At What Price Control?
On Monday September 30, 2002, Universal Music, Sony Music, Warner Music, Bertelsmann’s BMG Music and EMI Group, plus retailers Musicland Stores, Tower Records and Trans World Entertainment agreed to pay a $67 million fine and to distribute $75 million worth of CDs to the public. The fine and damages settled lawsuits in 43 States over accusations that the top five record companies and top three music-only retailers had colluded to fix CD prices in the 1990s at an artificially high level. (Read http://www2.warwick.ac.uk/fac/soc/law/elj/eslj/issues/volume3/number2/fuhr/fuhr.pdf)
As part of the agreement, the eight parties admitted no wrongdoing and defended the controversial changes in the industry-wide “terms of sale” practices that precipitated the lawsuit. Yes, that’s right, facing convulsive challenges to their business model, record companies came to the conclusion that if they just tweaked their terms of sale, all would be well again. This happened ten years ago.
The new model was called MAP or minimum advertised price. In exchange for the retailers not to price a CD below a record company’s dictated minimum, retailers would continue to be reimbursed by the record companies for their advertising costs (what is known as Cooperative Advertising). If the retailer did not abide its MAP, the record company would not pay co-op. As co-op is a major part of a retailer’s bottom line (without it, their business is unsustainable), everyone got in line.
MAP was instituted across the industry as a means to combat the explosive growth of big box retailers (Wal-Mart, Circuit City, and Best Buy). The big boxes were pricing CDs below their wholesale prices, taking a loss in order to drive traffic into their stores. Once customers were inside a Wal-Mart, they were more likely to purchase a big ticket item or load up on bulk supplies. Statistics showed that the allure of $4.99 prices for top ten CDs reeled in customers who would end up leaving the store with $200 worth of purchases in their shopping carts. Taking a loss on a small margin business for the big box (CDs) made sense because it drove bigger margin sales elsewhere in the store.
Traditional music stores didn’t like being undersold. Plus they only sold CDs, not plasma screens and toilet paper too. For them, the $4.99 buyer left spending $4.99. They needed to turn back the clock. They already knew that elevated prices for CDs supported their high rents (whiz bang stores in major metropolitan areas) and made the business viable.
The record companies went along with the demand for MAP because they thought the policy would keep the independent music-only retailers afloat. At the time (1995), Wal-Mart, Target, Best Buy and Circuit City were seizing market share at an incredible rate. In the late 80s, 75% of music was bought at the independent and small chain level. By 1992, 62% and by 2000, the little guys only controlled 42% of retail sales. More than 1000 stores went bust in that interim.
While the big boxes seized market share, they gained more and more power. Power of the “if you don’t do it our way, we won’t sell any of your products” variety. So given the opportunity to hold back that disturbing tide with MAP, the record companies played ball with the “little” guys. The big boxes either fudged in their advertising and continued to discount (Circuit City, now bankrupt, was the most aggressive obfuscator), or they bided their time.
Another factor in MAP’s favor was that the record companies also subscribed to the “devaluation of product” theory. The controlling idea of this theory is that if you price a product too low, the value of the product will be lessened in consumers’ minds. The “If it’s cheap, it must be crap,” phenomenon. Try giving something away for free and you’ll understand this theory very quickly. In record company-think, MAP would not only keep competition robust at the retail level, it would keep the value of music in consumers’ minds high. Remember, this was the era of the $17.99 new release CD which had one hit on it and a bunch of other songs you’d never heard before.
MAP, while not an idea Adam Smith would embrace, makes sense…if it’s the 1970s or 1980s. The promise of MAP was that it would keep prices high and serve the same old audience—a tightly defined mass of connoisseurs who valued and spent their disposable income on music. Essentially baby boomers and their offspring in college. As a kid, I remember the two days of the year when I was lucky enough to become an owner of music—my birthday and Christmas. When I was in college music wasn’t an indulgence, it was a necessity. The mass of my generation and those before me were reliable buyers and big enough to sustain the gatekeeper hierarchy business model of the record companies.
The problem record companies would face was a phenomenon Alvin Toffler coined forty years ago, Future Shock. Communication was turning upside down when their MAP strategy went into practice. An alternative world made up of zeros and ones had come online and the old gatekeeper rules wouldn’t work here. The shock of the system was that the core ethos of this world was about sharing, not shilling. And what was the one thing that a critical mass of early adopters of the Internet shared?
College students who define and follow musical trends now had access to high speed Internet connections at school. And what they loathed most about the music business was the tyranny of the $17.99 CD with one great song and eleven fillers. They felt ripped off.
