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Kindle sales and profit forecasts are running wild.  Key to the bullish assumptions is the idea that publishers will soon cut wholesale prices on e-books, allowing Amazon to start making money on them.  In the meantime, Amazon is losing its shirt, selling e-books for about $1-$1.50 less than the wholesale price it pays.

The negotiations between book publishers and e-reader distributors like Amazon will determine how large and profitable the e-reader market will become.  So we called a number of book publishers to see how these discussions are progressing.

Here are the key points:

Publishers are showing no willingness to cut wholesale prices for e-books.  Thus, neither wholesale nor retail prices on e-books are changing anytime soon, which means Amazon will continue to lose money on e-books for the foreseeable future.

Amazon is probably making a small gross profit from older titles like paperbacks - likely about $0.50 to $1 per book.  This is because the wholesale price for these titles is lower than it is for new books. So the near-term picture for Amazon is slightly less dreary than we originally thought. 

But older books (paperbacks, etc.) only account for about 50% of sales, so Amazon's average loss per book is likely $1-$1.50.

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FOR NOW, NEITHER SIDE IS BUDGING

Industry sources indicate that neither book publishers nor e-book retailers like Amazon are currently willing to compromise their positions.  Amazon is refusing to raise retail ebook prices, and publishers are refusing to cut wholesale prices.  Unless/until this changes, e-books will be a money-losing business for Amazon.

The book publishers can suggest a retail price, but there is very little point-by-point negotiations occurring to work out deals that are profitable for both parties.

A group of literary agents recently visited Amazon to convince the company to raise their retail prices.  The argument they made was that prolonged discounts in pricing will hurt sales for both parties over time because high quality authors will stop writing as much since their incomes will have been considerably damaged (we go into more detail below).

The meetings went nowhere and both sides left having not agreed on anything.

Most publishers we spoke with believe that Amazon will eventually have to increase its retail price if the publishers hold their ground.  For now, Amazon hasn’t gained enough leverage through sales of the Kindle to make publishers change their mind in that regard.

PUBLISHERS ARGUE THAT BOOK QUALITY WILL DECREASE, HURTING OVERALL BOOK SALES FOR PUBLISHERS AND DISTRIBUTORS

To some degree publishers have their hands tied since they need to compensate authors enough to keep them writing.  Enabling a further decrease in book prices only hurts their ability to do this since author royalties are paid off of retail sales.

If e-book prices remain low, publishers argue that:

  • Royalties to authors will decrease and won’t be able to support books that take several years to research and write. 
  • Authors will stop writing quality books since they won’t be able to support themselves given the amount of time and resources invested in researching and preparing the books. 
  • This would lead to fewer people buying books, which would hurt revenue growth for both publishers and e-readers.

Companies like Amazon are content to wait and see if publishers finally cave and cut prices.

THERE ARE ONLY A FEW WAYS THIS CAN END

Publishers offered a variety of different ways the pricing battle could play out, including:

  • Books are sold for less and are commoditized, leading to fewer quality books being released.
  • E-books are sold at a discount, but are sold after hardcopies are released, similar to the way paperbacks are currently released.
  • Some kind of model is developed where e-books are sold as part of a hard copy purchase (not a lot of specifics here).

A more likely result is that Amazon wins and books are sold at lower prices.  This would likely lead to consumers buying more books.  In theory, this could lead to essentially the same amount of overall revenue for publishers, e-readers, and authors. 

In theory.  But secular trends of declining book readership are continuing, and we don’t see this trend easing anytime soon.  The book, unfortunately, is an outdated format and technology.

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VERY FAINT SIGNS E-BOOKS MAY DRIVE INCREMENTAL SALES

The one thing companies like Amazon and book publishers appear to agree on is that they both hope e-book sales will prove to be incremental, not substitiutional.  Unfortunately, most publishers we spoke with thought e-books would largely be substitutional, which does not bode well for those hoping publishers will lower their wholesale e-book prices anytime soon.

We caution that data is limited, but we did hear of a few examples of authors claiming e-books sales boosted their overall book sales through incremental purchases.  These ranged from modest bumps to a 50% increase.

These were isolated examples and did not include blockbuster authors, but if this trend continues it would support the case that e-books could drive incremental book sales or that lowering prices on books across the board could lead to a greater volume of sales.

APPLE HAS HELD PRELIMINARY DISCUSSIONS, BUT NOTHING SUBSTANTIAL

Right now competition does not impact wholesale pricing much – each e-book distributor must pay the same price and most e-book prices are currently similar across the board. 

Apple has held preliminary discussions with the trade book publishers, but little contact has been made the past six months.  We believe this is likely because Apple’s tablet release is not imminent, the company is negotiating with other content providers first, or that the company is waiting until the last minute to cut content deals in order to avoid any leaks about the tablet.