What's the future of e-book pricing?

In case you missed it, the U.S. government recently filed an antitrust lawsuit against Apple and five of this country's largest publishers, alleging they conspired to limit competition for the pricing of e-books. Three of the five -- HarperCollins, Hachette and Simon & Schuster -- opted to settle the case, while Penguin, Macmillan, and Apple didn't.

So where does that leave us?

Well, if you've spent any time reading through the terms of the settlement, you quickly realize not everything's all that black and white and is in fact quite muddled. For starters, a judge has to actually approve the settlement and then the three companies that have settled have to unwind themselves from their current contracts with retailers. All this should take a few months.

New terms
HarperCollins, Hachette, and Simon & Schuster, which is owned by CBS, the parent company of CNET, will have a couple of pricing models to choose from. Either they can go back to the old way of charging wholesale pricing (retailers buy a book for right around half its list price and then sell it for whatever they want) or they can simply set the price for the book (as they are doing now under the "agency" model) and give a 30 percent cut to the retailer. Apple operates both its iBookstore and App Store under the latter terms. (See Why e-books cost so much for a detailed breakdown on the difference between the wholesale and agency pricing models.)

The big change will be that retailers will be allowed to discount the price of e-books. Under the terms of the current agency model that caught the eye of the DOJ and precipitated the investigation and eventual antitrust lawsuit, no retailer could set a price for a book below Apple's price in its iBookstore. That so-called "most favored nation" (MFN) clause has been removed as part of the settlement.

So retailers are free to discount under the new terms -- but not without a caveat. The terms are only good for two years. After two years, publishers can negotiate a new agreement that would allow them to go back to the current terms and restrict discounting.

If that's not complicated enough, a retailer like Amazon, which was aggressively discounting titles to $9.99 under the former "wholesale" model (and losing money on bestselling titles), isn't permitted to take an overall loss on a publisher's catalog. In other words, a retailer's commissions have to at least equal the amount of discounts its offering. For example, if a retailer makes $100,000 from the 30 percent commission it gets from the catalog of publisher X, it can only discount (take a loss) of up to $100,000.

What will change?
Amazon has already said it will begin discounting titles as soon as the new agreements are in place. You'll most likely soon start seeing titles that once cost $12.99-$14.99 now costing $9.99. Amazon firmly believes it knows how to price and sell books -- and a whole lot of other stuff -- better than anybody and it wants to be seen as having the best prices for e-books.

CEO Jeff Bezos' vision and marketing acumen was the catalyst for e-books and e-readers taking off the way they did (Amazon did create the market), but it was Amazon's ability to undercut the competition on e-book pricing that played a big role in putting it in a dominating position that publishers worried would become a monopoly. Analysts estimate that Amazon once held a 90 percent share of the U.S. market. That has since dipped to about 60 percent, with Barnes & Noble at around 25 percent, Apple at 10 to 15 percent, and Sony, Kobo, and others making up the rest of the pie.

The new rules will certainly work to push e-book prices down, particularly prices for new releases and bestsellers, with Amazon taking the lead on the cuts. But the fact of the matter is I don't think it will seem incredibly dramatic, especially with some players continuing to hold out. Also, people forget that Random House wasn't part of the DOJ's lawsuit because it initially didn't move to the agency model along with the other five major publishing houses (it is on the agency model now). Random House is huge and it's unclear just what it will do.

Beyond that, as you see a return to less uniform pricing from retailer to retailer, it will become harder for smaller players to compete. You are going to be left with Amazon, Barnes & Noble, Apple, and that's it -- here in the U.S. anyway. The Sonys and Kobos of the world will probably do better to focus their attention on overseas e-book markets, many of which are just getting off the ground.

What won't change?
While the rise of e-book has actually been a boon to many publishers, it's obviously been very disruptive to their traditional print business. One of the big reasons publishers jumped in bed with Apple was that they were worried Amazon was becoming too powerful and would eventually have publishers completely under its thumb, and would dictate terms going forward (ironically, Apple is known for this -- think music, wireless providers, and app developers).

One of the problems publishers have had with the new world of e-books is that readers have come to expect the digital version to be available the day the print version launches. In the past, you had the hardcover, and the paperback would come out a year later (if the publisher decided to do a paperback). The gap between the hardcover and paperback release was -- and still is -- called windowing.

In essence, publishers see elevated prices on e-books as a form of windowing. Those e-book titles you see at $12.99 and $14.99 are at those prices because publishers want to provide some coverage for the hardcover -- and sometimes even the paperback -- and not make the print version look so expensive that no one will want to buy it.

