What are eBooks doing to the publishing industry?

We’ve now had a couple of quarters of earnings reports from the Big 6 publishers and some other large, publicly-held publishers, and two patterns have emerged:

1. Overall revenues (sales) are down, but earnings (profits) are up.
2. Print book sales are down, but eBook sales are up.

Overall revenues are down in part because consumers are substituting less-expensive eBooks for print books, and because total demand for books is declining (I’ll discuss that latter point in a moment.) Earnings are up because it’s less expensive to “manufacture” and distribute eBooks (the costs for editing and designing eBooks and print books are comparable and overlap to a great degree.) Folks are arguing all over the Internet as to whether or not eBooks are cheaper to produce than print books, and if it even matters. The fact is that eBooks are cheaper to produce, and it does matter. Here’s an abridged list of all the costs that print books require that eBooks don’t:

• Printing
• Binding
• Shipping
• Warehousing
• Acceptance of returns
• Inspection, warehousing and shipping of salable returns
• Recycling or destruction of unsalable returns

Publisher margins are up because consumers are substituting lower-cost eBooks for higher-cost printed books, and heavy book buyers are buying more eBooks. However, printing and binding costs are extremely sensitive to quantity, so as eBooks comprise a bigger and bigger percentage of overall book sales, book manufacturing costs will start to rise. That’s one of the reasons why the Big 6 publishers have been raising prices for their eBooks—the increased profits they earn on eBooks are being used in part to subsidize the manufacturing cost of print books.

There will come a time when eBook profits won’t cover increases in print book manufacturing. At that point, publishers are going to have to make some very hard choices:

• Raise print prices to reflect the full cost of manufacturing and risk an even faster decline in sales,
• Adopt Print-on-Demand (POD) technologies, which allow manufacturers to control costs and minimize inventories but require dramatic changes in how books are manufactured, warehoused and distributed, or
• Stop supplying printed books.

eBooks aren’t the only reason why demand for print books is declining. For many years, the average number of books read by each person has been dropping. The number started declining before eBooks became a major factor. The primary reason is that there are so many more ways for people to entertain and inform themselves. Consider that in the 1960s, when Random House co-founder Bennett Cerf was a regular panelist on the U.S. prime-time television game show “What’s My Line?”, there were three commercial television networks and, in most markets, three television stations. In most cities, you’d have one or two daily newspapers. Radio was an option, but it had been declining since the advent of television. There were movies, and of course there were books. Those were your choices.

Today, there are literally hundreds of thousands of additional media choices, most of which are available whenever and wherever you want via the Internet. There are video games and casual games available on game consoles, PCs, smartphones and tablets. Social media provides ways to get information and interact that weren’t thought possible in the 1960s. The result is that while the total media “pie” is getting bigger, each media choice is fighting for a smaller and smaller share of the pie.

Books haven’t fared well in the battle for attention, but eBooks may be slowing down the decline. Heavy book readers have been the most enthusiastic adopters of eBooks—they’re buying more titles, because the cost per title is less with eBooks than with print. Medium book readers’ use of eBooks is catching up with heavy readers, but they’re buying about the same number of eBooks as they did print titles. Light book readers are also light adopters of eBooks, and it’s unclear if they’ll buy or read any more eBooks than they do print books.

Even with eBooks, overall book sales will continue to decline—but they’re certainly not going to zero. In some countries, it’s entirely possible that eBooks will result in overall sales growth, as expensive, hard-to-distribute print books are replaced by less-expensive eBooks. (This is particularly true in markets such as India that still have primitive distribution infrastructures but fast-growing mobile phone availability.)

eBooks are changing publishers’ cost structures, redefining how print books are manufactured, reshaping channels of distribution and reeducating consumers about how much books “should cost.” However, they’re not changing the competitive environment in which publishers find themselves today, and at the end of the day, competition for consumers’ time and money may have far more impact on the publishing business than eBooks could ever hope to have.

eBooks: After the transition

In my last post, I examined the impact that eBooks have had on the publishing industry, and I noted that things are just getting started. Most industry observers agree that eBooks now comprise around 20% of book sales by unit volume. The Forrester Research/Digital Book World survey of U.S. publishers I wrote about found that the single largest group of respondents believes that eBooks will comprise 50% or more of total book sales by sometime in 2014.

What will the book industry look like when today's ratio of eBook to print book sales is reversed--when 80% of book sales by unit volume comes from eBooks? I'm not willing to guess when the industry will get to that point, but I have no doubts that it will get to that point eventually. Here are some likely results of the transition:

• Print books will be much more expensive: As anyone who's purchased large print jobs, from business cards to books, will tell you, the unit cost for printing decreases dramatically as the size of a print job increases. It's sometimes no more expensive to purchase a larger print run than a small one, even if you end up recycling some of the printed materials rather than using them. The reason is that set-up costs are the same whether you're printing a small number of items or a large number, and that set-up cost is spread over the total number of items that you print. Books encounter additional set-up costs for binding, especially for hardcover books.
  
