Psst. Amazon. Your fly is open. And your algorithm is showing.

Earlier this month, a UC Berkeley colleague brought to biologist Michael Eisen’s attention an astounding anomaly: a book entitled The Making of a Fly by Peter Lawrence was offered for sale on Amazon for almost two million dollars – $1,730,045.91  to be precise. Plus $3.99 shipping.

“At first I thought it was a joke – a graduate student with too much time on his hands. But there were TWO new copies for sale, each offered for well over a million dollars. And the two sellers seemed not only legit, but fairly big time (over 8,000 and 125,000 ratings in the last year respectively). The prices looked random – suggesting they were set by a computer. But how did they get so out of whack?”

Actually they got even out-of-wackier, soaring up up up until they reached $23,698,655.93!

His investigation into this phenomenon set Eisen on a path that led to some extremely significant discoveries about computer-driven pricing algorithms employed by Amazon and its retailers. Eisen writes: “I learned that Amazon retailers are increasingly using algorithmic pricing (something Amazon itself does on a large scale), with a number of companies offering pricing algorithms/services to retailers. Both [competing retailers] were clearly using automatic pricing – employing algorithms that didn’t have a built-in sanity check on the prices they produced. But the two retailers were clearly employing different strategies.”

If you love a good mystery story, follow Eisen’s footsteps as he tracks down the solution to the case of Amazon’s $23,698,655.93 book about flies.

Richard Curtis

“We will not only undersell Amazon, but we make this guarantee: if you find a book cheaper on Amazon, we’ll refund the difference plus 10 percent.”

That’s the offer that Borders Australia made to its customers as reported by Neerav Bhatt in ITnews.com.au. The feisty antipodal book chain “announced plans to launch online bookstores powered by e-books download service Kobo and sell its own e-book reader devices,” writes Bhatt.  Kobo expects to launch on May 19th with over 1 million e-books, newspapers and magazines.

Casually mentioned in the story is the projected list price of Kobo’s reading device: AUS $200. That’s $180 in Yankee dollars, about US $80.00 less than the Kindle.

Has anyone noticed that e-book prices are coming down, and royalties going up?

While you ponder, read Borders Australia Lays Down Challenge to Amazon.com

Richard Curtis

When the publishers of #1 bestselling print book Game Change held back the e-book edition instead of issuing it simultaneously with the hardback, furious Kindle owners staged a populist revolt, assigning en masse a mere one star in their Amazon reviews.

Whether or not this tactic discouraged potential buyers from purchasing the book or influenced the publisher to change its scheduling strategies, it demonstrated how strongly Kindle owners feel about the timing and pricing of e-books. It also demonstrated that either they have no patience for the subtle and complex thinking of publishers, or publishers have not done a very good job of explaining the issues to them.

Michael Cader, publisher of Publishers Marketplace, thinks publishers could be doing a better job of demystifying their decision-making processes. “Publishing people who care about these pricing discussions need to get in the online forums and start issuing press releases and find other ways to address readers honestly about price,” he said in a recent editorial. “The price landscape, and shift to an agency model, is honestly baffling to most people and there are a lot of price myths out there.” He also criticizes the media for failing to accurately represent the publisher’s viewpoint.

The task is formidable, largely because Amazon has reinforced the sense of entitlement that many e-book buyers feel. Setting the prices of e-books and timing their release is not only subtle and complex, it is far from scientific. There are as many exceptions as there are rules. (Indeed, because of its timeliness and high media exposure, Game Change might have been a good exception to the wisdom of “windowing” e-prints). All that head-scratching, P&L calculating, market analyzing and soul-searching are no match for the simplicity of an Idea Whose Time Has Come – the one called “$9.99″.

Try to recommend high prices and postponed gratification to someone who wants his $9.99 e-book and wants it now. Amazon is losing money on every sale? Shrug. E-books are the equivalent of mass market paperback reprints? Shrug. The agency model will enable publishers to recover power they conceded to Amazon? Shrug. There are plenty of e-books selling for more than $9.99? Shrug.

Cader is absolutely right that the industry and media must find a way to overcome public misperceptions: “If these things don’t get said, forcefully and clearly, to the press, in forums, and directly to readers by authors and publishers, the messages won’t get heard.”

Richard Curtis

Publishers Weekly just issued a bulletin that “the board of directors of the American Booksellers Association requested that the government begin an investigation into what the organization believes is the illegal predatory pricing policies being carried out by Amazon, Wal-Mart and Target in selling 10 hardcover titles for as low as $8.98. The ABA requested a meeting with officials as soon as possible, arguing that left unchecked, the predatory pricing policies ‘will devastate not only the book industry, but our collective ability to remain a society where the widest range of ideas are always made available to the public.’”

PW‘s Jim Milliot writes:

“The letter charged that the big box retailers are using predatory pricing practices to ‘attempt to win control of the market for hardcover bestsellers.’ By selling books below cost, Amazon, Wal-Mart and Target ‘are devaluing the very concept of the book. Authors and publishers, and ultimately consumers, stand to lose a great deal if this practice continues and/or grows,’ the letter stated. Furthermore, the letter noted, the companies involved in the price war are not engaged primarily in selling books, yet their fight could result in the entire book industry becoming collateral damage.

