Meissner Research Group

The iPad, Apple’s newest technological wonder, will be released on April 3^rd, just a few short weeks from now, but one thing probably missing from its advertised digital bookstore, iBookstore, will be the books from the world’s sales leader in publishing, Random House.

In the Financial Times article ‘Random House fears iPad price war’, Random House chief executive Markus Dohle said that Random House was still reviewing their options, as they fear that Apple’s pricing policy is of an interest to their stakeholders. The publisher was still in discussions with their agents and authors over the decision.

Random House is a division of Bertelsmann, whose profits declined over the past year, thanks in large part to the recession. And while the company believes they will make gains this year, they are not sure that allowing Apple to control the pricing policy of their e-books is the way to go about it.

Apple’s current e-book policy is that publishers will set the price for their own books, with Apple receiving 30 cents off every dollar. While the other five major publishers (which account for nearly all of Random House’s competition) have already signed on with Apple and their iBookstore, this new pricing scheme is very different from standard publishing policies.

In standard publishing pricing, the publishers sell books to the bookstores at a wholesale rate. The bookstores then make a profit by marking up the books from the wholesale rate. Bookstores can even return unsold books. Even Amazon, one of the world’s top bestsellers and one of the darlings of e-commerce, sells its book this way. While the publishers and Apple both agree that e-books are here to stay, neither is quite sure how to actually price them successfully to make both companies and their customers happy.

In the end, Random House must realize that a price war of any type is not beneficial to their company. If Random House takes Apple’s offer of controlling their own prices, they must quickly realize that trying to price their bestsellers at a price lower than their competitors will only result in spend-thrifty customers and low revenues. And if Random House decides to take Apple’s deal and then prices their books far too low, customers will always expect that price. And they will now be simply a few touches on the touchscreen away from picking up a book from Harper-Collins or Macmillan instead.

Customers have a habit of demanding lower prices, especially when they believe a product’s price represents a huge profit for the company. The case in point here is e-books, just one of many digital products facing the e-pricing dilemma.

In recent weeks, thanks to the soon-to-be-released Apple iPad, five of the six major publishers banded together to demand a change in price. Up until now, Amazon, the leading e-book seller, has set most bestsellers at a $9.99 price point, but by making a deal with Apple to price books from $12.99 to $14.99 and threatening to remove their products from Amazon’s online store and it’s e-reader Kindle, the publishers were able to push up the price.

To illustrate why publishers keep pushing for the higher price, the recent New York Times article ‘Math of Publishing Meets the E-Book’ by Motoko Rich broke down standard hardcover book pricing and compared it to the new iPad digital pricing, also suggesting, according to Rich, that “customers have exaggerated the savings and have developed unrealistic expectations of how low the prices of e-books can go.”

A hardcover books costs about $26. After all the production, editing, marketing, and author’s royalties are paid (see graph), the publisher actually only sees about $4.05 in return, but that’s before any of the overhead bills are paid. Compare this to $12.99 digital price. In the new set-up with Apple, the publishers make between $4.56 to $5.54 in profit (see graph).

But this profit does not actually represent how much profit a publisher makes off any book. Like movie producers, publishers expect a loss on most of their products. Most books are published and disappear from the bookstore shelves long before the publisher recoups the author’s original advance and the original run’s printing costs. In the end, publishers truly only make money off major blockbuster books, further creeping into the publisher’s profitability.

On the other side of the pricing debate is the booksellers themselves. America only has two major booksellers left: Barnes N Noble and Borders, and many of the smaller independent have started shutting down due to Amazon. If the digital revolution takes hold with book-buying customers at too low a price point, it could also mean the end for traditional printed books, as there won’t be any bookstores left o sell them. Borders has already closed the majority of their stores in the U.K.

Some are advocating that the publishing world should step away from digital publishing and should discourage their customers from buying e-books by setting a high price for them. A similar idea has been put forth to save newspapers, which seems to be failing.

Many, however, realize that trying to hold back the digital revolution simply won’t work. Anne Rice, one of the most popular paranormal and horror writers in the world, said, “The only thing I know is a mistake is people trying to hold back e-books or Kindle and trying to head off the revolution by building a dam. It’s not going to work.” Publishers, a notoriously conservative business as a whole, are going to have to find a way to start looking towards the future, if they want to make their products viable and profitable once more.

The story of the digital price wars is all about change. As each new technology develops and transitions into part of the mainstream culture, the way the average customer buys their goods is dramatically altered. And the price that customers pay must change right along with it.

According to the recent article ‘Is the price right for e-books?’ by BBC blogger Rory Cellan-Jones, the war over the price for e-book content is poised to become a major issue for the publishing world over the next year in the United Kingdom.

With Amazon, Sony, and Barnes N Noble all developing their own portable reading devices, UK patrons still complain that high prices and lousy access to the books they want have stopped them from purchasing e-books. This has allowed smaller companies like Kobobooks to develop e-readers that allow for easy reading across platforms (portable device, TV, computer, etc.) and easier, faster downloads.