Then in just 25 months (June 1999 to July 2001) Napster, driven by 25 million users (that’s 1 million adoptees a month) “sharing” 80 million songs (not albums), expanded the mass of music connoisseurs exponentially. These 25 million were willing to spend hours in front of their computers to complete downloads of a friend’s bootlegged mix tape of The Lounge Lizards at the Knitting Factory in 1988.
Did these 25 million people define a massive new market for music? Would they trade a “free” copy of a song or album for speed and simplicity for a reasonable charge? Obviously the answer was yes. But then record companies would have had to throw out their scarcity business model to serve them. They didn’t do it—couldn’t really—so Steve Jobs did.
MAP’s artificially high pricing didn’t work out so well. It just sped up the inevitable. Musicland filed for Chapter 11 in January 2006. Tower Records went bankrupt in September 2006. Trans World Entertainment, a media-focused retail conglomerate, is down to f.y.e. and two other specialty shops. It had to close Camelot Music, CD World, Streetside Records, Coconuts, Disc Jockey, Harmony House, Media Play, On Cue, Record Land, Record Town, Sam Goody, Spec’s Music Inc., Strawberries, Tape World, The Wall, Wall to Wall Sound and Video, Planet Music, SecondSpin.com, and Wherehouse Music.
What does this have to do with book publishing? A lot.
Because there has been no Napster for books, yet (http://torrentfreak.com/major-book-publisher-files-mass-bittorrent-lawsuit-111031/), publishers don’t know if there is a mass of frustrated book buyers out there who would come to the party if prices were lowered. Publishers don’t know if the equivalent of a “song,” a 30 page eBook, would attract a compelling audience. They are beginning to find out.
Setting prices is not easy. How do you put a price on a piece of art? A great book like any great work of art is priceless. Charging $.99 seems like an insult if your company spent tens of thousands of dollars if not hundreds of thousands of dollars to bring it to the marketplace.
And by the wholesale model, the publisher would only receive 50% of that $.99 to keep the lights on. A book that sells 10,000 copies at $25 brings in $125,000 of gross revenue. In order to get the same amount of dollars in at $.99, the publisher would have to sell 250,000 units. 25 times more.
Geez, maybe publishers should take a page from their retail partners—Amazon and Barnes and Noble—and try out the business from the other side… If they did, they would double revenue with every unit they sold and be able to pass on substantial savings to the people who actually bought their books. Plus they’d find out who the fans are and have a chance to talk to them. A $25.00 book could be sold for $12.50 if you didn’t have to give someone else $12.50 to “display” it.
If there is no problem with a retailer putting on the publisher hat, why don’t the publishers put on the retailing hat? Doubleday used to have retail outlets, but sold them to Barnes and Noble in 1990. It made sense then. But it doesn’t now. As additional retailers would actually lower prices for consumers, I doubt there would be any major issues with anti-trust, either. Especially since retailers have become aggressive publishers.
Would Amazon and Barnes and Noble refuse to sell their books if the publishers started to compete with them? Maybe, but I doubt it. Why don’t the big six do what the major airlines did when they were being squeezed by Travelocity? The top five airlines got together, split the costs, and started Orbitz. Travelocity still books tickets for the Orbitz airlines and the competition between the two discount sites keeps prices as low as possible. Consumers win.
I don’t know the answers to these questions. And I’m happy to be a guy who doesn’t have to face them every day of my life. Imagine walking into a board room and laying out my cockamamie scheme…Hey; let’s alienate our biggest “customers” (retailers)? I doubt anyone has. But (you knew I’d have a but) it seems to me that changing the terms of sale from wholesale to the agency model for eBooks is short term thinking.
The agency model actually damages publishers in the eyes of the most important people to them—consumers who want to buy a lot of books. I’m so sick of hearing about how terrible the big houses are. They aren’t Cosmo-demonic enterprises. They are just uncertain and cautious.
Why don’t they do something for consumers to make them want to support the big houses instead of longing for their demise? The amount of favorable press Amazon has received for competing with its own customers is indicative of just how damaged the Big Six are in terms of public perception. Of course Amazon can offer books cheaper than the publishers…they sell all kinds of other high margin items and they have their own publishing units…
The great thing about eBooks being less expensive than physical books is that the buyer doesn’t feel like a chump if he gets a quarter of the way through a book and not like it anymore. How many times have you forced yourself to finish a book because you dropped $20.00 to buy it? Or you got turned off to books entirely for a sizable period after that?
Guess what? If eBooks were priced by the competitive marketplace, all of that time you spent reading something you don’t like could be spent finding something else to read. If you can get four books for $20 and only one of them knocks you out of your socks, you still win. So do publishers. Especially if they are selling you those books from their own stores.