  Companies such as Kodak, HP and Xerox are major players in the print-on-demand market, using digital presses rather than offset or letterpress in order to make small runs economical. However, some of the costs, such as binding, remain, no matter what method is used to print. Even with digital presses, it's not going to be possible to make short-run books at the same unit cost as large-run books. We're already seeing this effect, as the "Big 6" publishers are using agency pricing to boost the prices of their eBooks in order to offset the lower profit margins they're getting on print titles. That's with 20% of sales going to eBooks. When eBooks comprise 80% of sales, publishers aren't going to be able to hide the true cost of printing and binding books.
• Nevertheless, print books will still be around: Even though print will be more expensive, I have no doubt that print books will survive, just as vinyl records have achieved a renaissance thanks to audiophiles and nostalgia buffs.
• Publishers will only commit to print runs for their "sure-fire hits": Just as the movie industry is fixated on producing sequels and movies based on existing successful books, television shows and comic book characters, major publishers will only print books that are from well-known, previously-successful authors, as well as new authors who are well-known from other arenas, such as television, movies, sports and politics. All of their other titles will be published as eBooks first, and will get print runs only if they're justified by customer demand.
• Bookstores will be very different: In the U.S., there will be far fewer Barnes & Noble bookstores, and the ones that remain will be much smaller. As I wrote some time ago, they're likely to be cafes with bookstores inside them, rather than bookstores with cafes inside them. They'll still carry some print books, albeit a much smaller selection. Big touchscreen displays will give customers a similar experience when shopping for eBooks that they have today when shopping for print books: They'll see bookshelves with book covers, and with a flick of a finger, they'll be able to see the back cover, inside covers, and leaf through the book, just as they can today with print books. With another few touches, they'll be able to buy the title as an eBook and download it instantly, or for some titles, purchase it in a print version that will be shipped directly to their home if it's not in stock at the store.
  
  As for independent bookstores, there will also be fewer of them, but the ones that focus on used books will do quite well. Used titles will be much less expensive than new ones, so for price-sensitive customers and those who have to have print books, used bookstores will be their best choices.
• Today's black & white eReaders will be a thing of the past: All eReaders and tablets will use color displays. In the case of eReaders, they'll use low-power displays such as Qualcomm's Mirasol and E Ink electrophoretic color displays; tablets will use LCD and OLED displays. The functionality of the devices will be more similar to each other than they are today; both eReaders and tablets will be able to handle audio, video and interactivity. The primary differences will be in battery life and cost.
• The "Big 6" will become the Big 3 or 4: Just as in the music industry, where financial problems have resulted in a wave of consolidation, we're almost certainly going to see consolidation among the "Big 6" publishers, as well as publishers in every market segment: Business and professional books, children's books, religious books, K-12 and college textbooks.

I would argue that most of these developments are already underway, and the ones that aren't will start once eBooks pass 50% market share. As I wrote in my last post, anyone who doesn't believe that eBooks will result in revolutionary changes in the book industry is fooling themselves.

The future is coming early to college bookstores

The trend toward print-on-demand books in college bookstores is gathering momentum. Last month, I wrote about the Espresso Book Machine, and now Hewlett Packard is getting into the act. Both Arizona State University and the University of Arizona have installed print-on-demand systems in their university-owned and operated bookstores. ASU is using the new HP system, while U of A has used an Espresso Book Machine for a year. (Portland State and the University of Kansas are also testing the HP system in their bookstores.)

The biggest goal of both universities is to drive down the cost of college textbooks. In the three largest Arizona universities, students will spend an average of $3,200 for textbooks and supplies over four years. Nationally, the average price of new textbooks went up 12% in 2009, far faster than inflation. Only a small selection of titles are available for print-on-demand at the two universities, but according to Dennis Mekelburg, the associate director of ASU Bookstores, if his school can replace conventional printed textbooks and materials with print-on-demand for 5% of its courses, students would save $500,000 per semester.

McGraw-Hill, John Wiley & Sons and Cengage Learning are supplying a small selection of their titles to ASU for print-on-demand, and the savings can be significant. One Marketing instructor at ASU switched from a conventionally-printed textbook and workbook that sold last year for $250 new to a softcover version of the same textbook and a workbook printed on demand, together priced at about $62.

In the long run, I believe that the most textbooks will be sold as electronic versions, and print-on-demand will be used to provide paper copies for special situations. The sophistication of eTextbooks and the devices used to read them is increasing so quickly that paper textbooks will soon be considered relics.

One big question is what the impact of these changes will be on the bookstores themselves. To date, the print-on-demand phenomenon seems to be limited to schools that own and operate their own bookstores. Publishers are demonstrating a willingness to negotiate better deals directly with colleges and universities, and some schools are in turn showing a willingness to cut the private operators of their bookstores out of the channel in order to lower the prices that their students pay for textbooks and materials. (In the U.S., the largest private college bookstore operators are Barnes & Noble and Follett.) If the college bookstores no longer sell textbooks, or no longer make any money selling them, what will be the role of the private operators? Probably not much. In fact, I wouldn't at all be surprised to see general retailers, anyone from 7-11 to Wal-Mart, compete for the contracts to run these "bookstores". They're likely much better positioned to sell general merchandise than the existing private bookstore operators.