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Ignorance and Competition in the Book Market

Posted By admin On Saturday, March 6, 2010 @ 5:54 AM In Books Industry | No Comments

I’ve been having a long Twitter discussion with Will Wilkinson about the economics of the book industry. Will wanted to know how authors could make money without “digital rights management” technology, and I replied by saying that writing a book has always been less about making money than it is about promoting the book’s author, and I suggested that the activity is going to become a lot less lucrative in the future.

To think clearly about the future of the book industry, it’s essential to understand its present. In particular, to make an educated guess about what the price of a book will be in the future, we need to understand why books cost what they cost today. I think there are two key insights that largely explain the structure of the book market. First, publishers are really bad at predicting whether any given book will be a success. And second, there is an almost unlimited supply of aspiring authors, some non-trivial fraction of whom would, if given the opportunity, produce a best-selling book. Call these the ignorance and competition assumptions, respectively.

Now, today’s book prices have two distinct and puzzling characteristics. First, book prices don’t vary much and don’t seem to be correlated with popularity or quality. Most categories of hardcover books cost around $25.00. Publishers do not seem to charge extra for books by famous people. They don’t jack up the price if a book is well-reviewed, or offer discounts they’re panned in the New York Review of Books. As Paul Graham has observed, publishers seem to price their books in rough proportion to the cost of the raw materials: longer books are somewhat more expensive, but what’s actually printed on the page has relatively little effect on a book’s price.

This can be explained by ignorance (on the part of customers) and competition (among publishers). A customer generally don’t get to read a book before you buy it, and other indicators of quality, such as reviews, are only weakly correlated with a given customer’s enjoyment of a book. Moreover, there are lots and lots of books to choose from. These factors, together, make the book-buying public strongly price-sensitive. A publisher selling a $40 book in a market where the norm was $25 would lose a lot of customers. Because book-buying is always a hit-or-miss affair, few would want that specific book enough to pay an extra $15 for it, while most would have plenty of other books of similar perceived quality and dramatically lower price.

The second puzzling characteristic is that books are dramatically more expensive than their cost of raw materials. Printing and distributing a book costs around $5. This means that every book sold for $25 represents a huge profit to be divided among the bookseller, publisher, and author. This too is explained by ignorance, this time on the part of publishers. The print process is characterized by high fixed costs and economies of scale. This means you have to sell several thousand copies of a book to recoup the costs of printing it. Most books do not hit this target and so lose their publishers money. Hence, when you buy a book for $25, you’re not only covering the $5 it cost to print and distribute that book, but you’re also helping to defray the costs of several other books that wound up in the remainder bin.
With this background, it should be easy to see how authors’ compensation is determined. To simplify the math a bit, let’s assume there are only two outcomes for a book: hit or not-hit. Then the value of a manuscript is the profit from a hit, times the probability of a hit, minus the losses from a non-hit times the probability of a non-hit. Our ignorance assumption means that the probability of a hit is low, which means that the expected value of printing a book—and hence the value of a manuscript from a first time author—is very low. And this is what we see in the marketplace. When a publisher takes a chance on a non-famous, first-time author, the advance tends to be relatively small……………. Click here to read the complete article [1]

Article written by Timothy B. Lee

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