By Steven Pearlstein
Wednesday, February 3, 2010; A11
Last weekend, a noisy little melodrama in the book publishing world involving Amazon.com and Macmillan provided a wonderful case study of the radical transformation taking place all across the economy as a result of the digital revolution.
In the book business, that transformation has been led by Amazon's Jeff Bezos, who has been a master at using the Internet to cut out the middlemen that stand between the author and the reader, delivering books to consumers at lower prices. This process of "disintermediation" started about 15 years ago, when Bezos figured out how to cut out bricks-and-mortar retailers by shipping books directly to consumers' homes from his company's warehouses. But the real breakthrough came when Amazon introduced the Kindle reader and began using wireless phone networks to deliver digital books for $9.99 a pop.
Amazon's business model was, in fact, the reverse of the one used so successfully by Gillette, selling razors at little or no profit but making it up on high-margin razor blades. In this case, the $9.99 retail price for the books (the blades) was actually less than the $12 to $14 "wholesale" price Amazon paid to publishers. That loss, however, was made up for by the high profit margins on the Kindles (the razors), which sell for $260 to $490.
The genius behind the deeply discounted book price is that it seems to have greatly accelerated the inevitable transition from physical books to digital ones, while allowing Amazon to build a commanding lead in the digital space. That has not sat particularly well with book publishers, which continue to get the overwhelming share of their profits from hard-copy sales and don't welcome competition on pricing or the prospect of getting strong-armed by a dominant distributor. But as long as Kindle was the digital reader of choice for nearly 3 million consumers, there wasn't much they could do to challenge Amazon's dominance.
And then Steve Jobs showed up with the iPad. Apple's new $500 tablet computer can do almost everything a Kindle can, and much more. And to the delight of publishers, he was offering not only 25 million new potential customers but also a new business model in which Apple would serve merely as a distribution agent for the publishers, rather than a wholesaler. Under this arrangement, publishers are free to set retail prices as high as $15 per book and pay Apple a flat fee of 30 percent of the price.
With a higher price for both the tablet and the books, you wouldn't expect this new model to pose much of a challenge to Amazon's dominance in digital books. But then over the weekend, Macmillan told Amazon that if it didn't agree to the same terms it had hammered out with Apple, Amazon would no longer have access to new books from the publishing house until several months after they were released through bookstores and Apple. Amazon's initial response was to prevent users from buying Macmillan books on its Web site. By late Sunday, however, Amazon had raised the white flag and announced that it would go along with the new arrangement. Other publishers are now expected to follow Macmillan's lead.
The new arrangement will actually increase the amount of money that Amazon earns on each book, while publishers are likely to earn less. The higher retail prices will not only slow the transition from hard copy to digital but also open the digital market to more robust competition -- from Apple, and also from Google.
Although Bezos & Co. were not pleased by the weekend's developments, they were hardly surprised. Amazon had already anticipated Apple's entry into the market by inviting software companies to begin developing applications for the Kindle that would allow it to compete directly with the more multifunctional iPad, particularly in the area of video games. And Amazon fired its own shot across the bow of the book publishers last month when it announced that it would make it easier and more lucrative for authors to use Amazon's digital bookstore to sell their work directly to consumers, bypassing the publishers entirely.
It will still be years before e-book technology matures and a sustainable business model emerges for the publishing industry. In the meantime, you'll hear lots of moaning and groaning about how the quality of writing and editing will decline, browsing for books will become a lost art, authors and their agents will be forced into poverty, and consumers will get hosed. Don't believe any of it for a minute.
While markets have their flaws, over the long run they are good at executing these technological transformations. My guess is that in the not-so-distant future, best-selling authors such as John Grisham and Malcolm Gladwell -- along with unknown authors peddling their first books -- will publish their own works, contracting with independent editors and marketers and selling directly to consumers as much as possible. Other authors will turn to smaller, more specialized publishing houses that will offer smaller advances but bigger royalties and will be built, as they once were, around great editors. Publishers will sell their books through competing online distributors and traditional hard-copy bookstores, the latter of which will continue to exist not only as places to browse and socialize, but also as places to have printed on demand. Backlists will be infinite, pricing will be dynamic, and more copies of more books will be read and sold.
Reports of the death of book publishing, like those of music publishing and newspaper publishing, are greatly exaggerated. Business models will change, companies will come and go, and people will lose their jobs. But at the end of the process, there will be fewer people who will be paid higher incomes to produce a wider array of products at lower prices. There's a word for that -- progress -- and it's exciting to see it unfold right in front of us.
Steven Pearlstein will host a Web discussion today at 11 a.m. at washingtonpost.com.