TCS Daily

Dead Trees to

By Chris Charuhas - January 30, 2003 12:00 AM

Retail book publishers are in trouble. A decade ago, they could expect a healthy 10% profit margin selling books in bookstores. Now publishers' profits are less than half that, averaging around 4%. Their bookstore sales have also dropped in each of the past five years.

This slow decline is more perilous than it seems. A steep drop in sales or profits throws a company into survival mode, where it can make fundamental changes. But a slow descent lulls companies into doing business the same old way. It gives them room to say, "We just need better salespeople to get things moving again," or, "This is a cyclical downturn. Things will eventually get better."

Unfortunately, things never do. This sort of consistent, industry-wide decline signifies not the failings of an individual company, but the erosion of an entire business model. The retail publishing industry is in trouble, whether it knows it or not.

The Miserable Economics of Retail Publishing

In the retail book business, publishers still sell around $10 billion worth of books every year. But middlemen and chain bookstores have acquired most of the money-making power, squeezing publishers' profits in order to boost their own.

Wholesalers sit astride the book business' bottleneck. To get books into stores, a publisher must use a wholesaler, because stores would rather order from a few wholesalers than hundreds of individual publishers. The biggest wholesaler, Ingram Book Company, warehouses over 80% of the books sold in stores. Like any monopolist, it takes advantage of its position, taking a big chunk of each sale and months to pay. Ingram presents a cashflow nightmare for publishers, and has acquired a reputation for "we'll pay you when we feel like it" treatment that makes it difficult for many to stay solvent.

Big chains like Borders and Barnes & Noble now dominate the book trade, and they make publishers' lives even tougher. These chains don't buy books from publishers-they sell them on consignment. If a book doesn't sell, it's returned to the publisher. Consignment sales are almost unheard of in other industries, because most manufacturers know that that without incentives to control inventory, retailers will order too much of whatever they're selling. This has happened in the book business, where almost 40% of the books shipped to stores get shipped back to publishers... at the publisher's expense.

Bookstore chains have also begun to adopt standard retail practices that squeeze publishers even more. Barnes & Noble is now selling books it publishes itself, siphoning off sales to its "in-house brand." Borders is making publishers bid for shelf space. While standard practice in supermarkets, to publishers this is an alarming new expense.

The growth of online bookstore initially boosted sales and promised publishers some relief. Not anymore: Amazon is now selling used books right alongside new ones. Around a quarter of the books now sold on its site are used. Amazon makes a tidy profit when it brokers a used book sale, but publishers, of course, get nothing.

Obstacles to Progress

Monopolist wholesalers, hostile retailers, inventory problems-it's hard to imagine a more unfriendly business climate for publishers. The costs of selling "dead trees" in bookstores are becoming prohibitive. Assuming publishers aren't content to become subsidiaries of chain bookstores, they're confronted with two questions: Can they develop strong alternative sales systems? And, can they deploy them before they run out of money? An initial assessment isn't encouraging.

To its credit, publishing has always been a genteel sort of business, employing people whose primary concern isn't making filthy lucre. That being the case, it's no surprise that they aren't very good at it. Large publishers release thousands of books, most of which lose money, and rely on a few profitable bestsellers to emerge. This roulette-like strategy is sadly outdated. Vincent Flanders, author of the bestselling book Web Pages That Suck, says of the retail publishing industry, "As someone who came from the direct mail business, I have never seen an industry that has less comprehension of who buys their products and why they are being bought."

Even in its most business-oriented segment, computer books, the publishing industry stumbles badly. A couple of years ago, sales of Dummies computer books plummeted to half their former level when people stopped buying the poor-quality titles their publisher rushed to market. Computer publishing's Next Big Thing, "Visual" books, was crippled by poor branding. When one publisher put four different "visual" brands on the market, each brand cannibalized sales from the others and sales dropped 60% in two years.

Large publishers' lack of business acumen makes them ill-suited to developing new sales systems. Even if they did, they'd have a tough time implementing them. Large companies are notoriously slow to change, and as they merged and consolidated during the 1990s, the major publishing houses got pretty large. These companies are also conservative: since the 1800s, they've built their businesses on selling books in bookstores. Overcoming a century's worth of inertia isn't easy.

Small publishers appear better able to change. They've proliferated by serving niche markets that large publishers ignore. However, while small publishers are often more innovative than large publishers, their size makes it difficult for them to exploit innovations. Constrained by the low-profit economics of trade publishing, they can't generate the capital to finance new projects on a large scale.

The Promise of Internet Sales

The Internet offers publishers a solution to their pressing retail problems. By selling books directly to customers over the Internet, publishers can increase their profits and sales.

The Internet, as has demonstrated, is an excellent medium for selling books. New print-on-demand technology allows publishers to eliminate costly inventory. PDF and other eBook formats make electronic books readable by any customer. By combining these three technologies-the Internet, print-on-demand, and eBooks-a publisher can, like Dell Computer, employ "just in time" manufacturing and direct online sales to thrive in a tough, low-margin business.

