The Penguin and Random House Merger


In response to this post on The Atlantic:
A New Era for Books: The Random House-Penguin Merger Is Just the Start

The merger of Random House and Penguin unquestionably represents an enormous change in the scale of publishing companies. It is a direct response to the power of the digital marketplace, but shifting ownership in the publishing industry is nothing new…

…It is widely assumed that this type of consolidation will continue, with the likelihood of further mergers among the Big Six, or the acquisition of independent publishers in the belief that scale is an advantage in dealing with the giants of technology and e-commerce…

I made this comment:

I agree.

In economics, there’s a concept called the Rule of Three.  Basically, in any highly competitive free-market industry consolidation will result in only three major firms. One of the best empirical examples is the US auto industry before Japanese imports entered. At the turn of the century there were something like a hundred auto manufacturers (start-up and growth phases). As the industry started to mature and a dominant design emerged firms started to face stiff competition from each other, a shakeout began. To survive, most of the firms started to bulk up through acquisitions eventually leaving us with Ford, GM, and Chrysler. Also see the broadcast networks before cable (there aren’t much more than three major owners of content providers on cable now – just give it time).

One could argue that the publishing industry had managed to maintain its wider oligarchy through certain practices, that weren’t outright collusion, but effectively the same. Authors shopped their books not for the best deal, but for the firm that would actually give them a shot. On the other side, the publishers all charged the same wholesale price, so no firm had a price advantage and a comfortable piece of market share.

To me, the greatest pressure is not Amazon alone, but the larger shifts within the industry that favor a small number of retailers (the firms mentioned in the article: Amazon, Google, Apple, Barnes & Noble) and the technology shift. Any time 25% of your product changes its fundamental delivery medium you’re in a for a titanic shift in the industry. What the publishing industry has going for it, however, that other industries did not is that the new technology is actually more profitable than the old. Kodak didn’t shift to digital when it should have because it was less profitable than film, at the time – until it was too late. Ebooks aren’t like that. What the publishers have, though, is a lot of fixed costs tied up in physical books which are shrinking in sales volumes. By merging they’re able to share some of those fixed costs and shift more focus to ebooks and growing with the new technology.

So, yes. Others will merge and the Big 6 may someday by the Big 3.

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Today, a discussion of the article appeared on The Passive Voice.

I reposted my reply to the article from The Atlantic to PV and got these replies.  I wanted to record the conversation here because I think it’s an interesting look at ideas on the fate of the publishing industry, but mostly because I did a lot of jabbering.

  • Passive Guy November 9, 2012 at 10:45 am

    Excellent points, Richard.

    I would mention that the new technology is more profitable than the old if you can maintain your old pricing. One of the characteristics of disruptive technology change is that new market entrants typically enter at substantially lower price points.

    • Richard Finn November 9, 2012 at 11:42 am

      Well, given that the incremental cost is pretty close to $0 but not exactly $0, even discount pricing can be more profitable than old pricing. I don’t know enough about the full economics of producing an ebook, but I do know that certain ebook only costs will come down as the technology matures (e.g. formatting for various reader formats).

      But your absolutely right, new entrants enter a lower price point and a lower quality point, as well. Often, however, it turns out the customer doesn’t need all the functionality of the older product. Computers were kind of like this. Lower priced, lower quality, lower margin microcomputers turned out to be a better business than mini computers. Here, the added quality of a physical book (put in on the shelf to impress your friends, loan out as much as you want, resell it, license never expires, etc…) aren’t needed by many customers who will gladly trade these features for a lower price and functionality they like such as fitting 2000 books in the palm of your hand.

      But, in this case, the barriers to the industry incumbents are mostly ones in their minds. Once they mentally get over the change they will be well positioned. Those that don’t will be consigned to history, but I do not think they’ll all end up there. They can let the indies and little publishers test out various models and then the incumbents pick the best ones or buy a company or two already doing it.

      • Edward M. Grant November 9, 2012 at 11:48 am

        Except the incumbents are lumbered with hugely expensive business structures built for a different time. Sure, the Big Six can dump their New York offices and set up in Detroit to reduce costs, but I don’t see anyone who works there wanting to suggest such an idea.
        • Richard Finn November 9, 2012 at 12:19 pm

          You’re right about costs. It’s not just NYC offices, but a lot of capital assets tied up in producing paper books, long-term labor contracts, relationships built-up around a diminishing model, etc…

          Paradoxically, this is why mergers make sense. They provide a reason and rationale for shedding many of these outmoded business structures.

          If firm A used to sell 100 physical books and firm B used to sell 200 physical books, but now customers only want 75 and 125 books respectively – they can merge, dump all the fixed costs for firm A and now have production to match demand.

