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Economics of e-books: where we are now

Is there a more contentious current issue for authors than digital royalties? Let us sample a couple of perhaps representative shots from both sides of the trenches. The Society of Authors (SoA) chair, Tom Holland, has continually upheld the SoA's call for higher digital royalty rates. Last year he blasted publishers in his Bookseller column for trying to "strongarm" authors into "miserly" deals for 15-25 per cent of net receipts for e-book royalties for the duration of copyright. He added that "it is hard to see what it is about the selling of an e-book that entitles the publisher to cream off such an exorbitant share of the revenues... publishers seem instead to have constructed a collective wall of silence around their accounting."

A salvo from the other side comes from the blog of Evan Schnittman, Bloomsbury's group managing director for sales and marketing, and one of the industry's leading digital gurus. Schnittman said that authors' calls for increased e-book royalty rates was "built on the self-serving and reductive assumption that e-books can and should be viewed as separate from a book's overall economy... The object of this ploy is to dissect the intellectual property into as many different pieces as possible and negotiate them on the open market in order to maximise the deal."

The two sides seem very far apart indeed. Authors, seeing a product that reduces the production and distribution costs feel aggrieved that publishers are taking a greater part of the pie. Publishers, meanwhile, believe that authors and agents do not fully understand the publishing process nor appreciate the considerable costs involved in the infrastructure required for e-books. It does beg the question, will there ever be common ground?

Book costing: old school

To fully understand both sides, it is useful to run through on how e-books are priced and costed. Be prepared: this will require some maths.

First, by comparison, we need to examine the economics of the printed book. Let's take a hardback, Dean Koontz's What the Night Knows (HarperCollins) released in early January with a recommended retail price of £18.99. Let's assume that the retailer is getting a 50 per cent discount (though, of course, the supermarkets, Amazon and the bigger multiples often demand more) which takes the gross revenue for that book down to £9.50. Of that, 15 per cent of the retail price would be royalty payments to Koontz, subtracting £2.85 to get us down to £6.65. Printing, production, shipping, warehousing and dealing with returns generally cost about 12.5 per cent of the retail price, in this case £2.37.

We are now down to £4.28 for that £18.99 hardback. Publicity and marketing costs average around 5 per cent of retail (0.95p) and typesetting and proof-editing might chop off another, say, 3 per cent (0.57p). That brings us down to £2.76, which is 14.5 per cent of the £18.99 hardback. But the publisher still has to use some of those costs to contribute to overheads like salaries, rent, utilities, etc, perhaps half of the remaining value, leaving HarperCollins with £1.38 for that hardback, or a 7 per cent profit on that £18.99 book.

This is, of course, a rather broad measuring stick, not factoring in advances, royalty rates that can vary from 10-15 per cent depending on sales, if the books are actually sold in sufficient quantity to top the break even production point, and is rather conservative on the cost of salaries, rent and utilities. And when the format changes to paperbacks the costing varies, not least due to royalty rate decreases and sales increases.

Costings: ebooks

Now let's run through the same costing for e-books. The e-book formula is more complicated because of the two kind of retail pricing models for trade books: agency and wholesale. Wholesale is the traditional print model, where a retailer buys the book at a margin and is free to sell at whatever price it chooses. Agency is where the publisher sets the retailer price and divides the proceeds from each sale on a 70/30 split with the retailer.

Further complicating things is pricing. For a time, UK publishers tried the quite frankly asinine policy of directly linking e-book price to the most recent print version. If a new hardback was out at £18.99, the list digital price would be £18.99 (usually slightly more because VAT is applied to e-books); when the title changed to a £7.99 paperback, the e-book RRP would switch as well. This policy has largely shifted downward, with "first run" digital RRPs hovering around the £12.99 mark (when released in time with the hardback), a "trade paper" e-book around £8.99 (print: £12.99) and the "mass market" e-book list price averaging around £5.99 (print: £7.99).

