Act as consultants to the organization presented in the case.
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externalcp5273_pcs_2.pdf
1.
Principles of Management
R.A.S. McDonald
MGMT 1120
Northern Alberta Institute of Technology
Table of Contents
Harlequin Enterprises: Assessing e-Books.......................................................................................5
Principles of Management MGMT 1120
R.A.S. McDonald Northern Alberta Institute of Technology
2.
9B14M027 HARLEQUIN ENTERPRISES: ASSESSING E-BOOKS
Ken Mark wrote this case under the supervision of Professors Rod White and Tony Frost solely to provide material for class discussion. The authors do not intend to illustrate either effective or ineffective handling of a managerial situation. The authors may have disguised certain names and other information to protect confidentiality. This publication may not be transmitted, photocopied, digitized or otherwise reproduced in any form or by any means without the permission of the copyright holder. Reproduction of this material is not covered under authorization by any reproduction rights organization. To order copies or request permission to reproduce materials, contact Ivey Publishing, Ivey Business School, Western University, London, Ontario, Canada, N6G 0N1; (t) 519.661.3208; (e) [email protected]; www.iveycases.com. Copyright © 2014, Richard Ivey School of Business Foundation Version: 2014-06-26 INTRODUCTION Simeen Mohsen, vice-president of strategy at Harlequin Enterprises, returned to her office, closed the door and reflected upon her conversation with the company’s new chief executive officer (CEO) and publisher, Craig Swinwood. It was November 2013, and Mohsen had been with Harlequin for just over a year, after having completed her MBA at Harvard and spending seven years in various positions at Time Inc. During her early tenure at Harlequin, Mohsen had assisted various business units with strategy issues, mostly involving ways to adapt to the rise of e-books. Craig Swinwood had recently been appointed Harlequin’s CEO and publisher, and one of his initial agenda items was to pull together the members of his top management team to brainstorm about the big issues affecting the company. Swinwood asked Mohsen to prepare a presentation, saying, “I’d like you to briefly size up the current environment, including what’s happening with e-books, and then outline what you see as the most significant strategic challenges and opportunities for Harlequin. We don’t expect you to have all the answers, but if you can help the team to focus on the right questions, that would take us a long way.” Based in Toronto, Canada, Harlequin was part of Torstar Corporation,1 a broad-based media company that published more than 120 newspapers, including the Toronto Star; it also operated dozens of digital businesses. In 2012, book publishing revenues of $426,483,000 accounted for just over 29 per cent of Torstar’s total revenue and over 37 per cent of EBITDA. Mohsen knew that, from 2008 to 2012, the e-book category had rapidly grown in value from 0.5 per cent to 21.6 per cent of all trade book sales in the United States.2 But Harlequin specialized in publishing for women and enjoyed a solid position as the global leader in series romance fiction (SRF), having dominated the SRF segment of the publishing industry for over 40 years. In 1993, Harlequin had expanded into the women’s single-title segment. As shown in Exhibit 1, the most recent data indicated that e-book penetration in the romance fiction genre (in the United States, as well as other developed countries)
1 www.torstar.com/index.cfm, accessed December 2, 2013. 2 BookStats Extrapolated data, as provided by Harlequin.
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Page 2 9B14M027 exceeded 50 per cent of unit sales, more than any other category (see Exhibit 1). In this respect, Harlequin stood at the leading edge of the e-book trend. Mohsen sat down and contemplated her situation. She had a lot of information about the book industry in general and about e-books specifically. The difficulty lay in finding a way to make sense of it all and to then persuasively communicate her findings to the senior management team. That particular task represented a big challenge but also a big opportunity. HARLEQUIN ENTERPRISES LIMITED With more than 95 per cent of its sales coming from outside Canada, Harlequin enjoyed a decades-old reputation as one of the world’s top publishers of books for women. Founded in 1949, Harlequin began applying its revolutionary approach to publishing — a packaged, consumer-goods strategy — in 1968, shortly after acquiring the publishing business of U.K.-based Mills & Boon. With a growth rate of 25 per cent per year during the 1970s, Harlequin became the world’s largest publisher of women’s series romance fiction (SRF), with a profitability rate that stood out as the envy of the publishing industry. During this same timeframe, Torstar, a newspaper publisher, acquired all of Harlequin Enterprises Limited. For the next three decades, Harlequin expanded its highly profitable series romance fiction, fending off many new entrants, including Simon & Schuster’s Silhouette series romance fiction imprint. (Harlequin acquired Silhouette in 1984.) As shown Table 1, the growth of Harlequin’s very successful original SRF business model slowed during the 1980s, when North American markets were saturated and international markets were fully exploited; but margins remained strong. Every month, 100 titles were published in North America, with a subset of these published in 100 international markets in over 30 languages. Around the world, the Harlequin name became synonymous with romance novels.
