Who is the real price-fixer?

19 April, 2012 by Tom Kaneshige, CIO (US)
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In the mid-1990s, I ran across what looked like an incredible story: A teenager dubbed the Whiz Kid was selling a ton of computers from his parents’ home. Newspapers told the story, complete with images of the teenager talking on his cell phone – which, at the time, was a big deal.

So I called the teenager and spoke to him and his father. Turns out, his dad had set up a business to buy computers through a distributor and sell them directly to companies at cost. That’s right: no margin. The dad and his son moved lots of computers because they were undercutting everyone’s price.

The business wasn’t about making money, rather it was just a publicity stunt for the teenager. But ultimately, even if companies are able to get computers on the cheap, business models with a hidden agenda and no margins aren’t good for anyone.

The value of no margins

The Whiz Kid story came to mind as I thought about the drama going on with Amazon, Apple, book publishers and the Department of Justice over alleged price-fixing of ebooks.

In this scenario, Amazon is the teenager with a not-so-hidden agenda.

Amazon set the price of an ebook at US$9.99, a low-ball number with little, if any, margin. Critics point out that Amazon overall makes little profit on a whopping US$48 billion in revenue. Amazon’s goal is to offer ebooks at a huge discount and seed the ebook reader market with Kindle devices, which, in turn, will create a monopoly that forces customers to buy ebooks only from Amazon.

And it was working: Amazon quickly grabbed 90 percent of the ebook market.

With the iPad, book publishers had another ebook distribution option. Ebooks on Apple’s iBookstore rose to the range of US$12.99 to US$14.99 under Apple’s agency pricing model, which allows book publishers to set the price of an ebook while Apple takes a 30 percent cut. As a result, Amazon’s market share fell to 60 percent.

If Amazon is the teenager in the Whiz Kid story, then book publishers are the value-added computer resellers, known as VARs. They are victims but not completely innocent.

In the early days of computer distribution, VARs often did little more than receive a computer from a low-margin mass distributor, slap on a 30 percent markup and push the box to the corporate customer. I doubt VARs got together and fixed the price, but it was an industry-standard practice.

If there’s any upside to the Whiz Kid story, it’s this: A teenager shed light on what VARs were contributing to the value chain for that 30 percent markup, which wasn’t much. VARs eventually changed their ways and became solutions providers and integrators, often not even taking ownership of hardware and software as it moved from distributor to the corporate customer.

Book publishers, too, will need to change their ways in the ebook era. Book publishers do not provide as much value with ebooks as they do with traditional books, so they can’t expect the same margins. On the other hand, Amazon’s US$9.99 price point cannot support quality ebook production, which is what happens when no one makes money.

I suspect there will be a compromise: Ebooks will have to be sold for more than Amazon’s US$9.99 but less than the Apple-publisher’s US$14.99. To make the new price-point work, publishers will have to cut the fat out of the old book publishing model.

Let the market decide

Enter the DOJ, the newspapers of the Whiz Kid story.

The DOJ’s mission is to protect consumers against monopolies and price-fixing, but in this case their approach is flawed. A quick glance at Apple’s agency model and one might jump to the conclusion that consumers faced an ebook price hike from US$9.99 to US$14.99. This means Apple’s agency model is bad for consumers, right?

A quick glance at the Whiz Kid’s business and one might jump to the conclusion that computer-buying companies are making out with the cheap price. So is the Whiz Kid business model good for the computer market?

We know this isn’t true in both cases.

Dig a little deeper and you’ll find that the DOJ’s thinking doesn’t make sense. You simply cannot break Apple’s agency model and swing the pendulum back in favour of an Amazon monopoly, all in the name of protecting consumers.

The DOJ can and should penalise book publishers and Apple if it finds price collusion – after all, price fixing is illegal – but not to the benefit of Amazon and its money-losing, monopoly-building enterprise. Apple and book publishers may have to pay a penalty or settle, as some already have. The price of an ebook should be determined by the market, not Amazon.

Too simple? Maybe. But this is how it’s supposed to work. I could ask the Whiz Kid what he thinks, but he went out of business a long time ago.

 

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