Who's Right in the Amazon-Hachette Battle?

The online retailer is acting like a bully, but its suggestions may be good for the industry.

Aug 5, 2014 at 8:22AM

The battle between Amazon (NASDAQ:AMZN) and book publisher Hachette may serve as a test case for how the e-commerce giant and publishers will work together going forward.

The core of the dispute -- which has affected availability of Hachette's physical and digital books -- is that Amazon wants almost all e-books to cost no more than $9.99. Hachette disagrees and is willing to lose short-term sales to win the war.

Amazon has been portrayed in the media as the aggressor, using its massive buying power to force a vendor to agree to unfavorable terms. It would certainly not be the first company to do that, but the dispute is not that simple.

A blog post from Amazon adds further details, and it may change the view some have of the disagreement. In the piece, published in late July on Amazon's Kindle Forum, the company argues for flat pricing and makes a compelling case as to why digital books should never cost more than $9.99.

A key objective is lower e-book prices. Many e-books are being released at $14.99 and even $19.99. That is unjustifiably high for an e-book. With an e-book, there's no printing, no over-printing, no need to forecast, no returns, no lost sales due to out-of-stock, no warehousing costs, no transportation costs, and there is no secondary market -- e-books cannot be resold as used books. E-books can be and should be less expensive.

It's hard to argue with that logic. Publishers generally pay the same royalty rate to authors on digital books as they do on print copies, with none of the risks. They also receive a higher percentage from Amazon on an e-book sale than they get on traditional ones. Numbers vary, but Amazon generally gives a company 70% of revenue for e-books sold for $9.99 or less. Traditional books are usually sold to retailers at 50%-55% below the cover price. Amazon might pay publishers less for print books in some cases, and it may have a better deal when it comes to returning physical books than most booksellers do, but it's hard to argue that digital sales aren't less risky and more profitable for all involved.

Is Amazon's argument good for publishers?
Amazon wants lower prices, while Hachette wants higher ones. That's an age-old battle between retailers and vendors that is not unique to books. There is, however, a strong argument in favor of Amazon's case that lower prices is better for everyone. Here's more from the Amazon post:

It's also important to understand that e-books are highly price-elastic. This means that when the price goes up, customers buy much less. We've quantified the price elasticity of e-books from repeated measurements across many titles. For every copy an e-book would sell at $14.99, it would sell 1.74 copies if priced at $9.99. So, for example, if customers would buy 100,000 copies of a particular e-book at $14.99, then customers would buy 174,000 copies of that same e-book at $9.99. Total revenue at $14.99 would be $1,499,000. Total revenue at $9.99 is $1,738,000. 

If these numbers are true, then lowering the price is better for all involved. Customers pay 33% less for the book, the author gets a 16% larger royalty check -- plus a 74% larger fan base. Higher total revenue is generated, which is good for the publisher. More copies sold could help a book make a best-seller list -- also good for sales.

How is this hurting Hachette?
Amazon is the 300-pound gorilla in the e-book world, and having some Hachette titles not available on the website has hurt the publisher.

Lagardère, the French publishing company that owns Hachette, reported in late July that e-book sales in the U.S. have declined. That is not true in the rest of the world. In England, where Amazon and Hachette are not in dispute, sales have risen, The Guardian reported.

Company executives placed the blame on a lack of best-sellers, but sales overall in the U.S. jumped 5.6% during the reporting period.

Lagardère executives did acknowledge "a limited impact from Amazon's punitive measures," The Guardian reported.

The dispute has not only made some Hachette e-books unavailable, it has also affected physical book sales. The online retailer is not taking pre-orders on some Hachette titles and is not offering guaranteed delivery dates on others. Lagardère did not comment on the impact of the Amazon impasse on physical sales, but overall sales for the company were down 1% for the quarter.

How will this get resolved?
In the U.S., Hachette has dug in its heels and held fast to the idea that it should be able to set pricing. Amazon has been steadfast that flat pricing helps the whole industry.

"Amazon indicates that it considers books to be like any other consumer good," Hachette said in a statement. "They are not."

Authors have been united in backing Hachette, which is somewhat surprising because Amazon has called for authors to get more. The company suggested that the revenue split should be 30% for the retailer, 35% for the publishing company, and 35% for the author -- a huge increase on the 8%-10% royalty most authors currently receive. 

"... the way this would actually work is that we would send 70% of the total revenue to Hachette, and they would decide how much to share with the author," Amazon wrote. "We believe Hachette is sharing too small a portion with the author today, but ultimately that is not our call."

Amazon will win this fight because the numbers make sense. In physical books, publishers have much higher risks because they must distribute the books. In the digital realm, they still have acquisition, editing, and marketing costs, but not having to print physical books removes much of the financial downside. 

It's better for more books to be sold overall, and a lower price point is the best way for that to happen. Hachette is fighting to protect a model that no longer makes sense. Authors don't need publishers the way they used to. Amazon has seen that reality and will ultimately prevail. If Hachette concedes, perhaps the company can remain viable. If not, the book publisher will face the same problems its counterparts in the music world have.

Amazon may be a bully, but it's a bully that's correct in this case. Hachette should hand over its lunch money. In the end, it may actually pay off.

Daniel Kline has no position in any stocks mentioned. The Motley Fool recommends Amazon.com. The Motley Fool owns shares of Amazon.com. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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