The original pricing model caused some understandable customer confusion and downright anger. If you downloaded an e-book one day, the following day you could find that the e-tailer was selling exactly the same file 70 per cent cheaper. Even with the new models, customers still seethe about the perceived high price of e-books (remember we are talking about an online culture that equates digital with free) - and particularly against the publishers that have gone to the agency model (in the UK that includes Hachette, Penguin, HarperCollins and Macmillan).

Take a glance at the discussion forums on the big e-tailer sites or e-book techie blogs like Mobilereads or Teleread and you see almost universal vitriol against publishers. In a thread on the Kindle discussion forum after Amazon posted a press release explaining why it was forced to adopt agency pricing by publishers for some of its Kindle books, "Cuchulainn" writes: "This is nothing short of price fixing. I really think the publishers have made a big mistake here, it has been tried before and failed with paper books. I would suggest to everyone against this to contact the Office of Fair Trading with their concerns." That response is fairly typical of the tone, though "Mick" advocates less restrained measures: "Outdated Ludite [sic] publishers, smash their presses I say, and be damned!"

Devil in the detail

Now to the digital breakdown. Let's take a £13 "first-run" e-book, The Leopard (Harvill), by the Norwegian Jo Nesbø, one of the plethora of Scandi crime authors anointed with the "Next Stieg Larsson" tag. Harvill's parent group Random House is on the wholesale model, so let's assume a 50 per cent margin - though for e-books that is a small assumption, particularly for the bigger authors. The e-book of The Leopard at this writing is selling on Amazon for £5.84 (55 per cent off its RRP). The Waterstones and W H Smith's e-book stores, amusingly, have different RRPs (£13.27 and £13.56 respectively) so they can each claim that they are selling The Leopard at half price (£6.63 and £6.78). Amazon's bestselling e-book author Stieg Larsson has all three of his books discounted by over 60 per cent of their £7.99 digital RRPs. Harvill and Larsson's publisher Quercus would not reveal the terms they have negotiated with Amazon (quite rightly), but one would hazard a guess that it far exceeds 50 per cent.

But let us assume that 50 per cent wholesale benchmark. Nesbø's The Leopard £13 e-book is now down to £6.50. Now we have to subtract the costs. Herein lies the rub and the most fought over ground in the entire debate. How much does production of that e-book cost?

Standard file conversion is relatively cheap, not exceeding 50p a go. Now we are down to £6. If we again assume 5 per cent (65p) off retail for marketing and publicity costs we arrive at net receipts of £5.35. Take off Nesbø's 25 per cent and that gives the author £1.34. That leaves Harvill with £4.01 for those salaries, overheads and advances.

Let's quickly do the maths for an agency publisher. Irritable entrepreneur Lord Alan Sugar's memoir What You See Is What You Get (Macmillan) is currently priced at £12.99 on Apple's iBookstore. The 70/30 split means that Macmillan gets £9.09 from each sale. We'll again take off that 50p for digital conversion and 65p for marketing to leave us with £7.94. Advance depending, Lord Sugar would get 25 per cent of that (£1.99) leaving Macmillan £5.95 for overheads.

So publishers are absolutely raking it in from e-books? They would say no (or not yet) and they may have an argument. In physical book production, distribution and warehousing costs are temporal and once a book is printed it can last for literally thousands of years. A key thing to remember in the digital world is that e-book files do not float in the ether on their own. They have to be digitally warehoused, distributed and security protected. Files need to be ready to be converted to new and emerging formats - epub is the standard publishing building block for e-books, but will it still be in five or ten years time? And digital files are less hardy than their print counterparts. An increasingly vexing problem in archive libraries is what is called bit-rot or data decay. Digital files are hosted on physical machines and thus corrupt and "rot" eventually, due to things like electrical surges or improper insulation. If I wanted to preserve Alan Sugar's memoir for my ancestors to read in the year 3011 (and, hey, who wouldn't want to?) I would opt for the hardback, because the Kindle e-book version will unquestionably be unreadable.

