It’s no secret that I’m a huge fan of both Akerlof and Romer, not just the paper they co-wrote on looting in the financial system but also their work individually. Turns out one of Akerlof’s most famous papers is directly relevant to the ebook market.
For starters, a few basic premises. If you disagree with any one of these you can feel free to ignore the entire argument. I can easily pick apart any one of these statements myself, so I’d understand it very well if you disagreed with them. However, if you find them somewhat likely then the overall picture of the ebook market is a bit dark.
Ebook buyers buy more than they read. Book abandonment is high and out of proportion with the return rate.
Sampling the first few chapters is a lousy predictor of how much the reader will enjoy the book. You can only assess basic stylistic issues from a sample, not storytelling quality. Ergo the reader has to buy the ebook to assess the quality of the story.
Reviews are an extremely unreliable indicator of quality. The average quality of most reviews themselves is very low. Many reviewers are paid shills or just extremely overworked.
Luck is one of the biggest determinants of bestseller status.
Striking, marketable, differentiation is difficult in ebooks without having the reader actually read the book.
The marketing differentiation that is possible without having the reader actually read the ebook (sex, scandal, celebrity) is at best orthogonal to the book’s actual quality and at worst inversely correlated to quality.
Quality in this piece being defined as whatever the reader values, no matter how rubbish it looks to an over-educated twit like me. I’m not making any assumptions about writing, genre, or style.
The majority of ereader vendors implement style and design overrides to preserve a baseline of readability and usability, not to commodify their product’s complements. (I.e. they are well-meaning, rational actors.)
Distribution is becoming mostly self-serve with a very porous filter. (Like, for example, the self-publishing services run by Amazon, Kobo, B&N, and Apple.) Almost anybody with a computer has access to the publishing industry’s full ebook distribution chain.
Ebook development is underpaid and so will not attract experienced talent from the web industry.
It’s easier to make a bad book than a good one and so the vast majority of ebook supply will be bad.
The argument I’m about to make is that this situation gives publishers (both self- and non-self) an incentive to market poor quality books (remember the definition of quality I outlined above), that the average available quality of books will fall, and that the overall publishing market will shrink in terms of overall revenue (even though the the number of units sold increases).
First, the basics…
A market of lemons
It has been seen that the good cars may be driven out of the market by the lemons. But in a more continuous case with different grades of goods, even worse pathologies can exist. For it is quite possible to have the bad driving out the not-so-bad driving out the medium driving out the not-so-good driving out the good in such a sequence of events that no market exists at all. (Akerlof, 1970)
In 1970 Akerlof published a paper describing exactly why a new car loses a lot of its value as soon as you drive it newly bought out of the showroom.
With new cars you can assume that most cars of the same make will be of a similar quality and that if something goes wrong you are probably covered by a warranty.
Anybody who is in the market for a car doesn’t have access to the information that would let them tell the difference between a good car and a bad car (otherwise known as a ‘lemon’, hence the title of the paper).
If a new car is a lemon, i.e. has some sort of manufacturing flaw, neither the buyer or the seller are aware of the flaw and the manufacturer usually covers the repairs if the flaw is discovered within the warranty period.
However, because used cars have a history, the seller of a used car is likely to know which are lemons and which aren’t. This asymmetry of information in the used car market is, according to Akerlof, the primary reason why there is a pricing disparity between a new car and even the most recent of a used car.
Both bad and good used cars are likely to sell for the same price because the buyer can’t tell the difference between those that are lemons and those that are not. And because the buyer knows this there will be s strict upper limit to what they will pay for a used car—the seller of a good used car will not get its full value.
The sellers of good cars have an incentive not to sell while the less well-meaning sellers of lemons have an incentive to sell. The information asymmetry means that less scrupulous will, at least while the market is still maturing, get more than their ‘lemon’ car is worth.
The Lemons model can be used to make some comments on the costs of dishonesty. Consider a market in which goods are sold honestly or dishonestly; quality may be represented, or it may be misrepresented. The purchaser’s problem, of course, is to identify quality. The presence of people in the market who are willing to offer inferior goods tends to drive the market out of existence- as in the case of our automobile “lemons.” It is this possibility that represents the major costs of dishonesty - for dishonest dealings tend to drive honest dealings out of the market. There may be potential buyers of good quality products and there may be potential sellers of such products in the appropriate price range; however, the presence of people who wish to pawn bad wares as good wares tends to drive out the legitimate business. The cost of dishonesty, therefore, lies not only in the amount by which the purchaser is cheated; the cost also must include the loss incurred from driving legitimate business out of existence. (Akerlof, 1970)
What worries me…
Reliable information about ebook quality is increasingly hard to find in the market. Reviews have almost completely been gamed; a casual reader has few reliable indicators that tell them whether a review is an honest one or not. Rubbish books, ones that most buyers don’t even read to the end before giving up, shoot up the bestseller lists due to viral marketing. Bestseller lists themselves are increasingly either gamed by publishers or by ebook retailers themselves who are trying to shift their sales in one direction or another.
