenders into readers is an exciting prospect for anyone who cares about bringing in new business--and Macmillan executives are keenly aware of the opportunity e-books represent for turning nonreaders into new customers. Tom Doherty, publisher of Macmillan's Tor imprint (Tor publishes my novels), is positively luminous on the importance of inducting nonreaders into the practice of regular reading. And there's no bookseller on earth with more nonreader customers than Amazon, which, in addition to books sells everything from server space to freeze-dried steaks, sex toys, and uranium ore.

The Price Is Right

(Image: Price discrimination.small GFDL licensed, Wikimedia Commons)


  1. Thanks for posting this. I’ve been quite dismayed at what seems to be a complete failure to realize that lowering price substantially increases profit substantially. Valve seems to be the only company that realizes this. For example, check out these figures.

    They lowered price by 75%, and got a 1470% increase in sales. Lower price is more money.

    The problem that movie, music, and book publishers have when selling digitally is they only dip in their toe. Then when the toe dip fails, they pretend the whole thing is a failure. Look at Stephen King who only sold a chapter at a time, then declared the model a failure.

    I strongly believe that if a publisher had the testicular fortitude to go in whole hog, they would see similar results to what Valve and other video game publishers see on Steam.

    Sell a DRM-free e-book for $1. You will see more than 10 times the sales you will see at $10 price point. Sell a DRM-Free MP3 for $0.10 and you will see more than 10 times the sales you see at $0.99. Sell a movie download for $1. Sell an entire TV season for $5.

    The cheapest Netflix plan is $9 a month. If you watch one TV episode per day that is approximately $0.30 per episode.

    Pricing is all screwed up because there aren’t enough people willing to take the risk and demonstrate the truth in any medium besides PC games.

  2. In the Bold Digital Future(tm) the idea that there will be “a price” seems increasingly unlikely.

    Amazon, for instance, does absolutely loads of customer profiling. To generate better recommendations, sure; but it also provides them with a strong basis for inferring your level of wealth, response to apparent “sale prices” and the shape of your demand curve generally. They know what you buy, in many cases they know who referred you to a given product you bought or didn’t buy.

    It wouldn’t be trivial; but it would be well within the realm of possible, for them to start varying the price per customer. Charge more to those they suspect will be willing to pay more, less to those willing to pay less. The era of near-perfect price discrimination awaits!(which, for customers, is largely a bad thing. Textbook econ tells us that the more perfect the price discrimination, the less of the transaction’s surplus value ends up in the pocket of the buyer).

  3. Actually, it’s not self-evident to me that $9.99 will net more profits than $17.00. As I wrote in the article, I don’t think Amazon’s sole motivation is to maximize its current profits, they’re also interested in locking in as many Kindle customers as they can, so that they can have more control over the publishers in general.

    But I also don’t think that it’s self-evident to me that $9.99 *won’t* make more money than $17. But the reason that $9.99, $0.99 or $20.99 turns out to be the “best” price won’t be because $0.99 is less than $9.99 — it will be because it is the right amount to balance price-discrimination losses with demand-elasticity gains.

    That’s nothing new. The two new things are:

    1. The floor on demand-elasticity prices: when the marginal cost of goods is (basically) zero, you have the option of dropping the price to lows that no one was ever able to sustainably try before

    2. The fine-grained degree of price-discrimination: between your sales-history and realtime market information, retailers like Amazon have the power to tailor their prices to you (either through premiums, which usually get them in trouble, or discounts, which, for some reason, don’t) to a finer degree than ever before

    This means that pretty much all the solid ground about what the best price is is in the process of liquefying, and the industries are having a hard time keeping their footing.

  4. One interesting facet of piracy is that it can help with price discrimination by offering a “lowest price” that is nevertheless off-limits to more price-sensitive customers (because rich straight cits are worried about getting busted for piracy). Price discrimination often involves finding a price that is neither so high that the bottom end of the market isn’t excluded but not so low that you don’t get *something* out of the top end. Piracy moves the market’s bottom *up*, making that middle price that much higher.