          Physical books are still 80-75% of book sold, and the rate of ebook adoption is slowing. Many observers on the outside of traditional publishing expect the 75% threshold to hold in the medium to long-term.

          Oh, and firms always benefit from being in the same local area. Silicon Valley for software, Detroit for auto manufacturing, Dallas for energy companies, NYC for finance and publishing, Paris for fashion, etc… There are many reasons for this. The costs for not being there can be a lot more than the cost of rent and a cost-of-living adjustment for their small staff. DEC decided to be a lot more closed than HP in its dealings with other firms – the result was that Boston was surpassed in technology by Silicon Valley.

          So, if publishing know-how starting appearing in Detroit around a few key firms and a publishing house could move there without giving up the very real benefits of being around other publishing houses, then firms that don’t move would be at a small disadvantage until a critical mass was reached.

          What’s more interesting is the idea of the know-how being distributed evenly around the country (or world) through the Internet. Oddly, this doesn’t seem to have happened even in the Internet field itself. Silicon Valley is still more relevant than ever. If any industry could be become dispersed over the Internet, it’s the Internet industry itself.

          My main point, however, is that the percent of publishing houses that will fail to adapt to the changing landscape is less than 100% (but probably more than 0%). Merging is a viable option for adapting and it won’t be the end of the journey for Penguin and Random House. Will they be ultimately successful in the end? I don’t know, they don’t really know – but one of the many benefits of bulking up is buying time to figure it out. Will some within those firms reject change (moving to Detroit)? Yes. Does that mean they won’t do it? No. These people aren’t stupid. Not all of them, anyway. Some are there because they don’t have to work (trust-fund, rich spouse, etc…) and they’re out of luck. The rest will roll up their sleeves and figure it out.

  • Edward M. Grant November 9, 2012 at 11:12 am

    To survive, most of the firms started to bulk up through acquisitions eventually leaving us with Ford, GM, and Chrysler.

    I’m not convinced that’s a good comparison. Early cars could be designed cheaply and you could sell just about anything with limited regulation. Over time, the cost of developing a new mass-market vehicle and the difficulty of meeting all the relevant regulations has meant that only a huge corporation can do it and, in many cases, even a huge corporation isn’t enough and they have to co-operate with other companies to build a common platform.

    That’s not true of publishing, where I can write a book on my sofa for the cost of a jar of coffee and a few packets of biscuits. The only comparable situation I can see is creating best-sellers, where a big publisher may have the marketing muscle to push a book throughout the media, and I don’t.

    • Richard Finn November 9, 2012 at 11:47 am

      It was just an example of the Rule of Three concept. I mentioned why publishing had managed to stave off the Rule of Three… until now.

      The Rule of Three is not that there will only be 3 firms total, but only 3 major competitors. There are reasons why 4 tends to reduce to 3 and why 2 tends to increase to 3. For more information see “The Rule of Three: Surviving and Thriving in Competitive Markets” by Sheth and Sisodia.

  • Mira November 9, 2012 at 11:25 am

    I saw your comment, which was very interesting and wanted to add that I think the Big Three in publishing will be: Amazon, Apple and Google.

    The Publishers are highly likely to fade into extinction. They are not doing what they need to do to survive.

    • Richard Finn November 9, 2012 at 11:59 am

      So far, however, Amazon, Apple, and Google are not really players in publishing (Amazon’s the only one that’s made a decent effort at it). They are, however, quickly becoming large players in content retail and distribution.

      Finding authors, taking a risk on a book, editing books, and marketing it are very different activities and competencies from selling it directly to consumers. Publishers have tried to reach customers directly and haven’t succeeded. It remains to be seen if Amazon will be successful on the publishing side. However, publishing is only tangentially related to their core strategy of selling to customers. If the publishers had not tried to enact agency pricing Amazon probably wouldn’t have even gotten into publishing itself. Now that agency pricing seems like its going away, Amazon may care a lot less about publishing.

      Now, I can hear you already: what about indie publishing? The version of you in my head that asked this question is right: the traditional publishers aren’t really players in this space, though they are trying (to gouge aspiring authors). However, indie publishing represents both a tiny fraction of the revenue from book sales and a “minor league” for the publishers. Like I was saying to PG, the publishers will let the indies and small publishers try stuff out before sweeping in and buying it. Many successful indies turn to traditional publishers for dealing with the stuff those companies still do well and that the indie has not spent the last several decades learning how to do.

      Are indie published books a challenge? Yes. Do they signify the death knell of an entire industry? No. Look at music: indie artists are doing better than ever, but the traditional producers that adapted are still there and still thriving.

      The traditional publishers will adapt. Maybe not all of them, but more than none of them.



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