Publishing’s Ecosystem on the Brink: The Backstory

Bloomberg Businessweek’s January 25th cover shows a book engulfed in flames. The book’s title? “Amazon Wants to Burn the Book Business.” A towering pile of books dominates the front page of Sunday’s NYT Business Section. The pile starts well below the fold (print edition), breaks through the section header at the top of the page, and leans precariously. Books are starting to tumble off. “The Bookstore’s Last Stand,” reads the headline.

These stories capture pretty well the state of book publishing: this appears to be no ordinary, cyclical crisis that future authors and publishers will shrug off. To understand how the book industry got into this predicament, however, a broader perspective may be needed. The cover story of February’s Harper’s Magazine provides that, discussing a fundamental shift in the federal approach to antitrust law that’s affected bookselling and countless other industries. It’s a story that hasn’t previously been told in a major periodical, to our knowledge.

 I’ll get to that in a moment. First, let’s set the stage with the other two stories.

Burning Down the Houses

Brad Stone’s Businessweek story discusses Amazon’s campaign to prevent other booksellers from securing a foothold in the booming e-book market and the company’s furious reaction to Random House’s decision last March to adopt agency pricing for e-books, just as five of the other “Big Six” trade publishers had the previous year. (Before agency pricing, Amazon could sell e-books from Big Six publishers at deep discounts, taking losses at a rate that Barnes & Noble could never afford to match. See How Apple Saved Barnes & Noble, Probably for more.)

Mr. Stone writes that after Random House’s March 2011 agency-pricing announcement,

Amazon could no longer run the best play out of its playbook – slash prices and sustain losses in the short term to gain market share over the long term. … “For the first time, a level playing field was going to get forced on Amazon,” says James Gray [of UK bookseller John Smith & Son and formerly of Ingram Content Group]. Amazon execs “were basically spitting blood and nails.”

Amazon’s response to Random House’s move was stunning and swift:

The next month, an Amazon recruiter sent an e-mail to several editors at big publishing houses, looking for someone to launch a new New York-based publishing imprint. “The imprint will be supported with a large budget, and its success will directly impact the success of Amazon’s overall business,” read the e-mail, which was obtained by Bloomberg Businessweek.

Even with a large budget, directly affecting the success of Amazon’s overall business is a tall order for a new publishing imprint. Amazon pulled in well north of $40 billion in revenue last year (final numbers aren’t yet in), dwarfing the combined revenues of the Big Six publishers.

Luring a substantial contingent of bestselling authors away from the Big Six seems the only plausible route for an imprint to affect Amazon’s overall business. Amazon needed someone with a substantial industry pedigree to pull this off. Amazon quickly – in time for last spring’s Book Expo America — landed just the man for the job: Larry Kirshbaum, formerly of Warner Books.

Just three months after Random House’s announcement, Amazon had all but declared war on the six unruly members of its book supply chain. Jeff Bezos had $6 billion in cash, the patience to absorb losses for years, and a former Big Six chief to lead the fight. The long-running behind-the-scenes battle for control of the publishing industry had finally broken into full public view.

Barnes & Noble’s New Role: The Contender

While Amazon directly threatens traditional publishers with its new imprint, it continues to undermine the ecosystem on which book publishers, and most new authors, depend. Julie Bosman describes this well in her NYT article, focusing on the last remaining brick-and-mortar bookseller with nationwide clout:

Without Barnes & Noble, the publishers’ marketing proposition crumbles. The idea that publishers can spot, mold and publicize new talent, then get someone to buy books at prices that actually makes economic sense suddenly seems a reach. …

What publishers count on from bookstores is the browsing effect. Surveys indicate that only a third of the people who step into a bookstore and walk out with a book actually arrived with the specific desire to buy one.

“That display space they have in the store is really one of the most valuable places that exists in this country for communicating to the consumer that a book is a big deal,” said Madeline McIntosh, president of sales, operations and digital for Random House.

Established authors, for the most part, do fine selling through online bookstores. It’s new authors who lose out if browsing in bookstores becomes a thing of the past. Advances for unproven and non-bestselling authors have already plummeted, by all accounts. Literary diversity is at risk.

To understand just how precarious things are, realize that last year’s Borders’ bankruptcy represented an enormous reduction in browsing space, shuttering 650 stores. (B&N has about 700 stores.) One benefit of the loss of Borders should have been a short-term lift to B&N’s 700 stores and the 1,500 or so remaining independent bookstores. B&N’s sales were indeed up in the nine weeks before Christmas, Ms. Bosman reports. How much? Borders’ collapse led to a bounce of just four percent, compared to the prior Christmas. That’s what’s passing for good news in brick-and-mortar bookselling at the moment.

There is a bright spot, however. Barnes & Noble, led by William Lynch, has exceeded all expectations in the past two years with its launch of the Nook. B&N’s 300-member Silicon Valley office, after giving Amazon’s Kindle developers a two-year head start, beat Amazon to the tablet market by fully twelve months, and introduced what’s generally seen as the state-of-the-art e-ink reader, the Nook Simple Touch, eight months ago.

B&N, in other words, has been out-engineering Amazon, and Ms. Bosman’s story is the best account we’ve had of B&N’s efforts. In the process, B&N has seen its e-book market share climb from zero, two Christmases ago, to roughly 27% today.

B&N remains vulnerable, however. The engineering race against Amazon continues, and Amazon has leverage for acquiring content for its Kindle (see Contracts on Fire: Amazon’s Lending Library Mess) that B&N can’t match. And, critically, one tool that should help B&N, our antitrust laws, is instead poised to undo it.

