What It Takes

What It Takes

Leveling the Playing Field

By Shawn Coyne | Published: October 14, 2011

Throughout the 1990s, the American Booksellers Association—the trade organization that represents independent bookstores across the country—spent more than $18 million dollars suing publishers and big box book retailers. (read: “Booksellers Settle Lawsuit Against Chains“) The controversy concerned the third line item of my recent samples of book publishing Profit and Loss reports:

TERMS OF SALE

In 1994, the ABA accused Random House, St. Martin’s Press, Penguin, Houghton Mifflin, and others of giving special rebates and discounts to Borders Group and Barnes & Noble that were not offered to its membership. While publishers were extending independent stores a 40% wholesale discount off the retail cover price of an individual title, they granted chains secret additional discounts and credits that in some cases resulted in 50% off.

Wholesale discount policies, credit calculations and payment terms make up what is known as a publisher’s terms of sale. Every publisher has a one-pager that outlines their policies for retailers to order and pay for its books. The term sheets have lots of small type but the bottom line is pretty much the same for all of the big six publishers and their distribution clients. (When I was a publisher, I was distributed by two of the big six and the biggest mini-major).

But today there are two terms of sale models…wholesale and agency.

The wholesale model is the traditional model for orders of everything but eBook titles. Publishers, for the most part, invoice physical books to third party sellers (Amazon, B&N, Mom and Pop’s Independent story) at 50% off the retail cover price. So for a profit and loss report using the wholesale model, you can figure out how much revenue a book will generate by multiplying the total number of orders shipped by the retail cover price of the book and then cut it in half.

The agency model is different—it’s commissioned based—and brand new. It is exclusively for eBooks and I’ll get more into it next week. Suffice it to say that it’s quite controversial and already the subject of a class action lawsuit. (read: “Apple, Publishers Conspired Against $9.99 Amazon E-Books, Says Lawsuit“) But before we look at the agency model, it’s worth reviewing how the standard “wholesale” model evolved.

Back in the 90s, Mom and Pop stores had to pay $12.00 (40% off) for a $20.00 title from a publisher. The chains could buy the same book for $11.00 or even $10.00.  The profit margin is the difference between what a store pays the publisher to offer the title and what price it sells the book to consumers. In this case Mom and Pop got $8.00 for every hardcover book they sold while the chains were getting $9-$10 per book.

This discrepancy led to the birth of the “deep discounting” era. Publishers favored chains because they are capable of ordering a thousand copies of an individual title for every single copy an independent can order. This favoritism allowed the chains to out-price the independents. The chains took the extra discounts and credits from publishers and passed them on to consumers with big displays that trumpeted 20% off! Because of the volume of sales, it could pass on a discount and still maintain a healthy profit margin. In fact, Barnes & Noble began discounting New York Times Bestsellers 40%. Unless an independent store was having a “going out of business sale,” you could pretty much count on paying full retail price for a book at Mom and Pop. That’s a big disadvantage.

The superstore discounts of the 90’s drove readers to chains instead of Mom and Pop’s stores. Buying there was cheaper. Over time, the independents started closing up shop. Estimates put their numbers at about 1,400 today. But in 1991, they numbered 5,400.

The side deals between publishers and chains were wink-wink, nod-nod arrangements, and they helped the publisher as well the chains. In many instances for the extra discount along with a publisher’s commitment to pay for “cooperative” advertising (front of store placement), the chain would increase its order. Instead of ordering 2,000 copies of a big book that a publisher was desperate to get onto the bestseller list, it would take 10,000.

The higher order would decrease the production costs for the publisher (the more you print the cheaper the per unit charge). The chain would often stack up the massive unit orders alongside escalators, front of store etc., which would give consumers the impression that “Hey, everyone must want to read that book because the bookstore has so many of them to sell…”

There wasn’t any real penalty for ordering a ton of books. Anything the chain didn’t sell, it could send back to the publisher and get its money back. I’ll get into why when I discuss “Returns” in a few weeks.

If you look at the under the table deals from the publishers’ point of view, favoring the chains back then made sense. Instead of having to employ an army of sales people to canvass thousands of independent stores for single or two or three copy orders, they could send one salesperson to Borders and get a 10,000 order for the entire country. It was more efficient.

