The recent decision by Pearson (PSON.LN) and Bertelsmann to spin-off their traditional book publishing businesses, Penguin and Random House respectively, has less to do with the future of publishing than it does with the past. Yet it tells us something about how Pearson and Bertelsmann are hedging their bets for the next five years.
The fundamental business problem in the traditional publishing business existed decades before Amazon opened its website. Books were sold to distributors and book stores at forty percent off with full credit if the book didn’t sell. This meant a book could end up being shipped to the publisher’s warehouse; then shipped to Ingram’s distribution warehouse; then shipped to a bookseller in Dubuque, IA; not sold and shipped back to Ingram; then resold to a bookseller in Harrisburg, PA. If it was a clunker, it might end up back at the publisher’s warehouse. 30-40% of books sold were returned in the last decade. As even the most untrained business eye can see, the shipping costs could easily destroy any book’s profit.
Yet the model worked as long as production met demand without exceeding it. Very easy to do with specific genres such as Sci-Fi or Romance. Not so easy to do with books that did not fit a known formula. Publishers made tons of money on tried-n-true books and everything worked fine. Readers got great, if not oddly similar, books to read.
Setting the first nail: Publishers were making money. In the ’80s and ’90s, they were seeing unheard of profits of $1-2 per share while their market capitalization stayed low. Big companies wanted that revenue stream. Companies like Disney, Time Warner, Sony, CBS, and News Corp began buying publishers and benefitting from that thick profit stream. $2/share boosted their bottom line and paid for the M&A debt of acquiring the undervalued publisher. Acquiring a publisher was a no-brainer.
Pounding of the first nail: Then came the Internet and, over a period of ten years, people wandered away from bookstores to order online. Why? If I’m buying a formula book by a known author (less risk for returns) why browse the shelves? I can pre-order the next book by my favorite author and presto, there it is when I come home from work. No extra trips to Border’s.
Pounding of the second nail: Amazon wants to cut out the ridiculous concept of holding inventory. In 2007 they introduced the Kindle, the first e-reader that worked almost as well as a book. No pages to turn, no shipping costs, no inventory to finance.
WHOA. At first, this looked bad for Borders–and was. Then Barnes and Noble became a showroom for Internet buyers. But how did this adversely affect the publishers? In two ways: first, book prices changed. Everyone knows that the Chinese will construct a great looking book for $1 each, meaning that $26 was left over for the publisher. Ebooks cost a lot less than hardcovers. Where is the problem? Remember when we talked about CBS and News Corp buying publishers for the revenue? They bought them based on the $27.95 cover price staying level and wholesale prices remaining 40% off. But suddenly there were only two bookstores, Amazon and BN. Less room for negotiations. Second, the new model allows a direct author-reader relationship in which the publisher is relegated to the role of book-financier. Publishers put up the money and resources for great editing, production, marketing and distribution. Notice that two of those four items, production and distribution, have lower costs today than twenty years ago? They needed to retain control of those pieces of business and Amazon was walking away with them.
Now we have the financial squeeze. We don’t know Bertelmann’s numbers because they’re privately held. But Pearson PLC is an open book and they are typical of publicly held companies on either side of the pond. Investors want higher dividends every year or they take their money elsewhere. Here is a quick look at Pearson’s spring dividends for the last 19 years:
£ 06.63 in Apr-93
£ 14.30 in Apr-03
£ 28.00 in Mar-12
What will we see in March, 2013? Will it be £29-30? Investors will walk if it isn’t…
Penguin and Random House have ancient infrastructures they can’t get rid of. They don’t need to reinvent themselves. They need to revolutionize themselves. That is not easy if you’re 20% of the revenue stream for your parent company. You’d kill the parent’s stock price by reinvesting in the business.
BUT, it is easy to do if you are a JOINT VENTURE.
Why JV? Because the parent company gets to claim JV profits without having to worry about JV liabilities. Same reason News Corp is separating the dragging businesses of newsprint and publishers. If the JV reinvests (and that’s what Random Penguin needs to do) in new technologies and downsizing, the required restructuring costs do not weigh down the parent’s dividends. If the reinvented JV succeeds, the parent can spin it off and make billions. If it files for bankruptcy, the parent is untarnished and issues a press release that says, “oh well”.
What could a Random Penguin do on the loose? The waddling giant could, and probably will:
- Push for a standardized e-reader format to free it from Amazon’s grip. It could then sell a standardized ebook on RP-owned websites direct to consumers of any model e-reader. No distribution costs at all.
- Devour successful advertising platforms by buying a year’s worth of endorsements and banner ads, leaving independents and other publishers scrounging for remainders.
- Dominate Social Media by sheer volume. Centralized Social Media conducted by the publisher would appeal to authors (simplification) while consolidating message and power in the hands of the publisher.
- Set prices and turn bookstores into show rooms. Damn the Justice Department, they can’t dictate our prices if we sell direct.
- Buy up other struggling publishers. Creating … HACHETTE HOUSE OF PENGUIN! (“Aw man. The heads. You’re looking at the heads. Sometimes he goes too far.”)
- Pay traditionally published authors just enough to keep them from going indie. But barely.
What do you think a behemoth Penguin could do?
Special NOTE: MY OPINIONS ARE MY OWN and not representative of the voices in my head. I have no relationship, financial or familial, with the companies discussed here. I do not offer any advice as financial guidance. Anyone making a financial decision based on my opinions should have his/her head examined. Just sayin.