“The letter added that the price war over hardcovers was precipitated by Amazon’s decision to price e-books at $9.99. “We believe the loss-leader pricing of digital content also bears scrutiny,” the letter stated.”

From time immemorial, loss-leader pricing has been an instrument to drive competitors out of business. But with so many retailers and big-box stores joining in the sale of books below cost, the ones being driven out of business are publishers, authors and independent booksellers. We don’t know if ABA has a case but kudos to them for trying.

Richard Curtis

Are books worth fighting over? Wal-Mart thinks so and has put its money where its mouth is by cutting to the bone the list price of more than 200 hardcover books by such bestselling author-stars as John Grisham and Dan Brown. And whether you think of Sarah Palin as either an author or a star, her forthcoming memoir Going Rogue will go off at the same retail price as Stephen King. Amazon promptly matched Wal-Mart’s $10.00 price, whereupon Wal-Mart dropped theirs to $9.00.

What’s behind these dramatic moves? Who benefits? And can anyone make money retailing books at half- or two-thirds-off?

To answer the last question first, it’s hard to see how either Wal-Mart, Amazon or any other retailer can earn a profit at those prices. Retailers buy books from publishers for a wholesale price of approximately 50% off the list price. If the buy is big – five or ten thousand copies or more – the publisher will give the retailer a better discount. But when that discount crosses the 60% line, the publisher’s profit margin becomes dangerously thin and at some point the publisher will have to say No Can Do. The retailer then has to decide if it wants to sell the books at a loss. From where I sit, that’s just what Wal-Mart has decided to do.

Why? There are two reasons a retailer will sell at a loss: short term and long. In the short term, loss leaders (as they’re called) are created to attract business. In this case, Wal-Mart wants to call attention to a new service it calls “America’s Reading List.” That’s fair, and it answers the question of who benefits: the customer does. But usually, once customers start patronizing the store, prices go up again.

But what if Wal-Mart’s discount extends for a longer period of time? Then you have to wonder whom they’re trying to knock out of the tournament. The obvious competitors are retailers like Barnes & Noble (Publishers Lunch reports that B&N’s stock fell more than 5% in morning trading), Borders, Books-a-Million, big-box stores like Costco, and above all, Amazon.com. I don’t think anybody – Amazon, B&N, or Wal-Mart itself – can sustain break-even or losses for an appreciable period of time. And independent bookstores? As if they didn’t have enough trouble, an extended price war could drive remaining indies out of business completely.

There’s someone else who stands to get hurt in a discount war. It’s called the author. Typically, publishing contracts reduce author royalties when the discount offered to retailers reaches a certain threshhold. I’m looking at some contracts with big houses that state that when the discount reaches 56%, the author’s royalty is cut from one based on list price to one based on net receipts. For example, on a $25 book that means your 10% royalty drops from $2.50 (10% of the list price) to $1.10 (10% of the $11.00 your publisher actually collects from the retailer).

So, authors, this is not merely a spectator sport. Some of you are gonna get killed.

Why Wal-Mart embark on this suicide mission is unclear, but we’ll be watching the fireworks attentively – and anxiously.

Read details here: Wal-Mart offers new books for $10.

Richard Curtis

The e-book industry was officially launched at a government-sponsored conference in 1998. Starry-eyed dreamers, technical pioneers, entrepreneurs, geeks and curious publishers convened with the evangelical fervor of a tent meeting. Bliss it was in that dawn to be in the e-book business, and the wave of zeal generated predictions of the end of printed books.

Alas, some hard realities set in soon afterward. Copyright issues, technical problems, muddled business models and a lack of standards hindered momentum for almost ten years. Though the industry grew at a steady double-digit rate in spite of these problems and has at last broken out, it took a decade to mature, and that’s a decade longer than most of us anticipated.

One of the problems that compromised progress was e-book pricing. No one really knew how much to charge to download a book. And the fact is, we’re still not sure. If you survey prices on various publisher and etail sites you will readily see that list prices are all over the place. A quick foray onto the website of Fictionwise, the world’s foremost book etailer, shows Janet Evanovich’s The Grand Finale e-book listing at $14.99 (discounted by Fictionwise to $12.74 for its Club members). Temptation and Surrender by Stephanie Laurens sells for $25.99 ($22.09 Club price). The Demon’s Librarian, a paranormal romance by Lilith Saintcrow, sells for $5.95 and $5.06 respectively.

As in every other business enterprise there are two schools of pricing merchandise. One is to set a target profit and peg the price to meet that target. The other is to gain an advantage over competitors by undercutting them, reducing profit to the thinnest possible margin. That easily explains the range of list prices from roughly $3.00 to $10.00. It doesn’t however account for e-books listing for $20.00 or more. We’ll examine that in a moment.

