Cross-posting: Amazon and the Big Squeeze

In one class I’m taking this semester, called “Strategic Decision Analysis”, we have a course blog where we, the students, are keeping track of things we notice in the news and in our lives that reflect the course topics, which largely revolves around Game Theory.  Earlier this year I posted an entry in this blog about the infamous “Amazonfail” event, otherwise known as the “Kerfuffle”, and what I was then learning about the future of publishing.  Well, recently, the Boston Review published an article that details the whole sordid history of how Amazon has put the squeeze on the publishing industry, and what that means for the future of the industry.  And I noticed that there were a lot of Game Theory aspects to this whole story.  So, I wrote about that for the course blog.  You can find my original entry herebut if the story of Amazon, publishing, and Game Theory are all topics of interest to you, you might be interested in reading it, so I’m replicating the content here:

How Amazon Changed the Publishing Game

Today, I read an interesting article in the Boston Review that tells the story of how Amazon changed the Publishing industry, and how that’s affected both the market for books (and, now, ebooks) and the ability of publishers to market new authors.

As both an MBA and an aspiring author, I found this article very intriguing.  As both a reader and a writer – both consumer and producer – I find it intriguing to consider both sides of this complicated situation.  The short version of the story is this: with the advent, first, of big-box booksellers like B&N and Borders and then, especially, of Amazon, book publishers have been squeezed tighter and tighter; forced to sell to retailers at steeper and steeper discounts.  With narrower profit margins, Publishers become increasingly more risk averse, and less likely to take a chance on an unknown author.  Consequently, each year there are fewer and fewer break-0ut authors – fewer J.K. Rowlings as time goes on.  At the same time, with the advent of ebooks and price wars between big box retailers, books are increasingly devalued in consumers minds.  In the last holiday season, the price of new bestseller hardbacks was driven below $10.  But for book publishers, this is extremely adverse to their economics, as a significant portion of their costs are fixed – even if they remove the printing costs for ebook editions, most of the costs associated with publishing these books don’t go away.  For consumers, lower-cost books are theoretically an excellent thing.  (As a reader, I certainly appreciate being able to get books for lower cost.)  But that comes at a  hidden price: a less-diversified book market with large publishers focusing only on books with mass-market appeal and niche players with potentially huge markets finding it more and more difficult to reach their full market potential.  In other words, for writers and publishers, it is becoming an all-or-nothing game: either your book is a bestseller, or you’re broke…

That’s the big picture of the economic and strategic climate (read the linked article for a lot more fascinating detail).  But what about Game Theory?  How does that apply in this situation?

Using the frameworks from class, we can ask: is this a game?  It’s a complex business situation with multiple players: Amazon, big-box retailers, the publishers and writers.  What each of these does can potentially affect the other players – and they all know it.  Check, check and check.  Does it matter?  There’s a lot of money flowing around in this market, and this can have a huge affect on profitability or bankruptcy.  For the writers involved, this is their livelihood!  It definitely matters.

So what are the key take-aways from SDA that apply in this situation?  For publishers, this game is a classic Prisoner’s Dilemma.  Each publisher can, individually, either continue to give in to Amazon’s demands for higher discounts and increased Co-op spending, or they can resist.  If they resist, then Amazon pulls their “buy” button or makes their books seem to disappear from Amazon’s site, and the publisher’s sales plummet.  (From the writer’s perspective, this is disastrous.)  If they give in, they see their margins erode, but at least continue to make some money from Amazon sales.  However, if multiple publishers band together in a cartel, or very large publishers individually resist Amazon’s demands successfully, they’ll find themselves in a stronger position.  (As Amazon immaturely complained after the recent Amazon-Macmillan kerfuffle in February 2010, “Macmillan” – and by extension all publishers – “have a monopoly on their own books”.  A publisher with a lot of clout and a full slate of bestsellers will find a way to move their books even without Amazon.  Amazon isn’t that big yet.)  For most of the smaller and niche publishers, this Prisoners Dilemma looks to have only one possible result.  At the very least, they haven’t yet figured out how to form cartels to increase their power in these situations, or possibly haven’t even figured out that they can.

For Amazon, this is the perfect meta-game situation.  Many publishers are in a position where they thing the opposing players are other publishers.  And in that game, their Nash Equilibrium is in a position that’s veryfavorable for Amazon – but in the larger scope, this is a meta-game where Amazon has been able to use its size to set the rules and change the game being played.  In the game of Amazon versus the Publishers, its more like a complex, multi-player version of Chicken.  Amazon sets an ultimatum for publishers: Offer your books at an extremely steep discount, or we yank your books.  Then we wait to see who blinks first.  Amazon has demonstrated on multiple occasions that they’re willing to go through with their strategic threats (some examples are mentioned in the linked article).  In the aforementioned Amazon-Macmillan Kerfuffle, however, Macmillan reasoned that the damage to Amazon of dropping Macmillan’s books would be greater for Amazon than it would be for Macmillan.  And for a publisher with a catalog as deep and wide as Macmillan’s, this proved to be true.  But for many smaller publisher, Amazon’s demonstration of their strength (and carrying out of their threats) has proven more damaging to those smaller publishers than it has to Amazon. 

The player in all of this with the biggest stake, however, is the player that is the least strategically aware and in the weakest position to challenge the status quo: the writers themselves.  It is they who stand the most to lose each time Amazon flexes its muscles.  But the writers do have a potential source of power in this game: their proximity to, and influence over, the book-buying public.  Successful writers are increasingly connected with their readers and fans, and those readers and fans who are connected with their favorite writers are becoming increasingly influential in the community of readers.  And as the strategic moves of Amazon and the Publishers create game situations that are unfavorable to the writers, they have the potential to retaliate by harnessing their community of fans to do some economic damage to those business institutions.  This is another fact that was demonstrated during the Amazon-Macmillan Kerfuffle (this blog post on my personal blog from that time period lists links to several sites where writers are doing just that). 

Ultimately, my strategic recommendation to publishers would be this: find a way to form cartels to overcome Amazon’s powerful position, and to escape the Nash-trap of the prisoner’s dilemma Amazon has tried to put you in.  However, ultimately, lower book prices will be good for consumers, which can lead to publishers selling more books.  This suggests another strategic concern for publishers: find ways to lower the fixed costs to produce your books without sacrificing quality so that you can sell them for cheaper and still profit.  Even if Amazon can be neutralized, on-line bookselling, ebooks and big-box retailers are here for the foreseeable future, and prices will come down.

3 thoughts on “Cross-posting: Amazon and the Big Squeeze

  1. I like your analysis. It is an interesting time for the publishing industry with lots of changes. Fortunately, I’m one of the few people I’ve met who seem to enjoy changes. [Okay, some changes aren’t fun… but you learn to take advantage of them when you can.]

    • It is those who are ready for or can embrace change who will thrive when everything changes… And yes… in the publishing industry everything is changing. It still remains to be seen what the end result will be; it’s still too early to tell what exactly the possibilities even might be.

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