The economies of scale that the chains brought to the table were irresistible because publishers were able to increase print runs (more orders meant bigger first printings and cheaper per unit costs) and decrease overhead (lay off sales people).  And if that weren’t enough, the discounts that the chains passed on to consumers actually increased unit sales in the big ticket hardcover format. With the discounting, consumers were starting to buy in hardcover instead of waiting for the cheaper mass market or trade paperback.

Multi-million copy hardcover bestsellers were anomalies before the advent of the chain store. They were Gone with the Wind/Jonathon Livingston Seagull kind of rare. But as the chains grew, million copy hardcover bestsellers became not just possible, but probable. With brand name writers like Sydney Sheldon, Stephen King, Danielle Steele, Clive Cussler, Robert Ludlum, Ken Follett, Mary Higgins Clark et al putting out a book a year, a publisher could begin to forecast its future more accurately. And probable bestselling performance for a publishing company (pretty much impossible to predict pre-1989) seemed to reduce that one thing most human beings and especially corporations hate—RISK.

There was only one problem. The different kinds of PUBLISHER/CHAIN “terms of sale” shenanigans were illegal. The Robinson-Patman Act of 1936—an era when small businesses were viewed as important job creators and vital components of a community—expanded on the old Sherman Antitrust Act of 1890. Robinson-Patman forbade anticompetitive business practices.

Back then; people didn’t believe that Standard Oil-like monopolies were in the best interests of the nation, even if they were more efficient and reduced prices for consumers.  Efficient capitalist behemoths, by definition, do everything they can to reduce their costs in order to increase their profits. And the biggest cost for a corporation is its employees. So if one player comes to dominate a market, the tail end of that process (no other competitors left) puts a lot of people out of work. And people out of work have a hard time buying things no matter how cheaply they are produced and sold.

So at the turn of the last century, for the greater good, the nation decided to regulate capitalism. The feeling was what was best for the U.S. was not what was best for John D. Rockefeller. Rather what was ideal was to have a lot of companies in the same business. The competition would bring prices to a proper equilibrium—not too expensive, but not too cheap either—and increase choice for the consumer. Having many choices at a reasonable price—produced by many employed people who could afford that very price—was better than having one choice (or the same choice in different packaging) sold dirt-cheap if millions of unemployed workers couldn’t afford it.

In 1936, Congress then took a hard look at oligarchies (a small number of big companies dominating a marketplace). Oligarchies came under the same scrutiny as the Standard Oil monopolies.

What appeared to happen when a single market was dominated by just a short list of companies was either intentional or unintentional collusion.  The steel industry was a perfect example. The price fixing became so outrageous that the U.S. would eventually lose the entire industry to foreign markets. Once J.P. Morgan’s U.S. Steel raised prices, so did Bethlehem Steel and Jones and Laughlin.

But, for me, the best example that comes to mind of this sort of behavior is in the black markets, probably the purest example of unregulated capitalism there is. In 1957, there was a meeting of the top 100 mafia in North America in upstate New York. The illegal markets were getting too competitive and bloody, so an influential Mafioso, Joe “Joe the Barber” Barbara, hosted a get together with a simple message. Lets all agree about how we do business and quit fighting among ourselves. There’s plenty of money to go around, let’s not cut off our nose to spite our face. It worked. Drugs, extortion, gambling, prostitution etc. exploded in the second half of the twentieth century. I hear those markets are still doing a pretty good business.

Book publishing, though, is not La Cosa Nostra. It’s not that efficient. At least not in the 1990s.

Citing the Robinson-Patman Act, the ABA sued publishers in 1994 for unfair business practices. The legal “discovery” process—a defendant has to turn over all its correspondence, record keeping etc. to the court—soon revealed the obvious. The publishers knew they’d been caught, so they settled out of court and agreed to abide by the same terms of sale for all of their wholesale customers. Estimates place the ABA’s reparations from the publishers of upwards of $25 million.