Most authors realise that the costs of building the digital infrastructure are not inconsiderable for publishers, particularly in these early days. Costs will lessen as digital becomes more and more prevalent, but it is worth underlining that costs will be ongoing. How much does that cost now? It varies. For big conglomerates with in-house aggregating systems, it is relatively low. For publishers going through third party e-book aggregators such as Gardner's, the digital warehousing can be as much as 50 per cent off the retail price of a book. Furthermore, conversion costs are not really on a per book basis, but rather are "front loaded", converted as a matter of course as part of the workflow, and most publishers say that the minimum amount of e-books that need to be sold to break even is 100. Not an inconsiderable amount, particularly if one is a small indie publisher, who might struggle to shift 500, let alone 100, e-books.

Fair dealings

So what is a "fair" e-book royalty rate? Doing the maths, 25 per cent of net actually outstrips standard print royalty rates for paperbacks, on the agency basis. Using our formula above, a £12.99 trade paper (with a 7.5 per cent royalty rate) will yield a 0.97p per book royalty for the author. Assuming a £8.99 "trade paper e-book" that would mean a wholesale e-book royalty rate of 0.89p (£8.99 less 50 per cent subtracted by marketing and conversion costs of .95p multiplied by .25), which would actually be 10 per cent of the retail price. The agency terms are even better (70 per cent of £8.99 subtracted by those same marketing and conversion costs multiplied by .25): £1.34, or 15 per cent of the retail price.

Take your standard 10 per cent royalty off a mass market paperback, and 25 per cent of net receipts for an e-book on agency terms would still beat it at 0.82p, and that's even given a "mass market" e-book price of £5.99 (£5.99 times .7 minus 0.89p in costs multiplied by .25).

But just pipping paperback royalty rates may seem unfair given the perceived lessening of production costs. But, for the reasons listed above, at the moment, a 50 per cent seems beyond the reach of many publishers. Why not split the difference at 35-40 per cent? A 40 per cent rate would seem to give publishers enough leeway for digital investment, and improve authors' royalties, even versus print books. The £8.99 e-book would earn the author £2.13 (agency) or £1.42 (wholesale).

The agency model clearly is the best deal in terms of per-book rate. Yet e-books customers at the moment are clearly price-sensitive.

As I write this, just eight of Amazon's Top 100 paid e-books are from an agency publisher, including Andrea Levy's Long Song and David Nicholls' One Day. Of the Top 100, 41 are retailing for £1 or under. Amazon, it should be pointed out, has about a 75 per cent share of the UK e-books market. It may in fact capture more than that this year. The price of the Kindle device itself is coming down and the Kindle app is available on the iPad, on the iPhone and on tablets and smartphones that run the Google Android operating system. About one third of Kindle customers access Amazon e-books in these ways and not on the actual device. This will undoubtedly marginalise Apple somewhat, and with it, in some measure the impact of the agency model. The issue of price maintenance - because that is what the agency model is in practice - is a vexing one. But publishers are going to decide very soon, as they did when the Net Book Agreement was abolished, whether they want to sell a lot of e-books as a low price, or far fewer at higher levels.

Ultimately, the difficulty running through this whole debate is what Holland referred to as the "collective wall of silence" around publisher's accounting. Specifically, how do digital costs get apportioned? Authors fear, perhaps rightly, that they may be in a situation like that of screenwriters, who are often denied "points" because Hollywood accountants can somehow show that a movie that grossed $500m through the worldwide box office never made a dime.

Happily, some publishers have made welcome noises. Pearson CEO Marjorie Scardino said last year that the industry was still in "the foothills" of the transition to digital books, but added "we will see a rise in royalty rates". She added: "Publishing digitally is cheaper - but paper, printing, that is only 25 per cent of the price [of a book], so even if we could do away with that totally, it's not going to make a huge difference. But it will make some difference, and then we'll have to make sure we do right by the author."

Last modified: 03 Jun 2011 - © 2011 contributors
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