Random House And The Agency Model

Sorry for the delay in posting today. My cat knocked over a glass of water on my desk. While the glass was not next to my laptop, the momentum of Bob's leap sent water flying across my keyboard. Grrrrrr.

Last Thursday, Mike Shatzin had a post on his blog here titled "What's So Hard to Understand About Random House's Strategy?"

He was referring, of course, to Random House's decision not to join the other five largest publishers in moving toward the "agency model" associated with Apple's forthcoming iPad.

As I've explained before, in the traditional "wholesale" model, the retailer pays 50% of the list price of the book and then sets its own retail prices. By contrast, in the agency model, the publisher decides the retail price and pays Apple a 30% commission on each sale.

To compare the two models, let's do the math on a traditional $27.95 hardcover book like the current best-seller, Clive Cussler's The Silent Sea. Under the wholesale method, retailers pay the publisher $13.97 for that book and then turn around and sell it to the consumer for prices ranging from Walmart's $16.50 to the D/FW Airport bookstall's cover price of $27.95.

Of course, Walmart has more clout with publishers than other retailers because, at $16.50 (a 41% discount to consumers), they'll sell a whole lot more copies of The Silent Sea than their competitors. Amazon is selling The Silent Sea for $16.77 (a 40% discount) and, if the consumer spends $25, he'll get free shipping from Amazon.

Remember, that $13.97 to the publisher is not net. The publisher still has to pay all its expenses: print, distribution, warehouse, marketing and author royalties out of those dollars.

Now, let's apply the wholesale model to e-books to see why Amazon is making publishers so crazy. Amazon still pays the publisher $13.97 for the book. But Amazon is selling the e-book version of The Silent Sea on the Kindle for $9.99.

That's right. Amazon is taking a $3.98 loss on every e-book they sell. Jeff Bezos was willing to take that hit for two reasons: (1) By doing so, he built Amazon into the largest e-book retailer in the U.S.; and (2) He also convinced a whole lot of readers to buy a Kindle device.

Let's take a look at the agency model that Apple and the Apple 5 have embraced for e-books on the iPad. Remember: Apple agrees to let the publisher set the price and takes a 30% commission for each sale.

The rumor is that e-books purchased through the iBookstore will cost $12.99. That means Apple gets a 30% commission or $3.90 and the publisher takes $9.09. Of course, the publisher's expenses are much less when releasing an e-book although the author's royalties are higher.

The bottom line is the Apple 5 publishers are willing to take less money under the agency model in order to control the list prices for e-books. They don't want that $9.99 to become set in stone.

Meanwhile, Mike Shatzkin has an interesting observation about Random House:

By holding themselves out of the new channels, continuing the current policies of “wholesale” discounting, and allowing the retailers to set prices, Random House will be maximizing their short-term sales and profits ... Random House will collect more money for each ebook sold than their competitors do while the public will pay less for each Random House ebook they buy than for comparable titles from other publishers.

When you put it like that, why wouldn't they stick with Amazon and the wholesale model for e-books?

Crain's New York Business.com reported last Tuesday here
that Random House's 2009 revenue results were flat at "$2.3 billion, while operating profit reached ... $185 million—keeping the company even with its 2008 results."

As Mike said in his post, "for the foreseeable future, all the Random House position means to them is more revenue per copy and lower prices to the consumer."

Sounds pretty good to me.