A page is turned
By David Gelles and Andrew Edgecliffe-Johnson
Published: February 9 2010 , Financial Times

It was the day after Apple unveiled its iPad and Macmillan's John Sargent was heading for the Amazon.com headquarters in Seattle on a hastily arranged visit. The chief executive of the venerable publisher arrived with an ultimatum for the world's largest bookseller - either let Macmillan charge more for its electronic books or wait a painful six months after it made new titles available through other outlets, including on the iPad.

Amazon balked. By the time Mr Sargent returned to New York that evening, it had begun removing all Macmillan titles - both e-books and physical books - from its website. If Macmillan wanted to play hardball, it seemed Amazon was game.

But just a day later, Amazon capitulated, agreeing in principle to raise the prices for Macmillan's e-books. The iPad launch had underscored the increasingly stiff competition it faced in the fast-growing digital books business and Amazon simply could not afford to lose Macmillan's titles, which include bestsellers such as Wolf Hall , The Politician and The Checklist Manifesto .

These were the opening shots in a battle that will determine the future of book publishing as it follows music and film online. Every media sector to make this transition has had its economics destroyed in the process. Now, suddenly, it is happening to books. An afterthought just six months ago, e-book sales have overnight become both the focus of the industry and a potentially lucrative new battleground for technology companies such as Amazon and Apple.

"It is an extremely important moment, because I think we are seeing a fundamental shift towards digital product," says John Makinson, chief executive of Penguin Group, which, like the Financial Times, is owned by Pearson. If publishers get the pricing negotiations wrong now, they may hand control of their future to a few large technology companies.

The changes come against a backdrop of a global print market for consumer books that has switched from slow growth to slow decline. PwC, the consultancy, predicts it will slip from $72.6bn (€53.1bn, £46.5bn) in 2008 to $71.9bn in 2013. Spending on electronic books is expected to rise from $1.1bn to $4.1bn over the same period.

While still a small portion of the total, such forecasts underscore that publishers' best hope of growth lies in e-books. Amazon, Sony and Barnes & Noble already operate their own e-book stores. Apple will launch the iBookstore when the iPad comes out next month and Google is preparing an e-book outlet.

Confronted by the digital future more quickly than they had anticipated, publishers are scrambling to gain the upper hand. With a single meeting in Seattle, Mr Sargent acted to wrest control of e-book prices from Amazon, which until now has in effect determined pricing thanks to the estimated 80 per cent market share held by its Kindle platform. A week after his trip, Mr Sargent sent an open letter to Macmillan staff and authors. "In the last three weeks, from a standing start we have moved to a new business model," he said.

The ground rules for digital publishing are being sketched out at a fast pace and in a very public fashion. But while Amazon has agreed to allow Macmillan to set the price of its e-books, and will do the same with other publishers, the fight is not over. In the same way that Apple quickly established a dominant position in online music through the iPod and was thereby able to control pricing, the early lead built by Amazon in the e-book business is part of a calculated strategy. With physical sales under threat, the bookseller stands to lose unless it has a foot in the new world.

"Amazon is trying to use all the power it has from its physical product business to secure a dominant position in the digital business," says Benedict Evans of Enders Analysis.

It has done this by selling e-books at a loss - $9.99 for most US titles. This lured in consumers, who were then locked into the Kindle platform with digital rights management software that meant they could read their e-books only on the Amazon e-reader or its applications for other devices.

Publishers complain that in its quest for market share, Amazon has set e-book prices artificially low. Rupert Murdoch, the News Corp chief executive whose properties include HarperCollins, last week expressed that concern during a conference call. "We don't like the Amazon model of selling everything at $9.99," he said. "We think it really devalues books and it hurts all the retailers."

Now, publishers are trying to take back control. Rather than let Amazon determine prices, they are demanding more flexible pricing for their digital wares. "E-books are seen as a very important part of the survival of publishers," says Mike Shatzkin of Idea Logical, a consultancy that helps publishers with their digital strategies. "So the publishers are looking to get some control of the retail pricing."

Until now, sellers of e-books including Amazon and Sony with its Reader device worked through a wholesale model. They bought e-books from publishers for 50 per cent of the physical version's list price, then sold it for whatever they chose. This often meant that Amazon was paying $15 for an e-book that it sold at more than a $5 loss. Amazon was willing to take that hit in order to build a market share that gained it leverage over the publishing industry in years to come.

Macmillan has now pushed Amazon to adopt the same "agency" model that the publisher uses with real-world bookshops. Under this arrangement, the publisher sets the price of a title and keeps 70 per cent of the sales, leaving 30 per cent for the retailer.

HarperCollins also looks poised to push for the agency model. Mr Murdoch said Apple was being flexible in its pricing for the iBookstore and signalled that Amazon would be next. "It appears that Amazon is now ready to sit down with us again and renegotiate pricing," he said. Penguin, too, says it would welcome a more consistent digital business model. Hachette said last Friday it would begin using the agency model to sell e-books.

The flurry of negotiations was triggered by news that Apple had agreed to adopt the agency model for the iBookstore. To publishers, Amazon suddenly was not the only game in town. By threatening to withhold their books from Amazon, publishers could now set their own terms.

Publishers hope that raising e-book prices will have a twofold effect on their business. In the long run it would set a higher benchmark for e-book pricing, critical as volumes increase. In the short term, it could forestall the decline of physical book sales. "We will make less money on the sale of e-books, but we will have a stable and rational market," wrote Mr Sargent in his letter.

For as much as they tout their embrace of digital books, the big six publishers are at least for now still reliant on the success of their current distribution model - the bookshop. "Legacy publishers still want bookstores to last as long as possible," says Mr Shatzkin. "Their business model is built on their expertise in navigating that industry."
Read the full lengthy and thoughtful piece at FT online.