Table 1: Harlequin Revenues and Operating Profits (in thousands of Canadian dollars at 2013 exchange rates)
Source: Company records. Harlequin’s Foundation: Series Romance Fiction Each paperback-series romance book was part of an identifiable branded product line that consistently, reliably and conveniently delivered the expected benefit to the consumer. The look, size and length of each book in a given series was the same. Harlequin books were printed in a small-sized format (105 mm × 168 mm), suitable to fit in distribution racks located in mass-market stores, supermarkets and drugstores. Page lengths for books in a given series were limited to between 192 and 256 pages, the format a loyal reader would be accustomed to. Cover designs differed somewhat but complemented each particular theme.
Year 1986 1987 1988 1989 1990 1991 Revenue ($ thousands) 255,000 282,000 294,000 295,000 311,000 320,000 EBITDA 39,400 41,800 46,300 58,500 54,900 53,100 Depreciation & Amortization 3,000 3,000 3,000 3,000 3,000 3,000 Operating Profit 36,400 38,800 43,300 55,500 51,900 50,100 Margin % 14.3% 13.8% 14.7% 18.8% 16.7% 15.7%
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Page 3 9B14M027 The typical Harlequin series customer was female, around 40, married and educated. Over half of Harlequin’s series customers read for at least three hours per week. These readers were loyal to the Harlequin brand, with 80 per cent of them indicating that they would buy Harlequin books again during the next year. Harlequin advertised its offerings in print magazines and on websites. Series books usually focused on a particular theme and attracted readers who were looking for a consistent reading experience. Each new book in a series served as an addition to a clearly defined and clearly branded product line. Harlequin had up to 20 different series-romance fiction brands, such as American Romance, Blaze, Desire, Heartwarming, Intrigue and Historical, each with its own particular theme. For example, American Romance offered readers this theme: “You love small towns and cowboys! Harlequin American Romance stories are heartwarming contemporary tales of everyday women finding love, becoming part of a family or community — or maybe starting a family of her own.” In contrast, Harlequin Desire’s product offered a different kind of positioning: “You want to leave behind the everyday! Harlequin Desire stories feature sexy, romantic heroes who have it all: wealth, status, incredible good looks … everything but the right woman. Add some secrets, maybe a scandal, and start turning pages!” Over the years, the number of different SRF product lines had proliferated from two during the 1970s — Harlequin Romance and Presents — to the 18 currently available. Each different series product line offered between two and eight new titles per month, for a total of around 90 new titles published each month. The Harlequin author-editor team played a critical role in ensuring the series products demonstrated consistency and quality and reliably met readers’ expectations. Working in acquisition centres in Toronto, New York and London, Harlequin’s editors reviewed as many as 30,000 unsolicited manuscripts annually and worked closely with a group of over 1,300 authors to develop and publish the company’s titles. The author-editor teams strove to incorporate the appropriate level of realism, fantasy, sensuality and — most importantly — consistency into each title for a particular series. The editor served as equal parts creative consultant, coach and curator, with a mandate to identify good writers, nurture them and develop them through their careers as Harlequin SRF authors. Ensuring a steady flow of high-quality product was instrumental, especially since Harlequin’s franchise had been built on series-romance fiction. Series authors received a standard royalty of 6 per cent to 10 per cent of the