Can Penguin and Random House re-write the ending?

The book industry has suffered immensely with the arrival of the internet and e-books. So does the newly-formed Penguin-Random House joint venture have any hope of success?

Two of the world’s biggest English-language book publishers, Penguin and Random House, are forming a joint venture. Bertelsmann, the owner of Random House, will have 53 per cent of the venture with Penguin’s owner, Pearson, having 47 per cent. It is not a merger – each company retains certain ‘exclusive’ rights and, as is common with joint ventures, there are a variety of rules to protect each party.

So why are these two publishing giants forming Penguin Random House?

The reasoning is simple. The book industry is going through a period of change driven by the internet and electronic delivery. Like the music and newspaper industries before it, traditional business models in book publishing are failing, and established publishers are desperately seeking a sustainable way forward.

This rationale is clear from the press release. Together, the two publishers "will have a stronger platform and greater resources to invest in rich content, new digital publishing models and high-growth emerging markets”. But does it make sense, or is this simply a last gasp from dying businesses?

Unlike recorded music and newspapers, book publishers have been reasonably successful in the internet age. The internet has created new ways to ‘sell books’. The original internet retailing model, pioneered by Amazon, involved the physical delivery of books around the world. It undermined the ability of publishers to set different prices in different countries, but at least people still bought books.

The second internet model, the delivery of e-books, has had a bigger impact on physical book sales. However, selling e-books rather than physical books has probably been positive to publishers’ profits. The marginal cost of producing and distributing an e-book is close to zero, so both prices and costs have fallen. Ease of access has broadened the book market. So why aren’t the publishers smiling all the way to the bank?

There are two problems with this rosy picture. First, book publishers have not driven these changes. The publishers have been followers – of Amazon and Barnes & Noble for internet retailing and of Amazon and Apple for e-books. So while new internet models have needed the publishers to access the authors and the back catalogue, the publishers have been the passive beneficiaries of innovation by others. This is unlikely to continue in the future. Someone will want to cut the publishers out of the picture and take their profits away.

Which brings us to the second problem: e-publishing. Apple has dipped its toes into the water with iBooks Author, but others will aggressively follow. And if authors can work directly with the suppliers of e-book hardware, like the Kindle (Amazon) and iPad (Apple), then the publishers are redundant. This is why the publishers are scrambling for new business models, like the PRH joint venture. They are trying to work out a business model in a world where authors, readers, and hardware providers do not need them.

How should the competition watchdogs, like our Australian Competition and Consumer Commission, respond to these market developments? In the US, competition authorities prosecuted Apple and six publishers for collusion. The case is ongoing, but relates to contractual conditions that limited the ability of publishers to discount e-books.

Matthew Yglesias dismissed this case in Slate, saying: "Worrying about anti-trust issues in the book publishing industry is like worrying about a horse and buggy cartel”.

But Yglesias misses the point. Book publishing is in a period of evolution, and market participants have strong incentives to design the market in a way that limits competition and raises profits. The US authorities correctly kept an eye out for such conduct and pounced when it arose.

What about the PRH deal? It requires clearance by competition authorities around the world. Should they be concerned?

The (unhelpful) answer is yes and no. It all depends on how fast the industry evolves. If evolution is slow, and book publishers remain the gate-keepers for authors for, say, the next five years, then a joint venture between two of the industry giants raises significant concerns. It could lead to higher prices and allow PRH and other large publishers to "massage” the industry in a way that protects their own profits.

In contrast, if evolution is fast, then within five years, book publishers could be reduced to niche players only dealing with back catalogue until copyright expires.

So competition regulators will have to hope their crystal balls are working when considering the PRH joint venture. But whether the deal is cleared or not, it is certain that we will see a lot more change in book publishing over the next few years.

Stephen King is a professor in the department of economics at Monash University. This story first appeared on The Conversation. Reproduced with permission.

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