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.

Bundling is the act of grouping services and products together to create a new price point. This technique is common in most industries, but the question remains of whether the buyer or the seller actually benefits more from the bundling itself.

In the recent article ‘The Pros and Cons of Bundling’ by Anthony Tjan (The Harvard Business Review, February 26, 2010), Tjan discussed how bundling, in his opinion, ultimately benefits the seller. His argument is based on the lack of transparency in bundling; the sellers can group products and services together in a way that hides how much the customer pays for each individual item. This illusion then prompts the customer to pay more for simple items than they would if the bundle had been broken into a product-by-product invoice.

An illustration of this idea is when customers buy all-inclusion cruise packages – the customer does not know how much they are paying for each individual part of the cruise but only the total price. For example, the overall price for one person could $1050, which doesn’t sound bad to the customer, but if they knew that when the prices were broken down, they were paying $50 for their breakfasts every morning, they might reconsider the price or demand a lower one, as they don’t eat breakfast anyway.

Tjan does point out that this is not always true. Fast food restaurants have the bundled (the value meals) and the individual item’s price points both visible on their menu boards. Customers can quickly see that the bundle of sandwich, fries, and drink is several cents cheaper than buying them separately. In this case, the bundling (having given up its inherent transparency) now benefits the customers. The company, however, does benefit from the increased speed and efficiency of the value meals, as their employees can greatly generate the meals. For a company focused on speed, this might be an overall benefit greater than the loss of a few cents per meal. This also benefits their marketing plans – by being able to advertise a lower price point, they could gain customers who are focused solely on price.

It should be noted, however, that customers are also less likely to purchase the whole package when not given a bundled option. If there were no value meals, many customers wouldn’t get the fries or drinks. They might just order a smaller meal. Or in terms of a car sales, the customer would be likely to not buy additional add-ons if they are all presented individually – customers are much more likely to either go all-in (all the add-ons available) or none (the bare minimum they can live with).

In these cases, therefore, buyers and sellers can both benefit from bundling. The lack of transparency in bundling does benefit the seller, especially when the seller wants to put a high price point on items that some customers would balk at paying. But the customer can also benefit when the seller’s objective in bundling isn’t the price, but the act of creating a better advertising market or a swifter, more efficient product.

In the end, bundling can also be seen as pricing based on value. The customers will pay the higher bundled price, if the extra add-ons were somewhat worth it (the fries) and doesn’t add that much to the price. The seller then benefits by the customers paying the higher, bundled prices for products they might not have purchased in the first place. This added value could possibly be seen as beneficial to both.

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.