In an attempt to bring discipline to e-book pricing and do for books what Apple did for music (at least, for whole albums) via the iPod, Amazon has strongly prescribed a $9.99 cap for books carried on the Kindle. But an analysis of list prices of Kindle titles, described in a blog headlined “Paid Is a Lot More Complicated than You Think–So Is the Truth”*, reveals the following:

“Using two different methods for checking Kindle price data in Amazon’s system, we find that roughly 30 percent of the 240,000 or so Kindle titles sell for more than $9.99 (and well over 20 percent sell for more than $20).

Yes, approximately 33,000 titles sell for around the magic $9.99–but about 13,000 titles sell for between $10 and $20. Here’s is one slice of approximate numbers for the four most popular price bands:

1. $20.01 and up: 55,750
2. $10.00 and $9.01: 33,000
3. $4.00 and $3.01: 25,500
4. $8.00 and $7.01: 20,750″

The writer goes on to point out that “There are more than 7,000 free books, and another 28,000 or so titles that sell for $2 or less.” He or she goes on to say,

“Now take a look just at their hourly bestseller list, as we have done both yesterday and today. As of one slice this morning, two of the top three Kindle books (and 18 of the top 100) are free.

But the No. 4 title sells for more than the magic $9.99–Breaking Dawn, by Stephenie Meyer, at $11.38. (The print version, at No. 2 on Amazon’s overall list, sells at discount for $12.64.) The Sony eBookstore sells it for $11.99 and the iPhone app version sells for $19.99.

In all, 16 titles on the top 100 are selling for more than $9.99. Some of those are pre-orders of books by the likes of Jodi Picoult, selling now at $15.37 even though presumably those books would sell for less once they are available and hit the NYT list.”

A $15.00 or $20.00+ price for an e-book seems counterintuitive, but don’t worry, your intuition is quite sound. We know (and appreciate) that there are diehard fans so desperate to read a new book by their favorite author that they’re ready to shell out as much for a download as they would pay for the hardcover in a bookstore or on amazon.com, maybe even more. But it’s safe to say that most readers and fans feel that, confronted with a choice of paying $25.00 for either an e-book or a hard copy of the same book, they will elect the version that they can put on their bookshelf when they’re finished with it.

What’s behind that high list price for so many e-books has to do with a stubborn fact of book publishing life. The business model of traditional publishers like Random House, Simon & Schuster and Penguin, is built around printed books. The profit to be made on a successful “book-book’ is at this time far greater than that made on an e-book. Furthermore, publishers employ sales representatives who earn commissions on sales of printed books; they do not earn anything on e-book sales.

It stands to reason, then, that from the viewpoint of a publisher and its sales reps, a low e-book price will cannibalize the profit made on sale of the higher priced print edition, and deprive the sales reps of their commissions. To bring the e-book profit up to parity with that of the print book, publishers must bring the e-book list price up to parity with that of the print book as well. That explains why Temptation and Surrender, the Stephanie Laurens novel selling in e-book for 25.99, is being sold for the very same price in hardcover on amazon.com. When a hardcover edition goes out of print and a cheaper paperback is issued, the publisher will in all likelihood lower the e-book price to maintain that same parity. (And there are mystifying anomalies. The Grand Finale, the Evanovich novel mentioned above that sells for $14.99 in e-book format, can be purchased in mass market paperback for $7.99!)

If your intuition tells you that this brick and mortar mentality is a significant reason why it’s taken so long for the e-book business to prosper – well, again, you’re absolutely correct. Whether the problem can be remedied is hard to say. Traditional publishers are traditional for a good reason. Newer entries into the e-book publishing field are not hampered by the same considerations as the Simon & Schusters of the world, and price their wares without concern about cannibalizing themselves or keeping commissioned sales representatives happy. On the other hand, traditional publishers enjoy distribution advantages that are the envy of every e-book startup.

So – you pays yer money and you takes yer choice.

Our anonymous blogger also raises a cogent point about Kindle pricing: though the price of an e-book purchased on the device may be discounted, you have to build in the price of the Kindle itself in order to ascertain the true cost of the downloaded book:

Logically speaking, the overall save-money-by-buying-a-Kindle argument is also specious for most consumers; as others have pointed out, if you save an average of $7.50 a book–supposed Kindle price of a new hardcover versus discounted Amazon print price–you need to buy at least 50 books or so before recovering the purchase price of the device. Yet it’s clearly one factor in the purchase decision by many Kindle owners.

Which brings us back to the “Gillette Razor” solution we’ve championed in these pages. The inventor of the modern razor shrewdly observed that the most effective strategy to boost his product was to give away the razor and sell the blades. Giving away the e-reader and selling the books might be just the rocket boost the e-book industry needs to send it into the stratosphere.

Richard Curtis

*(Apologies to the unnamed author of this survey, which was emailed to me by a friend without a link to the source. In a rare failure of Google search capabilities I was unable to ascertain the blog’s author. If the author happens to read this, sir or madame, please identify yourself so that I can accord you well deserved recognition!)