retail cover price. Advertising campaigns supporting each series focused on the brand promise to the reader, not on individual authors. Harlequin’s author-editor relationships remained strong, so much so that many series authors became enthusiastic about maintaining a long-term relationship with a trusted editor as they pursued their break-out mainstream single-title book. If these authors achieved single-title success, it was hoped they would remain loyal to Harlequin. Traditional bookstores did not serve as the principal distribution channel for print series romance fiction. Rather, SRF books were available for sale at supermarkets, drugstores and mass merchandisers, and these locations accounted for 70 per cent of Harlequin’s North American retail sales (not including sales through retailers such as Amazon.com). Harlequin maintained a distribution presence of about 250,000 points of sale around the world. The typical SRF book sold at a suggested retail list price of $5.99, less than the $7.99+ price for single-title paperback novels. The suggested selling prices for the print books and e-books were identical; however, retailers generally sold books at less than the suggested price (e.g., Walmart discounted all its print books). Newly released popular e-books were often heavily discounted, a practice pioneered by Amazon. Print series romance novels were delivered to retail stores on a standing-order distribution basis: retailers would commit a certain amount of facings for Harlequin products, and Harlequin (working with its distributors) Fo
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Page 4 9B14M027 would employ order regulation logarithms to optimize the mix and number of titles delivered to the retailer. Harlequin (or its distributor) would then automatically ship the preset number of copies to the store on a regular basis. Every four weeks, unsold books were returned to Harlequin for credit. Another channel for Harlequin’s books came from its own Harlequin Reader Service Book Club (Reader Service), which allowed readers to receive regular deliveries to their homes. Books sold through Reader Service predominately consisted of series products, although select Harlequin single-titles were also available. For Harlequin, about 30 per cent of its North American sales of physical books derived from its book club, for which Harlequin received a greater margin than that from the retail channel, and this higher margin made the Reader Service business very profitable. However, because of increased mailing and acquisition costs and the declining availability of mailing lists, sales through this channel had begun to decline. Avid Harlequin readers who owned an e-reader no longer had to order print copies for delivery to their homes. Instead, they could download Harlequin e-books directly from Harlequin’s site or from an e-retailer like Amazon. Exhibit 2 illustrates the Harlequin and Amazon webpages for the same SRF title. Amazon.com sold Harlequin books, both print and e-book versions, at a discount to the suggested retail price, and in many cases, it was cheaper for readers to buy Harlequin books from Amazon.com than from the Harlequin.com Reader Service. In an attempt to retain its loyal readers, Harlequin offered “bonus bucks” — one free bonus buck per book ordered — that could be redeemed on the Harlequin website for books and gifts. To entice new customers to its Reader Service, Harlequin provided its customers with special sign-up offers (i.e., two free books and two mystery gifts valued at about $10). Harlequin MIRA and Single-Title Publishing With the maturing of the series romance business, Harlequin branched out into single-title publishing during the early 1990s with its MIRA imprint — “the brightest stars in women’s fiction.” As shown in Table 2, this product expansion resulted in significant sales growth throughout the 1990s.
