Why e-books cost so much

Here's something that tends to get lost in the debate over e-book prices: Paper doesn't cost very much.

There's a perception among consumers that an e-book should cost very little or next to nothing because there is no paper, printing, and shipping involved.

But in fact, for a brand new bestselling hardcover, all of the costs associated with print, from the printing to the shipping to the distribution to the warehousing to returns, amount to a mere few dollars per copy, depending on the size of the print run.

The vast majority of a publisher's costs come from expenses that still exist in an e-book world: Author advances, design, marketing, publicity, office space, and staff.

You can therefore imagine the fear that e-book prices instill in publishing executives' hearts. They're only saving a few dollars per copy in the switch to the e-book world, but the price of books were slashed more than half: from $24.99 to $9.99 and even lower.

That begins to explain why publishers are trying to keep e-book prices high. But it doesn't tell the whole story.

Along came the iPad 

Before the introduction of the iPad, publishers sold e-books according to the "wholesale" model. Publishers set a list price for a book, they took roughly half, e-book vendors like Amazon took roughly half, and the vendor could set whatever price they want.

So for instance, for a new e-book, let's say the list price was around $24.99. Amazon paid publishers $12.50 per copy, but then turned around and sold the e-book for $9.99. They took a loss on e-book copies in order to help sell Kindles and in order to build a huge early lead in the e-book market.

This created several pressing concerns for publishers. For one, Amazon was helping devalue consumers' notion of what a new book "should" cost. And two, publishers badly wanted competition in the marketplace, but they were hearing from other companies that wanted to get into the game that they couldn't compete with Amazon's prices.

So along came Steve Jobs and the "agency" model: Publishers set the price of e-books and receive 70%. Publishers took that deal and then imposed it on Amazon, as detailed by my colleague Greg Sandoval.

But here's the irony of the agency model: It wasn't about making more money in the short term, even though e-book prices went up. Publishers raised prices and made less money per e-book copy sold.

Take that $24.99 list price. Let's say the e-book would have sold for $9.99 at Amazon in the old days but now the publisher charges the consumer $12.99:

Wholesale model e-book:
Publisher: $12.50 (roughly 50% of $24.99 hardcover retail price)
Amazon: - $2.50 (selling at $9.99)

Agency model e-book:
Publisher: $9.09 (70% of $12.99)
E-bookseller: $3.90 (30% of $12.99)

This wasn't a story of money grubbing publishers trying to stick it to consumers. They actually left money on the table.

The result: The e-book marketplace competition that publishers wanted began to take place. Rather than competing on price, e-book sellers like Apple, Barnes & Noble, Amazon, and others have, up until now, mainly been competing on user experience.

And if higher prices slowed down consumers' adoption of e-books and kept people attached to print, publishers were okay with that. Here's why.

It's still a print world

Not only are publishers' margins better on higher-priced print books, but when bookstores close it has enormous ramifications for the industry. When Borders went bankrupt, for instance, Penguin Group was their single largest creditor, with $41.1 million outstanding.

And even aside from financial considerations, publishers' entire reason for existence is bound up in print. The major publishers are, quite simply, the best companies in the world at getting print books from authors to readers. Most of the tools at their disposal for making a book a hit are tied to a print world, from buying front-of-the-bookstore placement (yes, publishers pay for that) to book tours.

As the exponential growth of e-books has slowed, some publishers are even whispering their hopes that perhaps the rate of e-book adoption will slow further and print will be viable well into the future.

But meanwhile, on the other side of the e-book price divide lie consumers. Whatever the cost of paper, $10+ e-books look mighty expensive when they're undercut by $0.99 Kindle bestsellers sold by authors who don't have a publisher's overhead.

Publishers have a massive problem with perception of value. When you can't hold it in your hands and easily pass it along to a friend, $10+ just feels too expensive to many people.

Whether publishers want it or not, change may be on the horizon. Three of the publishers named in the DOJ suit have already settled with the DOJ and have agreed to variable pricing. Lower prices seem inevitable.

Publishers may have bought themselves some time with higher e-book prices, but they won't be able to hold the line forever.

Posted in: CNET NEWS