Since then, to the best of my knowledge, the publishers have kept their word. Ironically, the penalty for colluding with Barnes & Noble and Borders resulted in an unintentional collusion among publishers. In order to level the “terms of sale” playing field, the lights in the publishing stadium had to be turned on (the ABA’s lawsuit did that) and all of the publishers were able to see what terms of sale their competitors were offering. So today, retailers of all stripes order and pay for a book in just about the same way from all of the big six and their distribution clients.

All of the big players came down to essentially the same place. So Random House and Simon & Schuster and Penguin and Macmillan and Hachette and HarperCollins don’t compete with each other in the ways they “sell” a book. They’ve already raced to the bottom among themselves and discovered that it would be best for all of them if they held the line at 50% off the retail cover price for the wholesale model. (Again a broad estimate)

Would it be possible to seize a bit more of the book market, or even expand it, if one of the big six, say offered 60% off? Or came up with a completely different way to sell books than they do now? Would they still make a reasonable return on investment?

Maybe, but it won’t happen at the big publisher level. Why? Because the big six are too big to take that kind of risk. The business model they live and breathe barely works at 50% off. The way they see it—if they even think of it at all—they’ve already competed at the “terms of sale” level. It’s a done deal. That’s just the way it works. Everyone knows that. Besides consumers don’t buy books based on price, right? A $2.99 eBook from a nobody thriller writer doesn’t stand a chance against a big name… Right? Besides you can’t make any money—real money—off of a $2.99 eBook.

Back to the ABA.

In 1996, emboldened by their victory over the publishers, the ABA took on the chains—Borders and Barnes & Noble. One of the bones of contention for them was predatory pricing. Predatory pricing is selling a product cheaper than it costs until you drive off competition.  The chains settled their case with the ABA, too. But for pennies on the dollar of what it cost the ABA to litigate.

The judge in the case didn’t buy the ABA’s argument that the chains’ behavior hurt consumers, a critical element of Robinson-Patman. Prices went down not up because of the chains’ behavior. It was clear he wasn’t about to even consider awarding damages to independent bookstores. So in 1998, the ABA accepted $4.7 million as reimbursement of court fees from the chains. But the problem was that the case cost the ABA more than $15 million to take to the judge.

One of the more chilling pieces of evidence presented in the case was an internal memo in which a high-level Borders executive wrote that one publisher “claims to have leveled the playing field, what they don’t realize is that in a couple of years there may only be a couple of players left who will dictate the game on their own terms.” (read: “Booksellers Settle Lawsuit Against Chains“)

The wholesale model is all about the necessity of having a warehouse. And the chains had, and one of them still has, some great warehouses. But what would happen if you didn’t need warehouses anymore? Who dictates the game on their own terms then? It’s certainly not going to be the Borders Group.

TO BE CONTINUED.

Posted in What It Takes

4 Responses to “Leveling the Playing Field”

  1. Paul C
    October 14, 2011 at 3:56 pm

    Here’s what a Borders executive wrote on Quora, explaining the demise of Borders:

    “B&N invested considerable time/energy/money through the 90’s in systems and processes. To provide one example, a lower ranked title that sells out in a B&N will be replenished from a central warehouse within 2-3 days. The same process could take up to 16 weeks for Borders.”

    Replenishment is now instant.

    Amazon is trying to use the Kindle as a sub for the warehouses but that didn’t work for television or radio. Using hardware to control content won’t work in the long run. Excellent post.

  2. October 14, 2011 at 4:34 pm

    Great post Shawn. All this talk of lawsuits and monopolies has me looking forward to reading what happens if we don’t need warehouses anymore. I can’t help wondering what would happen if all the big authors had their own “Apalachin Meeting” and decided to quit fighting for shelf space and pub dates and went right to the readers.

    I’m hoping you can include some tips for unknown writers on where to focus energy when it comes to publishers. Is it still worth it to aim for the big six?

  3. Ronald Sieber
    October 15, 2011 at 5:03 am

    Shawn:

    This is eye-opening muckracking journalism at its best! Even if it weren’t true, it would still be great story.

    Keep the episodes coming. I’m hooked!

  4. November 19, 2013 at 7:10 am

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