For example, a publisher could establish a Web site where a customer orders a $20 paperback. The order would be sent directly to a print-on-demand facility, where the book would be printed, packed and shipped to the customer. After paying for printing and sales costs, the publisher would make $7-$8. It might receive only a dollar or two if the book were sold in a bookstore.

Or, the publisher could sell a "print-it-yourself" PDF copy to the customer for $10. The customer would get the book for half price, and obtain it immediately by download-no waiting to receive it in the mail. On this eBook sale, the publisher still makes $7-$8, by eliminating printing and shipping costs.

There's no free lunch, though. To make this Dell-like model work, a publisher must use Dell-like marketing to bring customers to its site, employing sophisticated branding and promotion. Most publishers are unable or unwilling to do this.

Encouraging Trends

Not all is inertia in publishing, however. Some small companies are selling downloadable books successfully on the Web. Syngress, a computer security publisher, makes all its books available for purchase as PDF files at its Web site. And a new publisher called Expert Guides sells thousands of its technical eBooks from its Web site every month.

Print-on-demand companies have also invented profitable ways to do business online. In a new system set up by print-on-demand firm Booksurge, Amazon collects a 15% fee for selling books on its site, while the books are supplied by Booksurge. In this system, everyone makes money:

  1. Booksurge gets paid to print and ship books.

  2. Amazon makes almost pure profit, because it doesn't have to touch the books it sells.

  3. The publisher avoids expensive print runs, warehouse fees and returns, which increases its profits.

Everyone wins, including the customer, who gets books for around half of what they'd cost in a bookstore.

A few large publishers are selling electronic books through third-party Web sites like Yahoo Shopping. Although none has embarked on a Dell-like direct-sales strategy, their eBook sales have been surprisingly good. For instance, eBook revenues at Random House doubled from 2001 to 2002.

This big eBook-friendly publisher is owned by Bertelsmann. That's probably no coincidence: Bertelsmann has already seen sales drop in its BMG music division. Customers like cheap music, and if they can't get it from record companies, they'll get it on the Internet. Perhaps to avoid the same fate in book publishing that it's suffered in music, Bertelsmann is attempting to get "ahead of the curve" in selling electronic books.

To publishers that have traditionally fought tooth and nail to protect copyright, selling books in electronic format makes them uneasy. They're right to be apprehensive: copy protection schemes can be broken, and the Internet makes it easy to copy and distribute "cracked" books for free. Their fears, however, are exaggerated. As Harry Helms, the proprietor of eBooktech, puts it: "Some theft is inevitable. It happens in all retail businesses. Publishers need to recognize that and quit obsessing over it."

Jim Kimsey of AOL once said that, "People used to spend time to save money. Now they'll spend money to save time." This basic fact will preserve sales of digital books. People with more time than money, like high school and college students, will go to the trouble of searching out free books. But this sort of piracy actually works to the advantage of publishers-every free book read creates more readers who want more books. The software industry has already figured this out: while Adobe Photoshop is the most-pirated program in the world, it's also Adobe's best-selling product.

Rather than spending time trying to get a free book that might be incomplete or bowdlerized, most people would rather just visit a legitimate Web site, pay $5 or $10, and download the book in a minute or two. Or buy a print-on-demand paperback and have it shipped to them. When publishers make digital books cheap and convenient to buy, most people buy them.

A New Model Emerges

Many publishers will remain complacent, and concentrate on selling books through bookstores as they always have. After all, it's still sort of profitable, and making the shift to direct sales would require them to conduct market research, build brands, invest in computer technology, and do other difficult things that modern business demands.

But these traditional publishers will eventually be displaced by ones that employ new technology and sales methods to circumvent retail bookstores. These publishers will incur greater expenses, but earn much higher profits. With better cashflow, they'll be able to pay higher royalties to attract good authors, and pay higher salaries to hire good managers. This will in turn lead to higher profits, fueling a cycle that drives less-profitable traditional publishers out of the market.

This won't occur overnight. Founding new companies to displace old ones takes lots of capital, and book publishing isn't exactly a hot "space" for investment. Investors put money into what they know, and most savvy financiers don't know publishing. What's more likely is that big publishers with money will buy small ones with good e-business operations. Large publishers have traditionally grown through purchases, so it's a comfortable way for them to do business. While not as profitable as they once were, large publishers still have cash reserves to deploy in promising ventures. Look for Bertelsmann-owned publishers to buy small e-business concerns and fund their growth into large enterprises. Once this happens, look out: these Internet-oriented companies will quickly outperform more traditional publishers.

The old gentleman's profession of publishing is passing away. The good news is that the technologies and business models that will replace it are being born, and they'll be more profitable and elegant than what prevails today.

Chris Charuhas is president of Visibooks, a computer book publisher in Richmond, Virginia.

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