What is a Fair Price for an E-Book?

Yesterday, I came across a Facebook post which I decided to repost on my timeline. The Facebook post, for those of you who can’t see it, compared a $3.50 cup of coffee with a $2.99 e-book. The point of the post was that a cup of coffee which can be produced in under a minute is worth more than a book that took 2 years to produce. Whether it should be or not is the question before us.

This Facebook post has been shared over 25 times as of this writing. Obviously a lot of people believe that e-books hold more value than cups of coffee. But a high school friend of mine decided to post a comment on my edition of the post. Here is what he said: “It’s the economy of scale. The ebook can be replicated unlimited times while the coffee can only be consumed once.” While it was nice to hear from him after about 2 decades since we last saw each other, I have to say, in my opinion, that his argument is misleading and essentially false.

My friend’s argument is logical, but inaccurate. He starts with the premise that, because an e-book is electronic data, it has the potential to be copied an unlimited number of times—with the implication that there are actually an infinite number of possible copies available over the lifetime of the book, which is also unlimited. However, even though the book can be reproduced easily, the market for that book—the number of people who may be willing to buy the book—is decidedly limited. The market may be 1 person, or it could be multiple millions, but it is still limited.

Let’s say that an average e-book has a market size of one million readers who will actually pay to read the book (I should wish for a potential market of one million for my books!). My friend’s argument seems to be that, because the book has the potential to sell a million copies, we should price it as if there is a buyer today who is willing to purchase every one of those million copies right now (this concept is known as short run economies of scale). If I could sell a million books today, yes, I can see giving a discount to that buyer that would cover the cost of making the book (author time to write the book, editing, cover art, e-book formatting and conversion, and marketing), and would give me a nice little profit. If the fixed cost of making a book (before a single copy is sold) is, say, $20,000, I as the publisher (not to exclude self-publishers) can only break even if I earn those $20,000 back. As a business, I’m entitled to make a profit on my investment, albeit perhaps a small one. So let’s say I sell one million copies at once (remember, selling them one at a time has a different economic model), then I would need to charge $20,000 plus a profit of, say, $1.00 per book (this is actually kind of low, but remember, we are giving a bulk discount here). The sale price would be $1,020,000, and I should be able to put that money in the bank today.

However, there is NO buyer willing to pick up one million copies of the book today. Amazon is the biggest market for e-books today, but they don’t buy in bulk. They don’t buy at all. As I explained in a different post, Amazon only acts as a middle man. Someone comes to Amazon to buy this book, and Amazon sells it to them on the publisher’s behalf. Amazon takes a cut (usually about 30%), and imposes a download fee of $0.15 per MB on the publisher. This is a sale of one book, not one million, and thus the economics of the situation is that we, as publishers, should be able to charge a reasonable amount for that book based on the potential sales for the foreseeable future (a week, a month, a couple of months perhaps).

If economies of scale were the controlling factor here, and we used the numbers from the previous example, here’s the way it would look. We have potential sales for the foreseeable future of, say, 1,000 books. Economies of scale dictates that we divide the fixed cost (in this case, $20,000) by the number of potential sales (1,000) to get a base cost of $20.00 per book. ADD to that the 30% cut and the upload fee from amazon, and we get a price for an individual sale of the book of approximately $28.75 (the calculation is $20=0.7*x+$0.15, where x is the sale price—by the way, I rounded up $0.03). The problem with using economies of scale in this scenario is that there are very few people—hardly 1,000—who will pay $28.75 for an e-book under any circumstances. If we presume 2,000 sales in the foreseeable future, then the same formula yields a price of $14.44. Still too high. Let’s do the formula one more time for 3,000 potential sales in the foreseeable future. We come up with $9.67. Now, depending on the quality of the writing and the reputation of the author (and publisher), someone might be willing to pay that. I should point out that the author/publisher makes NO profit at these volumes and prices. NONE. If we add a reasonable profit—we’re in business, after all—the prices would go up again.

Now, my friend would argue that I’ve made his point. As the potential number of sales increases, the break-even price goes down until ultimately the price of an e-book normalizes to $0.00 (or something close to it). But economics is messy, and predicting the future is difficult and often wrong. We cannot predict the future with enough accuracy to be able to do the kind of analysis that is required by economies of scale. That’s why economies of scale was set up around a one-time sale, not many sales over time. If there were a buyer for 3,000 copies, or better, a million copies right now, then a business person can make a rational calculation of how they might cover their costs and make a profit. And the last time I checked, the purpose of being in business is to make a profit.

So I say to you, and to my friend, that economies of scale do not apply to the e-book market. Authors and publishers should be paid a fair, profitable price for their hard work. I, personally, am content with the “sweet-spot” that Amazon has established between $2.99 and $9.99 (which is where authors and publishers are paid 70% royalties). It would be nice if people were willing to pay more, but there’s no reason, just because an e-book is electronic, that they should pay less. And if that means I make $2.00 per book selling at that price, or $4.00, or even $7.00, good for me. But I don’t see any reason that, just because the e-book file can be reproduced an unlimited number of times, I should have to charge a price based on an infinite number of sales. That’s not economics, that’s fantasy.

Update: Some of you may have picked up on a small deviation of fact. Economies of Scale is generally considered a long-run phenomenon. In the short run, it is more accurate to say that the marginal cost of production goes down when fixed costs are averaged over an entire production run. They are effectively the same concept, but in different time domains (one is in the long run, the other is in the short run), and I find it amusing that both my friend and I made the same mistake in treating economies of scale as a short run phenomenon. Silly us! I guess the lesson on economies of scale was for me as much as anyone.