  5. For what its worth I’ve been holding off buying an e-reader because the book files are too expensive relative to their paper counterparts. If e-books came down in price I would probably jump in. I better pricing to compensate for not owning a physical copy of the book. I’m concerned about tech advancements, platform changes, hardware failures etc. that might cause me to lose my library sometime in the future.

    If the books were cheaper I would probably buy a bunch of them and worry less about the consequences. Each publisher would get more money from me than they get now.

    1. Well, that’s only true if you don’t buy fewer paper books at full price (I don’t know if that’s true or not). I think everyone in publishing understands that if prices were lower, they’d sell more ebooks. That’s not the question: the question is, how much lower should prices be to sell as many ebooks as are possible with the smallest possible impact on higher-margin printed books?

  6. I’d think that there is certainly a market for people who would buy ebooks as a replacement for only ever buying used books or trading with friends. I rarely purchase a new book, but I routinely hit the used stores, library sales, etc… In other words, I read a lot, but don’t have much of a budget for doing so. Ebooks seem like they’d be a great middle ground if they were cheaper. Extra bonus if they were easily able to be traded with friends!

  7. Sorry about my typos above. I would probably buy fewer paper books if I had an e-reader. If the e-books were around $3 I would jump in. I would buy more e-books than I buy paper books right now. If the e-reader failed at some point in the future I would probably buy some of my favorites again (after much complaining) in paper form to keep. Ultimately I would probably spend about as much as I do right now and get more for my $. Instead of one $12 book I might buy four e-books. Just me. I know everyone is different.

  8. Between DRM, licensing and pricing issues there sure is a lot of incentive to go through “alternative” channels to acquire e-books.

    Not to say that I have anything against publishers and authors making a good living but the mechanisms of their trade are exposed (thank you web tubes!) and the pricing issue is adding insult to insult. (My lifestyle isn’t really affected by a few bucks every couple of weeks, so injury is negligible.)

    As a matter of fact, I actually WANT to pay authors and publishers for their work and I feel they should WANT me to feel good about the “product” I’m buying. But all I feel like is the turf under foot in their race for a New Literary World Order.

    I wish authors would set up websites where I could pay them regardless of the channel through which I acquired their work; whether a paperback lent by a friend or an e-book downloaded on bit torrent. They could provide a recommended price point and I could pay them based on the expectations set by their marketing and my percieved value of the book. Then the authors could pay their publisher a portion based on their wishes.

    I know, this is all way to altruistic for the real world. The publishers and distributors would no longer control the game and would consequently crap a Miata and strong-arm the authors for condoning piracy etc. But this is what *I* want and isn’t the customer always right?

  9. Sometimes you can increase the price and sell more. There’s the issue of perceived value: if it’s cheap it must be rubbish; if it’s expensive, it must be good.

  10. The coverage of the pricing dispute seemed to give Macmillan a free pass that I’m not sure they deserved.

    What stuck in my craw was that what Macmillan plans a tiered pricing schedule for e-books, ignoring what you accurately describe as their very low actual cost to a publisher. On a hardcover release the e-book will be priced somewhat lower than the HC; on the release of the paperback edition, the e-book price will fall. That just seemed opportunistic to me. There can’t be any doubt that this is a pricing model based on nothing but what (Macmillan thinks) the market will bear.

    I do think that Macmillan looks better than that because of the alternative they offered Amazon at the beginning: keep the $9.99 price, but delay the release of an e-book edition until the paperback comes out. Obviously Amazon didn’t accept that, but it was a reasonable idea. (Though what happens to books that never see a paperback edition?)

  11. (Damn damn damn, BoingBoing, keep my damn comment when I’ve typed it all in and realize I’m not logged in!! Gah!)

    I’ve been following the ebook & DRM scene for quite a while, and currently own a Nook (and a small handful of ebooks, but downloaded quite a few Gutenberg books).

    First, I don’t see why books don’t follow the game software industry. Games come out at (typically) 59.99, and slowly (or quickly) drop to 49.99 and 39.99 eventually ending their life in bargain-bins at 5.99 or less. Only the truly exception games survive at 29.99 or 19.99 past a year or so after release (and often are rebundled). I’d think a reasonable scenario for books would be to capture the most ardent fans at near (but below) hardcover prices, and slowly (based on popularity) drop down to 1.99 or less… Seems like a win-win.

