E-book Price-Fixing: Finding the Best Model for Publishers — and Readers

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Despite the negative image of the agency model generated by the headline-grabbing lawsuit, the Internet has been a boon for this approach, notes Zhang. Apple’s “platform” (or agency) model for apps allows software developers to run their own stores and sell their own products directly to consumers. “In theory, the agency model is a very good way to solve this double marginalization problem because there is only one layer,” he points out. When, for example, a book publisher pays a constant 30% fee to Apple, “this doesn’t distort the price at which the publisher sells to the end user.” That’s because when the publisher gets 70% of the pie, his interest — like that of his agent (in this case, Apple) — is to increase the size of the pie, not to increase his own share of it. When the channel members all try to get a bigger share of the pie, the pie shrinks and everyone suffers, including consumers.

On the Internet, it is much easier for all kinds of manufacturers to implement the agency model — not just giant manufacturers like Apple, which have the product variety and strong brand to sell directly in their own online stores. A growing number of smaller manufacturers have been selling more and more of their products at competitive prices directly to customers over e-commerce platforms managed by such sites as Alice.com, Etsy.com and even Amazon’s own Amazon Marketplace. Rather than emerge weakened as a result of the Apple e-book controversy, “over time, the agency model has a good chance to win the day. In fact, it should win the day for the good of the economy and for consumers,” adds Zhang.

Short End of the Stick?

Why then, in the case of e-books, does the Department of Justice want to stand in the way of the agency model? For many, the most objectionable outcome of the alleged collusion between Apple and the publishers is that prices for Amazon’s e-books — and, in fact, e-books in general — increased, thereby harming consumers. However, Zhang questions whether this argument examines all of the ways the agency model has had an economic impact on the market for e-books. For example, although prices of Amazon e-books have risen, prices of Kindle readers also went down over the same period. “You can’t say that the consumer only gets the short end of the stick as a result of the agency model. You have to balance all of the interests of consumers.”

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Moreover, he suggests, the first wave of people who purchased Kindle readers were often more affluent consumers who were less sensitive to price and possibly more willing and able to pay somewhat higher prices for e-books. “For those people, there was very little impact when Amazon raised its e-book prices.” Society as a whole also gained when consumers who could finally afford a now-cheaper Kindle gained access to the thousands of e-books still available at little or no cost on Amazon’s website. Indeed, with the agency model taking hold in the publishing industry, “you will see that iPad, Kindle and Nook will all come down in price, competing even harder for new readers,” notes Zhang.

For their part, publishers also have a valid argument that if e-book publishers were restricted to using the wholesale model preferred by Amazon, consumers might eventually become unwilling to pay the higher prices Amazon might charge after it gained more and more share of the e-book market. “If Amazon became successful in building its market share, it could become so strong that it could go to the publishers and dictate the prices for e-books,” Zhang points out. If that happens, “who will have the incentive to produce e-books with the most advanced technologies,” such as videos, interactive elements and links to the Internet? “All of these things cost money, and publishers want room to make investments in the technology they need in order to be innovative. The pricing flexibility and discretion they gain through the agency model will give them the room they need.”

Initially, the agency model “may lead to higher prices for e-books, as we have observed,” Zhang concedes. This is because Amazon has been using loss-leader pricing to achieve its market share objectives. In addition, the agency model does have a tendency to reduce inter-store competition: If a publisher sells a book through both Apple and Amazon, “you can bet the publisher will not try to lower its price at Amazon to cut into its sales of the same book at Apple.” However, in that case, Zhang and his collaborators have shown that all bets are not off on price competition, as the agency model opens up inter-publisher price competition. “To sell a book, [one publisher] will have to compete much harder with other publishers with similar titles for readers.”

In their most recent paper, Zhang and his coauthors address a key question that e-tailers are now facing: When should they use a platform — or agency — model instead of the more conventional reselling format? In developing a theoretical model for their study, the researchers focused “on the effects of two main factors on the resulting selling format in electronic retailing: competition among e-tailers, and reaction by the manufacturer due to the impact of the electronic channel on sales in the traditional channel (brick-and-mortar retailing).” The results of their work suggest that “whenever sales in the electronic channel lead to a negative effect on demand in the traditional channel, e-tailers prefer to set up platforms, whereas when sales in the electronic channel lead to a substantial stimulation of demand in the traditional channel, e-tailers prefer reselling contracts with manufacturers.” Furthermore, “this preference is moderated by competition among e-tailers — as competition between them increases, e-tailers prefer to set up platforms.”

The researchers note that platforms have become widespread in industries as varied as consumer packaged goods (Alice.com), travel (Expedia, Travelocity) and vintage goods and arts (Etsy.com), as well as the “marketplaces” on Amazon Marketplace and Marketplace at Sears.com. They warn marketers, however, that “online retailing is still in flux,” and that although the agency model has “become a pervasive phenomenon, the understanding of this phenomenon is limited.” “This is one more reason why we should be extra careful not to throw the baby out with the bath water,” Zhang says.

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