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Understanding the agency model

While the Department of Justice lawsuit against the agency model rages on, the question I keep hearing, with a note of desperation, is: “What exactly are they suing about?”

I guess that’s kind of crucial to understanding the lawsuit. And while Appazoogle has written about the agency model in the past, we’ve yet to give you a play-by-play breakdown of the mechanics of this DOJ-angering monster. So here it is: the agency model, to the best of my understanding. With charts.

Book retail

chart outlining the retail model

The retail model involves retailers purchasing stock at wholesale prices and reselling to consumers at the consumer price. (Chart by Leah Thompson)

Here’s how book retail normally works. The publisher makes a book. They give the book a list price—say $25. That $25 price tag is the publisher saying, “This is what the book should be worth to a final consumer.” This is important because author royalties are calculated from list price, so in order to balance a profit/loss statement (the financial end of a book proposal), they have to know what consumers will be asked to pay.

Then publishers take the book to their bookselling accounts. Booksellers purchase books from publishing houses at a deep discount, usually in the ballpark of 40% (on a $20 book, that means booksellers will pay about $12 for the wholesale price). The bookseller turns around and sells the book at list price for an $8 profit on each unit sold. This is the normal retail model, and this is how we started with ebooks. But for publishers, it started to stink.

Loss leaders

Loss leader” is a retailing term that means “something you sell at cost (or at a loss).” Wal-Mart is notorious for selling items that people frequently price-shop for (i.e., detergent) at cost or at a loss in order to undercut the competition and bring more customers in to the store. Wal-Mart made up for this by marking up products that people don’t price-shop for (i.e., paper napkins), with the rationale that people will come into the store and pay $1 less for Tide but overpay $4 or $5 on their total purchase (because really, who only buys one thing at Wal-Mart?).

chart showing how loss leaders work

Amazon sold ebooks at a loss in order to capture a greater share of the ebook market. (Chart by Leah Thompson)

Returning to the book world, Amazon uses loss leaders to draw consumers to buy books online. Like Wal-Mart, Amazon deeply discounts a lot of popular titles that people will price-shop for. And in the case of ebooks, before the agency model Amazon discounted everything to $9.99.

At that point, ebooks were still operating under the same system as physical books: retailers paid a wholesale price and were kind of expected to turn around and sell the ebook at or near list price. Instead, Amazon paid the wholesale price and then sold each ebook at a steep loss.

Why did publishers care, you may ask? They had been okay with Amazon’s discounting up to that point.

True. But the thing was, Amazon was THE ebook retailer. So if Amazon said ebooks should be $9.99, suddenly consumers expected all ebooks to be $9.99. It wasn’t perceived as a discounted price: it was perceived as a normal price. And this is when publishers used their muscle to create the agency model.

Agency model

Publishers didn’t come up with the agency model on their own. Apple was already using this model for other forms of media (i.e., digital music) sold on Apple platforms. Publishers took that idea and made it theirs, and voila, the agency model happened.

chart of agency model

Under the agency model, the wholesale transaction is irrelevant. What the customer pays is split between the publisher and the retailer. (Chart by Leah Thompson)

Under agency pricing, the retailer acts as an agent for the publisher; each time an ebook is sold, the profits are split, 70% to publisher and 30% to retailer. As you can see in this chart, I haven’t included a “wholesale price”—that’s because there isn’t really a wholesale transaction. Instead of the traditional, two-transaction retail model (retailers buy from producer, consumers buy from retailer), under the agency model there’s only one real transaction: the point of consumer purchase.

(Note: Remember that under the wholesale model, retailers took about 40% of the list price as profit; under the agency model, they are only seeing 30% profit. However, also remember that with ebooks, retailers have far less risk than with physical books. There are no warehousing or shipping costs for ebooks. )

Publishers considered this a better system because it gave them more control over setting prices on ebooks, breaking the $9.99 norm.

Price setting

But at this point, things get even hairier. While the agency model gives publishers more control over price, publishers are not directly setting the ebook prices. Publishers set the list price of a physical book, as has traditionally been their prerogative. The ebook price is figured from a table of price ranges—for an easy analogy, think of tax brackets. See the chart below for an example of how this works.

chart showing conversion between physical book price and ebook price in agency model

An example of how the agency model pricing structure works. Note that these are not the actual terms of the agency model. (Chart by Leah Thompson)

So publishers can’t make the decree, “this ebook shall be $13.29.” The ebook price is a generic tag associated with books within a set range of value. So whether your book is, according to this example, $25.00 or $28.99, the ebook will always be $14.99. This is not necessarily the best of all possible scenarios for publishers, many of whom probably wouldn’t mind setting ebook prices in parity with physical book prices, but it does accomplish the goal of raising the ebook ceiling from $9.99, a price which, in the long run, publishers consider unsustainable.

The future

What happens next? It seems the legal system will decide. And I suspect that decision will be an important precedent for the shape that intangible (or, at least, non-physical) retail will take in the future.

About Leah Thompson

Writing and publishing professional in the Boston area.

9 comments on “Understanding the agency model

  1. Pingback: Understanding the agency model « appazoogle | AdShopEZ

  2. kosieeloff
    April 14, 2012
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  7. It’s hard to believe the models & Top Modelling Agency in the pictures are over 50 but heck, the clothing is really beautiful.

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  9. Pingback: Judge approves DoJ settlement. Who scores? « appazoogle

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