Would You Like a Kindle With That e-Book Order?

 |  Includes: AAPL, AMZN, BKS
by: Scott Berry

Recently, a colleague tweeted about how some publisher was selling an e-book at a higher price than the hardcover. His comment was the publisher (Penquin in this case) just “didn’t get it.”

I think he’s wrong on this one.

True, an e-book should be priced lower than the hardcover. It’s certainly cheaper to produce. But cost doesn’t drive price, demand does. Cost simply determines how much profit there will be, if any.

People buy e-books (and e-book readers - more on that in a minute) for a lot of reasons. But most of them are related to convenience. The ability to download books, a large and growing selection, the ability to carry an entire library with you, low weight, getting a new book the day it debuts without fears it will be sold out. And yes, they’re almost always cheaper.

Consumers have always been willing to pay for convenience.

If people really like e-books, why wouldn’t they pay more for the convenience? Now that they’ve shelled out good money for their Amazon (NASDAQ:AMZN) Kindle (or Nook, or whatever) they’re sort of stuck, aren’t they? Are they really going to go back to buying hardcovers - and trashing their e-readers - just because the book price went up?

Let me get a show of hands. How many of you walked back into the bank to use a real teller once they started charging a few bucks to withdraw money from an ATM? Not many, I bet. Remember when there were hardly any commercials on cable TV, because you paid a subscriber fee for it? Did you cut the cord because ads started showing up? Nope.

Publishers aren’t stupid. They’re going to charge as much as the market will bear for an e-book. But they have to be deliberate in how they go about it. For this to work they need two things:

  1. Enough separate e-book outlets so they maintain a measure of pricing control (no iBook store to monopolize distribution), and ...
  2. Enough e-book readers on the market so they have a critical mass of customers.

It’ll happen gradually, but e-book prices will drift up. They may never exceed hardcover prices - perhaps they’ll end up somewhere between that point and retail paperbacks. Whatever the level, it’s clear publishers will be raising prices on more titles in the future - particularly popular authors and hot books.

Which brings me to my second point. If publishers and sellers require a lot of e-book devices in the market to maximize profits from e-book sales, what do you think will happen to the price of e-readers?

If you answered “they’ll drop like a stone," go to the head of the class. When you expect to make most of your money from the blades, why in the world would you charge people for razors?

Sure, e-readers might not actually become “free." Perhaps they’ll be subsidized like cell phones by the operators whose networks are used to download the e-books. Sign up for AT&T (NYSE:T) service for two years, get a starter cell phone, and we’ll even throw in a Kindle. Or agree to buy two e-books a month from Barnes and Noble (NYSE:BKS) over the next year, and your Nook costs you nothing.

Consider this:

  • The number of available e-readers has grown significantly.
  • You can already read e-books on other (multi-purpose) platforms like PCs or tablets.
  • Apple (OTC:APPL) has sold more than 8 million iPads already, while Kindle sales are at best less than half that.
  • Entry-level e-readers have dropped dramatically in price since they premiered (though new ones with more features still command a premium).

E-reader prices will trend downward to the point where they’ll be as cheap as, well, kindling. And as that happens, e-book prices start to rise.

This all maximizes publisher profit. It also increases revenue for distributors like Amazon and Barnes & Noble which sell the devices. They will more than make up the cost of e-readers with increased profit on e-book sales.

The real beauty of this strategy is that it effectively takes the cannibalization of physical book sales completely off the table.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.