The Battle Between Amazon and Penguin Heats Up – What’s Behind the Ruckus

The battle between Amazon and Penguin over the agency pricing model Amazon wants to use continues to rage one, and now the casualties are starting to pile up. At the beginning of April, Penguin stopped providing digital copies of their books for Amazon to sell for the Kindle. This has caused frustration among Kindle users, such as our own Kristen having to run to the bookstore to get the new Penguin publishing book from J.R. Ward, Lover Mine, because it wasn’t available on the Kindle.

Electronista and The Wall Street Journal have the details of the latest events in the fight between the two companies. Last week, Amazon countered by offering four Penguin hardcover books The End of Wall Street, This is Just Exactly Like You, The Line, and Lucid Intervals at $9.99, which is about 60% lower than their regular hard cover price. While this move provides a great opportunity for fans of these books to pick them up at an amazingly low price, it’s also Amazon’s way of retaliating against Penguin until they reach an agreement. By encouraging consumers to purchase the deeply discounted books on their site instead of other retailers, Amazon is hitting directly at Penguin’s bottom line.

If you haven’t heard about the pricing disputes Amazon has had with different publishers, Knowledge Problem has a great breakdown of the details and the two pricing models Amazon uses, wholesale retailer pricing and the agency model. In short, under the wholesale model, when Amazon sells an ebook, it pays publishers a fixed 50% of the hardcover version’s retail price. So if the hardcover version of a book costs more than $19.98, Amazon loses money, they pay more than the $9.99 selling price of the ebook. Under the agency pricing model, a percentage of the sale (usually 30%) goes to the seller (Amazon) with the rest to the publisher. In this model, if Amazon sold an eBook at $10 (a negotiated retail price with the publisher), they would get $3 and the publisher $7.

Sounds like a no brainer right? Why would Amazon be pushing to sell eBooks at $9.99 at a loss (wholesale model) when they could sell the same book under the agency model and actually make money off the sale? As Knowledge Problem points out, Amazon is looking at the eBooks under the wholesale model as a loss leader to getting people to buy Kindles (this is similar to Apple’s original deals with music producers which acted as loss leaders for iPods), which you can use to infer that Amazon believes they will make more profit from the sale of a Kindle that potential losses from people buying their eBooks (otherwise there is no rational reason for the wholesale model). The benefit from the agency model though is that it allows for more flexible price points to be set between the publisher and Amazon. This is a benefit to both Amazon and the publishers, though consumers miss out on the opportunity to get a book at $9.99 (under wholesale models) that should have been priced at $15 (what consumers would pay under the agency model). Knowledge Problem does a great job dissecting the microeconomics of the models and how they affect consumer surplus and supply/demand equilibrium points.

What is partly lost in this whole discussion is that we are even seeing this dispute between publishers and a retailer. In a supplier – seller relationship, the price point is set by the party that has the most power in the relationship. For example, Walmart can demand that a movie studio set a certain price on a DVD because they can deliver a huge number of sales to the movie studio. Amazon could tell a publisher that it was selling books at $9.99 because they had the hot eBook reader and were the main source for eBooks. This began to change when there were solid competitors to the Kindle, like Barnes and Noble’s Nook reader, but the seismic shift occurred when Apple announced the iPad. Once that happened, publishers knew they had an outlet that used an agency model and could sell eBooks in significant quantities and they had an alternative to Amazon for a large volume of eBook sales. This has eroded Amazon’s pricing power to the point where they have adopted the agency model in their relationships with many publishers, but, as of now, not with Pengiun. The fact that Amazon has already made agency model deals with other publishers indicates that a deal with Penguin will be hashed out, and Amazon will soon find themselves duking it out with Apple’s iBooks for eBook sales superiority.

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