However, it appears most customers care more about the price of the book then how they get it or where they can read it. With Amazon in a power struggle with publishers both in the UK and in America over who determines the price of books, the standard pricing for any book is far from being decided. In fact, just last month Macmillan, one of “Big Six” English language publishers, blocked Amazon from selling any of their products, in a move designated to keep digital book prices high. Macmillan and Amazon may have compromised, but this was surely just one skirmish in a long war.

Perhaps Amazon should focus on how Apple transformed the music world with iTunes. By designating a simple pricing scheme (99 cents per song), Apple was able to give customers the access, speed, and (most importantly) price they wanted. They also won many court cases that gave them the right to determine their own prices. If Amazon and the other e-readers can follow suit, a bottom line price could help drive e-books and e-readers into the hands of every UK citizen.

While it’s common knowledge that the music industry was forever altered when iTunes, with its over 125 million customers, came onto the scene and allowed music fans to download songs for only 99 cents. In the past few years, it was the publishing world that has been changed, with digital book eaders like the Kindle and Nook, and online newspaper programs, like the recently mentioned Times Reader. Now it appears, it’s TV’s turn.

According to the article ‘Networks Wary of Apple’s Push to Cut Show Prices’ by Brian Stelter (New York Times, February 16^th, 2010), Apple executives are in talks with the heads of all the major television networks to plan a widespread price decrease for downloading TV episodes from iTunes.

Each TV show episode, with the exception of a few promotions from PBS, currently sells for a $1.99 per download. But for Apple, the magic number has always been 99 cents. It was the 99-cent price point that allowed iTunes to nearly overnight become the world’s main, and in most peoples’ eyes the only, place to buy music. iTunes’s 99 cent price point could very easily be said to be responsible for the end of the CD and probably helped lead to the end of nationwide electronic store Circuit City.

Apple executives are said to believe that by lowering TV episodes, released on iTunes only the day after their original broadcast on television, to the 99 cent price point could allow the mainstreaming of TV episode downloading, just as it did for music. With several new, cheaper models of digital and portal TV quickly becoming available, like Apple’s upcoming iPad, Apple believes this is its next goldmine waiting to be harvested.

TV executives on the other hand are not so sure. TV shows can cost millions of dollars to produce, and it normally takes hundreds of people (all of whom need to be paid) to produce a single episode. Unlike songs, which are often created in studios by a handful of professionals, TV shows will need far higher sales to return profitable returns.

On the other hand, if lowering the price point does help buying TV episodes become part of the mainstream world culture, as buying songs from iTunes has, then it might be worth it. Consumers have purchased over 10 billion songs from iTunes, while they have only purchased 375 million TV episodes, a huge difference in profits. And considering that there will also always be fewer episodes available then songs, this difference could translate into the change being well worth the risk for TV executives.

As with most digital products, there is little additional cost, so this situation is not about profit maximization, but simply revenue optimization. The refusal of the TV executives to lower the price indicates that they believe the market is not elastic, e.g. they do not believe there would be a volume gain sufficient enough to compensate for the lower price. In this particular case the calculation is easy, as a price decrease from $1.99 to $0.99 must result in doubling the volume to make sense. Apple, on the other hand, would probably be satisfied if it breaks even, as long as this fuels hardware sales.

A $0.99 price point could lead to a large demand raise, probably even of 100 percent. On the other hand, it could be that TV content is already bought by users that are less likely to download files from a peer-to-peer file sharing network, and demand is not actually elastic, which would be required if the demand was to raise high enough. In any case, it will be interesting to see what is going to happen.

To understand how to best set prices, manager first must understand that all products go through four distinct periods in their life cycles: emerging, growth, mature, and decline.

Emerging products have just been released to the public; perhaps they’re even in trial form and only available to select customers. During the next period of growth, the products have entered in the market at full-force and with each passing period, sales continue to grow at a steady rate. This is different from emerging in that your product is now part of the everyday, standard business – not necessarily the newest product on the market anymore. Once your product enters the mature phase of its life cycle, the sales growth has evened out. A large portion of your customers already own your product and only come to you for problems or repairs. And finally, your product will enter into decline – it becomes obsolete (hopefully because your company has already put its replacement into the market) and its sales dwindle to a few stragglers who are behind the times or devoted fans of your product that simply don’t want an upgrade.

Each of these periods of the life cycle change how your product is viewed in the marketplace. Unfortunately, most sales teams are not equipped and don’t even realize when each of these periods happen and the effect they have on your product and pricing. As an executive, it is your duty to recognize the shift in life cycles and to guide your sales staff in pricing accordingly.

Most executives unfortunately don’t like to think of their products having any sort of cycle to them; they prefer to think of their products as entering the market and remaining in the same growth phase forever. This simply is not the case. While it is true that you continually want your profits to grow, a single product cannot manage growth indefinitely. It is up to the executives to watch for signs that a product is entering a maturity phase, or even its decline phase, and react. New products should enter the market, starting new emerging and growth phases for your company. Without adherence to this law of entropy in business, your company will suffer.

A good example of this is the yearly nature of car manufacturers, or the ever-changing nature of Apple’s iPods. The moment one version of the iPod becomes obsolete, or even before (allowing Apple to control when a product enters its own decline phase), a new version appears on the market. Use your knowledge of product life cycles to shepherd your business into continual growth phases.