    The other thing I’d like to see is Amazon or B&N bundling ebooks with some of their hard copies (for a smaller price increase). That way I can satisfy my need for a book _right now_, and still have the physical book, and it would allow me to feel better about the dreaded DRM issue.

  12. Price discrimination only works when arbitrage is difficult and information costs are low.

    Arbitrage is difficult with digital copies because the only widely-accepted way to resell a digital copy you have purchased, is the sell the physical media (the hard drive or the device), and price discrimination is easy because retailers can set different prices for different demographics.

    And of course, Amazon will falsely claim that you haven’t purchased and don’t own anything in particular when you buy a Kindle book, and thus first sale rights (which apply to “owners” of “copies”) don’t apply. (This is hogwash–a contract or a “license” can’t turn a sale into a not-sale just by reciting magic words.)

    While I don’t have anything against price discrimination per se, the fact that it’s so difficult legally and technologically to exercise your first sale rights with digital downloads could give a windfall to publishers. Buyers should realize that one of the things they’re giving up with ebooks is the ability to recoup value from the purchase down the road.

  13. Cory, I’m sorry to say that you’re wrong on this one.

    The labour cost to produce a novel (mostly author’s advance plus a few grand for editor/proofreader/etc salaries) is, at minimum, around $10,000. So (assuming there’s no paper edition and ignoring ecommerce fees) you have to sell 10,000 copies at $1 a copy to break even.

    That’s not a problem for Cory Doctorow or Steven King. But it is a problem for a new author who nobody’s ever heard of.

    With paper books, for every author who sells out their first printings and makes back their advance, there’s a dozen who are lucky to sell a couple thousand copies. Which is why all paper books are priced about the same, regardless of how many copies are printed – so the publishers can pay for the new authors they hope will find an audience and become profitable with the profits from their bestselling authors.

    Are those former non-readers who might become book buyers if books cost less going to be buying something by Unknown Author? I don’t think so. Nor is Unknown Author necessarily going to sell ten times more than they do now if their ebook was cheaper — as far as I know, the evidence to date on the increased sales that happen when ebooks are offered for lower prices is all from established authors with a preexisting audience.

    Now if everyone’s ebook was priced to reflect their sales, King and Doctorow books would sell for $1 or less, but books by Unknown Author would sell for five or ten times that. Not a good idea. Sure, ebooks have zero marginal costs – but they have non-zero labour costs, and every book is a crapshoot whether it’s going to sell well or totally bomb. Because of that, publishers are smart to not cut the prices of new books in search of potential new sales from price-sensitive readers.

    For older books, OTOH, you are correct that Macmillan is setting their prices too high. Once the paper edition is out of print, they should cut the price to $2 or less and see how many copies they can sell.

    But right now, we don’t know how many new book buyers will materialize if new release books cost 1/5 or 1/10 what they do now. Ebook optimists think there will be tens of thousands of additional sales per book. Publishers are afraid it might be a couple of thousand additional sales, at the expense of gutting the market for paper books. Me, I remind myself that on the one hand a sizable fraction of books are sold as gifts, and an ebook makes a very unsatisfying gift… and on the other hand, the large majority of people who haven’t read a book for pleasure in the past year (or ever) are unlikely to start reading books just because you can now buy them in electronic form.

  14. Thanks for this article. It is nice to see Boing Boing grappling seriously with issues of economic theory.

    First, one quibble about your terminology. Price elasticity of demand is not a pricing strategy. It’s just a term that describes certain characteristics of the market. A corporation doesn’t “practice” demand elasticity any more than a skydiver “practices” gravity during his jumps. Both the corporation and the skydiver, however, use ideas about how things work (whether a model of demand elasticity or the theory of gravity) in planning their actions.

    Further, demand elasticity does not always suggest that a supplier should lower its prices. For highly (or perfectly) inelastic goods, a price increase may actually increase total revenue, since the accompanying decrease in quantity demanded is so small.

