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9Mar/11Off

The under-appreciation of the misunderstood

I kind of like reading publishing consultant/publishing industry insider Mike Shatzkin's blog because I feel like he's usually a straight shooter in giving his industry's perspective and he's more honest and digitally savvy than many others in that world. But, especially since the agency pricing debacle, I've found less and less to like in his posts.

Before delving into today's mess, though, I wanted to note that any analysis or debate about ebook pricing in 2011 happens against the backdrop of skyrocketing ebook sales. I was wrong about the immediate impact of agency pricing -- ebook sales continued to increase at a heady pace. We could could get mired in a debate about whether they would have increased even faster without agency pricing and so on but let's save that for another day (or to quote that great New Yorker cartoon "Tuesday's not good. How about never?")

In any event, today Shatzkin criticized publishers who, having seized control of the pricing of ebooks, are not doing a very good job of using those prices to maximize sales revenue. Shatzkin basically see little reason why big publishers can't easily develop adaptive pricing algorithms pronto. There is no appreciation for the innovations, patents or, most importantly, millions of lines of code that Amazon and a few others have developed over the past decade.

And that leads to the bigger point I wanted to make. The increasing digitalization of content businesses like music, movies and books brings into conflict what I'd call traditional liberal arts business people and more geeky, mathematical business people.

I first noticed this dichotomy when I followed Google, starting from way back at the company's IPO in 2004. A lot of traditional media and advertising people (and journalists!) were dismissive of Google's future prospects, figuring all they did was generate a bunch of links for web searchers. How hard could that be and how long until someone else did it on a prettier web page?

To grossly oversimplify, what those people missed or could not appreciate was the many difficult hardware and software innovations required behind the scenes that enabled Google to index more web sites more quickly and at a lower cost than anyone had ever previously achieved. Not easy to duplicate -- check Microsoft's multi-billion dollar efforts so far.

Lately, the misunderstood company run by geeks is Amazon.com. Just to pick on Shatkin for a minute, when I posted a comment about how agency pricing cut out the genius of Amazon's pricing system, Mike replied:

The key component for retailers shuffling their prices is competition for market share. What Amazon and others do very well is watch what others are charging and change their own prices to keep an enduring consumer perception that they're delivering the best value. And in fact, they don't care about maximizing revenue from any particular SKU (as publishers would), they care about maximizing total revenue from customers.

Of course and in fact, says Shatzkin, all Amazon does to set prices is some simple, easily duplicated, not very valuable, barely worthy of notice computer-sciency thing. They don't care about maximizing revenue from each product. It's just a big game of whack-a-mole to maintain the perception of low prices.

In actual fact, nothing could be further from the truth. Amazon has perfected an extremely complex pricing system that is designed to sell more of each of the specific items they are selling and collect the highest amount revenue on those sales. There's a great paper from last year about Amazon's pricing mechanisms by several consultants at A.T. Kearny. It's all worth a read but here's a relevant excerpt:

Amazon demonstrates surgical precision in adapting prices. Although competing e-tailers such as Best Buy and New Egg also vary prices, these firms tend to keep a price constant for longer periods—usually one week. Amazon sometimes changes prices for a single hour, as shown in figure 4. Clearly Amazon's prices are set by automated pricing engines that experiment continually, aiming to maximize profits by product and category to refine the answer to the question "Are we optimizing the category profitability?"

In addition to such pricing dynamics, Amazon uses product characteristics to help segment its customer base. It sells different colors of the same camera for different (and differentially fluctuating) prices. It may be using odd colors to attract price-conscious consumers, while justifying higher prices for more popular colors. It may even have customer research relating some colors to a willingness to pay higher prices.

Shatzkin still can't quite get it, though, and then shifted the argument to the unknowable ground of whether agency pricing was or was not dampening ebook sales.

But he's really missing the boat on ebook pricing specifically. Amazon has much greater selection than its competitors so most ebooks away from best-sellers are only being sold by Amazon. Price changes don't have anything to do with competitors. Not to mention that because of the publisher-required DRM locks, customers typically choose a single ebook platform and stick with it. So the amount of price comparison shopping is much less than for, say, television sets or DVDs. And Amazon knows far more about each customer than any publisher ever will. There's an awful lot going on in real-time to figure out how to maximize revenue.

Amazon is aiming to collect the most money from sales of each and every ebook. It's not after some vague "perception" of "best value." It's after cold, hard dollars and cents to the benefit of publishers and authors. Don't forget that before agency pricing, big publishers set the list price of ebooks and collected about half of that price as a royalty from Amazon on every sale. They collect less revenue on most agency sales now. Publishers may not want to accept the valuable contributions of smart retailers to their industry but they'll suffer as a result.

Posted by Aaron Pressman

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