Monday, February 7, 2011

The Cost of an E-Book

The Washington Post has a blog entry breaking down the costs associated with e-books.  The argument is that "the costs of creating an e-book and a hardcover edition are similar."

While the writer here is correct that the material costs of a book are a small percentage of the price the reader pays at the register, he's wrong to conclude that this means an e-book isn't cheaper than a conventional book.

There are two kinds of costs associated with selling a product: fixed costs and marginal costs.  Fixed costs are the costs that are necessary to create the product, and that do not rise with the volume of units created; as volume rises, the fixed costs diminish on a per unit basis because they are distributed over more units.  Marginal costs are the costs associated with producing each additional unit.

So, for example, the cost of building an auto factory is a fixed cost of making cars, and the materials that are used to construct the car are marginal costs.  Similarly, editorial costs and publisher overhead are the fixed cost of producing a book.  Author royalties are marginal costs, because they're costs that are incurred per-book, but the advance before earn-out might be considered a fixed cost.  

The costs associated with making a book into a physical object; printing, binding, shipping, are marginal costs.  So, even if that's only two bucks per hardcover, that means an e-book should either be two bucks cheaper or two bucks more profitable.

Selling books through bookstores is also costly.  Bookstores have to rent spaces.  They have to hire staff to handle retail transactions.  In order to sell you a book, people at the bookstore have to take it out of the box, enter it into inventory, put it on the shelf, help you find it, and ring up your transaction.  What you pay at a bookstore tends to be four or five dollars more than the wholesale price, and that covers the store's costs and profit.

So, in addition to having zero marginal cost of production, the marginal cost of selling an e-book drops to zero as well; if listing a book on Amazon's site and running the back-end functions necessary to get the file to your Kindle were costly, then Amazon's robust offerings of free or very cheap e-book content would be a giant money-losing operation.  If listing products on Amazon was costly, then it would be extremely burdensome for the site to list tens of thousands of self-published and vanity published books that sell nearly zero copies.

So Amazon has no cost or risk that justifies the $3.30 profit that's built into the Post blogger's analysis.  With no marginal cost and minimal costs associated with listing an item, Amazon can profitably sell books at a very small markup, or by taking a small cut to act as the conduit for books sold on the agency-model by publishers.

It's not unreasonable to think that publishers could sell an e-book for $5-6 less than the hardcover price and still make the same profit.

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