The Price is Right
// IT Revolution
A Glimpse inside the Economics of Book Publishing
DISCLAIMER: One of the areas we have been working on here at IT Revolution is the practice of continual learning. We have found that putting a focus on learning pushes us to ask better questions as we work to understand the community we serve. This post is heavy on the economics of book publishing—an important and growing area of our business. You'll see our practice of continual learning in action!
The Phoenix Project has now sold more than 115,000 copies. Less than 1% of books published ever reach that level, and because of that, we watch very closely what happens across our sales channels and publishing formats. One of the questions we return back to often is pricing.
Two ways to look at it
In regard to products and services, price is one of the most important decisions any business makes. McKinsey & Company did some well-documented research back in the 1990s that showed a 1% increase in price produced an 11% increase in operating profits. We also know from Economics 101 that price plays a role in demand for a product. Economists refer to that relationship as the elasticity of demand. In the world of book publishing, the amount of demand elasticity there is for books is one that has been up for debate in the last several years.
Historically, book publishers have chosen price discrimination as their go-to market technique. Publishers offer the same product to the same set of customers but change features like when they can get it, where they can buy it, or how much they can buy it for. Similar to other media, publishers choose to stagger the release of formats, starting with the original hardcover edition, then releasing the ebook, paperback, mass paperback, and possibly a repackaged movie tie-in edition several years later. For a product like books that slowly declines in value, the biggest benefit to price discrimination is publishers can maximize their profit with the staggered release windows, allowing them to capture maximum value for different customer segments.
Amazon sees the world in a completely different way. As founder and CEO Jeff Bezos has said, "There are two kinds of companies—those that work to raise prices and those that work to lower them." Amazon is clearly the latter, and you can see many of the company's motives trace back to the school of price elasticity. Roughly translated, this economic concept says, when prices go down, people buy more.
Authors who self-publish on the Kindle platform know this well. Amazon has long established $9.99 as an important price point, and the retailer lowers the royalty rate from 70% to 35% if titles are priced at $10 or more. The company creates a huge incentive to keep ebook prices low because they believe that lower pricing creates higher demand for books and in turn more profit for the retailer.
Which is right?
We launched The Phoenix Project with a hardcover edition in January 2013. Our retail price was $29.95, on the high end of the range for a business novel. By the time Amazon discounted the price, most people bought it for around $20. The ebook price has always been $9.99.
As demand for the book grew in the first year, we started to contemplate a paperback release. Most publishers push to keep the book in hardcover as long as possible because the margins are better. The unit cost of production is about $1.50 more for a hardcover versus a paperback, but hardcovers retail at a higher price point than their soft covered counterpart, which leads to higher margins. This is a classic price discrimination maneuver. For us through, the question was how elastic was demand and could we sell more books to make up the difference in margin lost?
At the time, we were seeing continued strength in both hardcover and ebook sales. Another data point was the direct sales we were doing for The Phoenix Project, and we found that we converted more orders with a lower price point. We took the gamble and planned the release for 21 months after the initial hardcover launch and to coincide with our first DevOps Enterprise Summit.
We priced the paperback edition of The Phoenix Project at $21.95. The chart below shows the last 18 months of sales. Since we made the switch to paperback, we have increased average sales by roughly 1000 units per month. The best part for us is seeing more people overall reading the book.
Our conclusion from our switch is that demand for The Phoenix Project is elastic—when we lower the price, we sell more copies. In our case, that was a good decision because additional demand made up for the lower unit margin.
Price Matching: Good or Bad?
We were presented with a similar question last month when we made the book available through Google Play. The electronic version of the book has been available on Kindle from the very beginning, and we added Apple iBooks, Barnes & Noble's Nook, and Kobo. Most recently we added the book to O'Reilly and their Safari Online subscription service.
Google has been working to get consumers attention, having followed most retailers into electronic media market. Their most recent tactic has been to discount ebooks by 20% for customers but still pay publishers their royalties at the full retail price. This is an attractive offer, except Amazon watches competitors' sites very closely and matches a lower price if they find one. In Amazon's case, the publisher is paid royalties based on the selling price. Since Amazon has such a large share of the ebook market, the lower royalties from their price matching can have a huge impact on publisher revenues. On the self-publishing forums, many have recommended raising the selling price on Google to offset their 20% discount and eliminate the problems with Amazon's price match.
We decided to take a more open view and look at the data. The question again becomes whether the demand elasticity exists for the electronic version of The Phoenix Project.
In the following week after Amazon matched the price on Google Play, sales for the Kindle edition increased, and they have stayed higher every week with the exception of one week (see graph below). On average, weekly sales have increased by 11%. At the same time, sales haven't increased enough to offset the lower unit margins. Our average weekly royalties have decreased by 11% or around $200 per week. So, demand is again elastic, but not enough to offset the lost revenue. The data would support following the advice on the forums and increasing the Google Play price to push the Amazon pricing back to $9.99.
The other factor to consider is the sales activity on Google Play. Right now, we are selling about 17 units per week and making about $120 in royalties. We are not making enough on this newest channel for us to make up the loss at Amazon.
In this case, we are making a non-economic-driven decision and have decided to keep Google Play at $9.99 and let Amazon price match for now. We are getting more books into readers' hands both with the new channel at Google and the increased demand on Amazon. The profit loss is around $100 per week, but we are selling an extra 100 copies.
This has been a great exercise in economics, marketing, and experimentation for us in understanding how our decisions have a direct impact in what happens in the marketplace. I wouldn't use our results to generalize that books as a category have an elastic demand curve, but instead encourage you to gather data, run experiments, and see what works best.
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