    To address your main point, I think the fear of Amazon developing too much power over the (e)book market is a bit overblown. Obviously, the Kindle has brought Amazon a powerful first-mover advantage. The relationship that Amazon has developed with publishers and the public has given it an unprecedented selection of books and a level of market penetration that no other eBook reader/software has been able to match.

    Still, this success only highlights the potential for further growth in the market. Now that panicked publishers have begun to see the impact that the eBook sector will make on their business, they will pay more attention to it in the future. Amazon has also demonstrated to its own potential rivals that eBooks have true mass market potential.

    As a result, it is only a matter of time before devices that compete with the Kindle will appear. Right now, Amazon has an unprecedented level of price control in the eBook market because it is the only real game in town. It is, in effect, a monopsony. Once other companies move into the “red hot eBook market,” (I can already see the boardroom presentations happening) publishers will have more leverage over what price their books are sold at, with what DRM, etc. etc.

    The most interesting part of this whole debacle is the bizarre sympathy that publishers like Macmillan seem to have engendered in the blogosphere, especially given the outcry against the parallel changes happening in the music world. Why is it that people think that a tiered pricing structure is acceptable? Or delaying the release of eBooks until the paperback comes out? I don’t think I have ever seen consumers actually ASKING to be subject to price discrimination (the whole point of price discrimination is that it lets producers capture wealth that would otherwise remain with consumers). Why are publishing corporations considered better than record corporations? Is it because the margins are lower? Is it because authors are, for some reason, respected more than musicians? Or are publishers considered nerdier and more affable than those slick record execs?

    Anyone who believes that innovation, art and literature will all disappear under an Amazonian pricing scheme (same trope that the record companies trot out, btw) has been seriously misled. Boing Boing writers are experts on how music will continue to flourish despite a decrease in prices, a total restructuring of distribution and marketing channels and new conceptions of intellectual property. I’d like to see them apply that to the book world as well.

  15. Cory, I’d like some clarification on another point you make in the article. I was unaware of Amazon’s affiliate program. You seem to indicate that if a customer follows a link you post to a specific product, and then moves on to purchase something altogether different within the same shopping trip (for lack of a better phrase) then you receive a commission based on the price of the purchased item.

    There was a time when I had no disposable income, and your willingness to make your books available online for free download kept my brain from atrophying while working at a series of mindless “keep-the-desk-warm-and-look-busy” temp jobs.

    Now that I’ve got a bit more income (and have purchased some of your books in good old paper form) I regularly buy goods through Amazon. I’d be thrilled if a commission on some of my future purchases (books or otherwise) would go to you. So if I begin an Amazon shopping trip by following a link you post to a product, then move on to my intended items, you’ll get a piece of the action?

    I also ask because it would be a nice way to casually support other artists or charitable organizations that I respect. If there’s commission to be made, I’d rather it go to someone I like.

  16. If Tom Doherty is positively luminous on the importance of inducting nonreaders into the practice of regular reading, then why are most Tor books unavailable as ebooks, and when they are available, Tor sets the MSRP ebook price for $14 when the mass market paperback is selling for $7.99? This is not going to convince that 18-34 year old to buy a shiny ebook reader for $250+ so they can pay more for that ebook than they would for the paperback.

    I understand that the publishers don’t want to subsidize ebooks from the print editions, so the cost of the ebook needs to start out as the fixed costs of creating ebooks divided by the expect sales + the marginal costs (royalties, fixed costs of ebook sale). This fixed cost ought to drop now the ebooks readers (except for Amazon’s Kindle) are finally standardizing on a single format, ePub, and the software used to create the printing plates/images can be enhanced to automatically create an ePub master. So, in the long run, the publishers ought to make more by dropping the ebook price to something closer to the marginal costs and increasing sales. I wait with anticipation to see whether Macmillan will experiment with ebook pricing as they switch to Agent model pricing. Given CEO Sargent’s comments about ebook and book pricing best seller sale pricing, I don’t expect them to do so.

  17. Authors should feel free to experiment. Don’t sign with a publisher. Publish yourself. With ebooks it’s easy and super-cheap.

    The right price will be found in time. MacMillan has delayed things, but only delayed them. Why? Because they know they lose their control of authors once e-books become the norm. That’s their fear.