Publishers are going to have a hard time letting go of that windowing concept. As I said, under the new rules, publishers have a couple of pricing models to chose from. Back when they were using the wholesale model, one way they sought to keep profit margins up and essentially punish Amazon for pricing new releases at $9.99 was to set the list price of the digital version at a very high price. For example, a typical hardcover carries a list price of around $25. But publishers might price the digital version at $30 so Amazon would have to buy it for $15, thus losing $5 on the sale.

The other option under the new terms is for publishers to set a relatively high price (say $14.99) and give Amazon its 30 percent cut on that price. If Amazon chooses to sell it for $9.99, it'll lose 50 cents on the sale. Either way, however, I expect that publishers will keep the list price for e-books high. (On a side note, publishers would be smart to move retailers away from the 30 percent commission Apple established and move to something closer to 20 percent or less. Naturally, Apple, Amazon, or Barnes & Noble wouldn't want to make that deal).

Amazon has deeper pockets and more customers, so it will be hurt less by these tactics and gain in the long run. As it did before, Barnes & Noble will do its best to compete with Amazon's pricing and also pick and choose titles to run with its own special discounts (that said, Amazon is remarkably adept at quickly matching prices). As for Apple, it's getting more sophisticated with its marketing of e-books, but it's unclear what kind of discounting it would do, if any. With its app store, developers set the price and that's it. It's been the same with the iBookstore.

Finally, Amazon is a publisher itself and has also been a great supporter of self-publishing ventures. It will continue to aggressively promote and price Amazon exclusives, putting pressure on traditional publishers to lower their prices. In some ways, while it continues to push traditionally published books, it's also taking a YouTube/Facebook approach to creating user-generated content that it can monetize.

What needs to change?
We can spend a lot of time debating who the bad guy is in all this, but if you look at things objectively, everybody has a perfectly reasonable position; it's hard to take sides.

Publishers are concerned that Amazon doesn't give a damn about anybody or anything beyond its bottom line, gaining market share, and that it's out to destroy the publishing industry as we know it. Amazon thinks it knows how to sell books and e-books a lot better than publishers and brick-and-mortar stores -- and ultimately it's helping publishers, not hurting them. And somewhere in the middle of all this consumers just want e-books to cost less.

I personally don't think all e-books are overpriced, just certain ones. And, no, I'm not talking about the latest Scott Turow novel that comes out and is priced at $14.99. Or Stephen King's latest blockbuster, "12/22/63." Or whatever big title comes out from whatever big-name author.

Sure, they often cost almost as much as the hardcover on Amazon, but if people are willing to buy them at that price, why would publishers price them lower? It's a simple case of supply and demand. If the market's there at that price, then go for it, although take note that it's a really bad idea to price the e-book higher than the hardcover (yes, this sometimes happens, and it infuriates potential buyers, as well it should).

Ultimately what I object to most is publishers lack of flexibility in pricing. The fact is, not all books are worth the same. One may be written better than another, but that doesn't mean it's worth more. It's not fair -- and just plain stupid -- for publishers to put the same price tag on a book from a well-known author as one from an unknown author. Readers may try a debut novelist at $4.99, but at $11.99 it's a difficult sale unless the book has had some sort of publicity.

The beauty of an e-book is that since material costs are virtually nothing, you can be much more flexible with pricing. Self-published authors are constantly playing around with pricing and seeing how it affects sales. Why shouldn't traditional publishers? Yes, some are experimenting, but pricing on the whole should be much more dynamic. Don't just set a price and let it sit there (Tip: you can monetize older backlist titles a lot better by simply pricing them at less than $5).

Each book is a product unto itself and needs to be priced accordingly. I can tell you that Amazon and Barnes & Noble understand this and publishers will eventually realize that the market is moving in a direction where it becomes much more about maximizing sales on each product, not just a few top sellers. All you have to do is watch Amazon's pricing on the titles it publishes under its Amazon Publishing umbrella.

Publishers also need to have a better understanding of how people buy e-books. The way people shop for e-books is much more like how they shop for apps. Sure, people have their favorite authors, but a lot folks simply browse top products lists, stop on something that seems intriguing, is rated highly by users, and is priced right. They may not ever actually read the book, but, hey, plenty of people buy print books and never read them.

My last suggestion: use price cuts as advertising. Most books don't have big marketing budgets -- or any marketing budget for that matter. Also, fewer and fewer publications bother to review books anymore. So price can be a publisher's best marketing weapon.

Some of this sounds like 101 stuff, but somehow it seems to get ignored in all this talk of agency and wholesale models and antitrust lawsuits.

The fact is, pricing is an art. You can publish that.