This brings us to an unlikely tale of books, chickens, beer, and a Silicon Valley gentlemen’s agreement.

The Backstory: Amazon, Chicken Processors & Silicon Valley

Harper’s cover art rivals Businessweek’s: an enormous businessman wearing a gray pinstriped suit is preparing to literally eat the competition, a jumbo handful of gray-suited men and women. In the article, “Killing the Competition: How the New Monopolies Are Destroying Open Markets,” (key excerpts at link, full article by subscription) Barry Lynn views the state of book publishing through a different lens.

Mr. Lynn makes the case that Amazon’s dominance isn’t just a story of an industry disrupted by online commerce and digital upheaval, it’s about the abandoning of New Deal era protections of retailers in 1975 (promoted by backers as a means to fight inflation, says Mr. Lynn) and what he portrays as a shift in 1981 in the Justice Department’s interpretation of antitrust law based on “Chicago School” theories of efficiency and consumer welfare. The upshot appears to be that non-consumer markets (business-to-business markets and labor markets) are often insufficiently protected from monopolies.

To a chicken grower, for example, the relevant market isn’t restaurants or household consumers of chicken, it’s the market of chicken processors. Through a variety of machinations, including long-term contracts and the physical placement of processing plants (think baseball, before free agency), chicken growers now routinely have a market of only one processor to sell to.

Chicken growers own their land, buildings, and equipment, and all of the debt and risk that go with them, but these entrepreneurs have no real control over their economic lives. Growers buy their chicks and feed from their poultry processor, for example, and processors often require growers to make new investments in buildings and equipment. The processors, Mr. Lynn seems to suggest, have something much better than mere capital: the economic power to dictate how others use theirs.

It’s not just chicken growers who face constrained markets, Mr. Lynn writes. In free-wheeling Silicon Valley, computer engineers and digital animation workers employed by Apple, Google, Intel, and Pixar, among others, were subject to a secret agreement not to bid on each others’ employees, according to a Justice Department lawsuit filed, and settled, in 2010. (On Friday, former employees of some of the companies filed an antitrust lawsuit in federal court in San Jose based on the Justice Department investigation.)

It’s even hit beer. The 1,750 U.S. microbrewers may appear to operate in a competitive environment, but they nearly all sell through two distributors: ABI and MillerCoors control 90% of the distribution market.

For book publishers, the relevant market isn’t readers (direct sales are few), but booksellers, and Amazon has firm control of bookselling’s online future as it works to undermine bookselling’s remaining brick-and-mortar infrastructure. Amazon controls every growing segment of the industry: online physical books, downloadable audio books, online used books, and e-books. Amazon commands about 75% of the online market for print books, and 60% of the e-book market (a percentage that decreased from Amazon’s reported 90% two years ago, as a result of agency pricing).

Mr. Lynn reports on a conversation with the head of one of the largest publishing houses in the U.S.:

He explained that Amazon was once a “wonderful customer with whom to do business.” As Jeff Bezos’s company became more powerful, however, it changed. “The question is, do you wear your power lightly? … Mr. Bezos has not. He is reckless. He is dangerous.”

The head of a small publishing house in Manhattan, Mr. Lynn reports, was even more blunt:

“Amazon is a bully,” he said, his voice rising, his cheeks flushing. “Anyone who gets that powerful can push people around, and Amazon pushes people around. They do not exercise their power responsibly.”

Neither man allowed me to use his name. Amazon, they made clear, had long since accumulated sufficient influence over their business to ensure that even these most dedicated defenders of the book – and of the First Amendment – dare not speak openly of the company’s predations.

Mr. Lynn then turns to Amazon’s blackout of Macmillan’s buy buttons, two years ago this week:

At the time, Amazon and Macmillan were scrapping over which firm would set the price for Macmillan’s e-books. Amazon wanted to price every Macmillan e-book, and indeed every e-book of every publisher, at $9.99 or less. This scorched-earth tactic, which guaranteed that Amazon lost money on many of the e-books it sold, was designed to cement the online retailer’s dominance in the nascent market. It also had the effect of persuading customers that this deeply discounted price, which publishers considered ruinously low, was the “natural” one for an e-book.

In January 2010, Macmillan at last claimed the right to set the price for each of its own products as it alone saw fit. Amazon resisted this arrangement, known in publishing as the “agency model.” When the two companies deadlocked, Amazon simply turned off the buttons that allowed customers to order Macmillan titles, in both their print and their e-book versions. The reasoning was obvious: the sudden loss of sales, which could amount to a sizable fraction of Macmillan’s total revenue, would soon bring the publisher to heel.

This was not the first time Amazon had used this stratagem. The retailer’s executives had previously cut off small firms such as Ten Speed Press and Melville House Publishing for bucking their will. But the fight with Macmillan was by far the most public of these showdowns.

In the late 1970s, when a single book retailer first captured a 10 percent share of the U.S. market, Congress and the regulatory agencies were swift to react. As the head of the Federal Trade Commission put it: “The First Amendment protects us from the chilling shadow of government interference with the media. But are there comparable dangers if other powerful economic or political institutions assume control…?”

***

Today, … a single private company has captured the ability to dictate terms to the people who publish our books, and hence to the people who write and read our books. It does so by employing the most blatant forms of predatory pricing to destroy its retail competitors. … [It] justifies its exercise of raw power in the same way our economic autocrats always do: it claims that the resulting “efficiencies” will serve the interests of the consumer.

The book industry is in play, and has been for a while. The good news is that people are finally starting to pay attention.

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