  18. All elaborately pretty justifications and hand-waves to try to make me ignore one simple fact: Macmillan, and the other publishers, want me to surrender my First Sale rights, and if possible want me to surrender any Fair Use rights, at the e-bookstore door, and do not want to offer me any kind of a price break for surrendering those rights. Damn straight the e-book price is less than the hardcover price. You get less than you get when you buy a hardcover.

  19. Ebooks have substantially the same fair use rights as any other books. What Macmillan would do “if possible” is not really relevant if it’s not possible is it?

    “You get less than you get when you buy a hardcover.”

    Not objectively true. It’s a trade-off. Ebooks are smaller.

    1. Publishers are doing everything they can to eliminate first sale and fair use rights for ebooks. If they do so with DRM, then these rights have been removed as it is illegal (in the USA) to remove DRM to allow for resale and fair use.

      To me, an ebook with DRM is more similar to a rental than a sale. Either drop the prices to match, or remove DRM.

      Another thing: if all books eventually become ebooks with DRM, then what happens to libraries?!

  20. As one of the boots on the ground actually selling books to real live people, the idea that cutting the price in half or a third will get enough people buying to make up the loss is laughable.

    There is not an unlimited amount of entertainment expenditure in the world. People will largely buy as much entertainment as they have time to consume, and books consume a lot of leisure time. Selling people books at half the price won’t get them to read twice as much, not unless you’re selling half a book. Buyers will read at more or less a fixed pace and acquire more or less a fixed number of books.

    The idea that it’s the cost of books that’s preventing the reading market from being larger is frankly ridiculous. Books are cheap. People just do other things with their time. So, no, it doesn’t make much sense for publishers to sell ebooks at fire sale prices, whatever the marginal cost to sell a given ebook is, there is a very real opportunity cost in letting books go too cheaply, because you can’t sell an unlimited number of the things.

  21. Can someone clarify what publishers have done to eliminate fair use?

    Also, what does first sale look like when applied to non-DRM’ed content?

    Should I be able to set up a web site and sell my mp3 purchases for any price I wish based purely on the promise that I will not sell any of them more than once or use them after they are sold?

    If not that, then what would non-DRM first sale look like?

  22. I stopped buying paper books when I got my digital reader, and I know I’m not the only one.

    So the impact on print books has been made for me. I’m not going to buy another one. Pricing is largely irrelevant, unless the digital price gets significantly higher than the physical price.

    Just offer the damn digital books already. Not offering them just drives me to discover independent authors and smaller publishers. There are only so many books I can read, it’s up to the publishers to decide if they want me to give them money or give it to their competitors.

  23. I’m an ereader owner (B&N nook) and since I got it on 04JAN2010 I’ve bought and read over a dozen novels. Some of them I’ve bought from B&N, some direct from a publisher (Baen).

    At the same time, I have over 3600 dead tree books in my personal library, and some of them I would like to add to my ereader, but there is no way I’m at all willing to pay for the books yet again…

    Why would I want to have ebook versions of books I already own as physical copies? Because I’m a person who occasionally re-reads favorites (and still, several re-reads later, find new things, or at least new ways of looking at things).

    What this means is that I also have downloaded a couple dozen OCR scans of some of my old favorites. While probably technically not legitimate, I feel that I have already paid for the privilege of reading those books, and aditionally that no one is losing a sale on them: I will NOT re-buy them.

    At no time do I feel that the ebook should cost more than the paperback, and in truth, considering the difference in cost to make and distribute, should never cost AS MUCH as the paperback…

  24. The reason I think Macmillan’s decision is foolish, is that I think the Internet breaks “windowing”.

    Back in the days of physical goods, sure, you could start off with a high price, and everyone not willing to pay that price would wait. Nowadays, though, people don’t want to wait, and they’re not used to waiting. I suspect that if you tell them to wait a year or two for a reasonable price, most of them will turn to piracy.

    Look at the last Harry Potter novel. In spite of the steep barrier to piracy, it got completely scanned and widely pirated online within a few days of release. Nobody wanted to wait, because they wanted to talk about the novel with all the other fans on the Internet.

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