Even some big publishers are getting into the game by dumping cheap OCR converted ebooks full of errors onto the market. Again, a casual reader has no way to know whether this particular big publisher is one that does a quality ebook version or one who pumps out ebook ‘lemons’ by the virtual truckload.
The same applies to self-publishing. The casual reader doesn’t have access to the information to help them tell the difference between the self-publisher who has invested substantially in the quality of their book and one who is dumping something onto the market looking for a quick profit that requires next to no cash outlay. That is without mentioning the publishers and authors who have been paying for reviews, engaging in sock-puppetry, and astroturfing left, right, and centre.
My worry is that the ebook market has all of the hallmarks of an early stage ‘market of lemons’. The information asymmetry—exacerbated by the information hoarding done by the big ebook retail players—the growth in dishonest actors, and the increasing disincentive for honest actors to even participate at all, make ebooks an ideal candidate for the lemon dynamic.
What this would mean, if true, is that publishers and self-publishers will begin to experience massive pressure to lower prices if they are to move their product at all.
I think this is already happening with self-publishers.
Alternatively, revenue might become a function of your reputation and your maximum addressable market. That is, once you’ve surpassed whatever necessary lower reputation bound that is required by your addressable market, the price becomes elastic within the bounds set by the market (e.g. there are only so many steampunk fans in the universe).
Below that reputation bound you will have problems even giving away your product.
If the former model is correct (i.e. the ‘we’re all screwed’ model) then the ebook market can only be saved by the ebook retailers. They’d have to begin to practice complete information transparency and put in place aggressive returns policies (yes, even more aggressive than the one Amazon currently practices). Sales information, return rate, who exactly is that reviewer and where did they come from—anything and everything about the book would have to be shared in a digestible manner. A culture of secrecy at this stage would risk killing the market off entirely.
If the latter model is correct (i.e. you can only charge when you’ve built up a reputation) then we enter a world where the publishing industry needs to learn how to engage directly with readers to build their audience. This means that they would have to give a lot more stuff away for free.
A note on free
Free creates the most value when it is specifically being used to build a community and decrease information asymmetry—transferring the burden of risk from the reader to the publisher. Short term free offers are of little use. You need to go long term and do it with work that is representative of what you do.
Free at the moment is used by exactly the crowd that churns out the most rubbish (Smashwords) and Amazon makes offering titles for free needlessly difficult.
A free offering is always preferable to a cheap offering for the seller because it suspends the buyer’s value judgement temporarily but in exchange buyers can assess the quality of the good at their own leisure. A mixture of free and higher or variable priced goods is likelier to result in a fairer exchange of value between the reader and author than an oversupply of cheap (the free offerings build reputation).
What to do?
If Akerlof’s theory is right and is applicable to the ebook market then it predicts that prices in the market will be driven down below what can sustain the good actors and investment in research and development will cease.
I.e. the books will all be rubbish, look like shit, and the big tech companies will cease to invest in their ebook platforms.
This isn’t a problem that can be solved through code or UI design. It requires a fundamental change in business tactics. You can’t solve structural business problems with code.
The biggest measure retailers could take to ease this asymmetry is an extended, no questions asked, refund policy. If a reader asks for a refund they should get it even if they bought it ages ago. A year should be enough. A market that is developing ‘lemon’ dynamics requires a generous refund policy.
(This is in addition to the radical information transparency I mentioned above.)
This would obviously shift most of the economic power back to the reader but it would also have several consequences. Low quality books would be hammered in the market. Publishers would no longer have incentive to market bad books. Prices would rise to account for the returns and the portion of readers who dishonestly return ebooks but readers would likely accept the rise because of the generous refund policy. The market would contract sharply at first as the bad actors get shaken out but would begin to grow aggressively as the good actors, who are rewarded with both a higher price and a lower return rate, reinvest their profits in product development.
That’s the theory, anyway.
I hope we are in for a world where reputation becomes the key to survival, where publishers and authors with a good reputation in a market segment can make a decent profit, because the alternative is horrifying. I don’t think it is likely that ebook retailers will take the measures necessary to correct the dynamic once it becomes more apparent that the ebook market is a market of lemons.
One thing worth mentioning:
If you assume that the above applies to the iOS app store as well then that would mean that the best pricing strategy for a new app is freemium. That is, the app itself should be free to use/play with variably priced add-ons and features you can buy once you know you like the app.
I’ve posted a followup to this post addressing some of people’s criticisms and misconceptions.