Table 2: Harlequin Revenues and Operating Profits (in thousands of Canadian dollars at 2013 exchange rates)
Source: Company records. In the book-publishing industry, bestseller single-title books usually featured a prominent author, such as Danielle Steele or Stephen King, who was paid a large advance for each book. The first printing of a single-title book was usually produced in hardcover — a premium format — and was priced between $15 and $30 at retail. After the initial sales period, single titles were released in a cheaper, softcover format, retailing for $7 to $12 to appeal to a larger audience. Single-title books were longer in length (e.g., 100,000 to 400,000 words) compared with a series romance book length of 75,000 words. Naturally, single-title book sizes were longer: from 250 to 400 pages versus a norm of 192 to 256 pages for series romance. Traditional publishing of single-title printed books constituted a higher risk venture compared to SRF. A business case had to be produced for each single-title under consideration for publication, taking into
Year 1991 1992 1993 1994 1995 1996 1997 1998 1999 Revenue ($ thousands) 320,000 346,000 359,000 364,000 362,000 389,000 386,000 401,000 425,000 EBITDA 53,100 55,900 56,600 58,300 58,400 63,300 64,800 66,600 58,100 Depreciation & Amortization 3,000 3,000 4,000 4,000 4,000 4,000 4,000 4,000 4,000 Operating Profit 50,100 52,900 52,600 54,300 54,400 59,300 60,800 62,600 54,100 Margin % 15.7% 15.3% 14.7% 14.9% 15.0% 15.2% 15.8% 15.6% 12.7%
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Page 5 9B14M027 account the author’s reputation, the subject matter and the writing quality. The objective of such cases was to estimate how well the single title would sell and how much should be spent on the author’s advance and on promoting the book. Further, estimates for the number of books to be printed and the expected return rate made up a critical part of the information provided. Single-title book publishing involved significant investments in infrastructure and working capital. An ecosystem of editors — curators of talent — had to be built up. Authors were identified, developed and nurtured, and their output edited. Manuscripts ready for publishing were analyzed for their marketing angles, and a suitable marketing plan had to be built around each launch. Developing expertise in single- title publishing required Harlequin’s editorial team to identify best-selling authors within its stable of series authors as well as others from outside the Harlequin author base. While successful series authors could expect to sell as many as 100,000 copies per book, single-title copies were expected to sell many more. Single-title authors’ royalty contracts were individually negotiated and typically included an advance payment that could amount to several hundred thousand dollars or more. Other publishers were known to sign established authors for up to a multi-book contract with large multimillion-dollar advances. Front list (first printing), back list (subsequent reprinting) and international sales estimates were drawn up. Advance copies were sent to book reviewers, retail buyers at bookstores such as Barnes & Noble, mass merchandisers such as Walmart and convenience store chains. The books were printed, distributed and displayed for a set amount of time. In terms of distribution, single-title books required a shift in focus away from supermarket and drugstores to traditional retail bookstores. At physical retail stores, single titles were displayed for six to 12 months, and once they had been made available online, titles remained available indefinitely. In addition, standing-order distribution, a hallmark of Harlequin’s series romance business model, was not used in the single-title business which relied on orders generated by the sales force for single titles. Because of author advances, prepublication promotion and fixed costs of printing, break-even volumes were significant. Any unsold books were returned to the publisher for full credit, and if the publisher failed to sell enough books, the losses could be substantial. In the book-publishing industry, the unit economics for a typical hardcover title were as follows: US$27.99 at retail price, 49 per cent of which would be the publisher’s share; manufacturing costs of US$1.92; the cost of returned books at US$1.17; royalty payments at US$4.20; and distribution or freight costs at US$0.76.3 When single-title books became successful, they could have a large impact on a publisher’s earnings. To offer some perspective, Random House sold a total of 750 million books in 2012. “Fifty Shades of Grey,” “Fifty Shades Darker” and “Fifty Shades Freed,” a trilogy of single titles written by E. L. James, sold a combined 70 million copies between March and December 2012, boosting Random House’s 2012 operating earnings by 75 per cent to €325 million.4 The suggested retail price of each book was $26.95 for hardcover, $15.95 for trade paperback and $9.99 for the e-book. A news article estimated that James earned $50 million from the first 20 million books sold.5 The success of this trilogy indicated an untapped demand for mainstream erotic romance novels. During the 1990s, Harlequin had entered the single-title business with the MIRA imprint, which focused on mainstream women’s fiction. Subsequently, other single-title imprints were added, including Harlequin HQN (“outstanding mainstream romance fiction”); Harlequin LUNA (“compelling, female-focused
3 http://glossi.com/Goodereader/31339-good-e-reader-magazine-july-2013, accessed December 2, 2013. 4 www.theguardian.com/media/2013/mar/26/fifty-shades-random-house-record-profi, accessed December 2, 2013. 5 www.hollywoodreporter.com/news/fifty-shades-grey-author-earns-50-million-346614, accessed December 2, 2013.
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Page 6 9B14M027 fantasy” set in “other worlds”); Harlequin Kimani Press (“romance stories featuring sophisticated, soulful and sensual African-American and multicultural heroes”); and Harlequin Teen (“fresh, authentic teen fiction featuring extraordinary stories”). Harlequin also developed a co-branded romance imprint with Cosmopolitan (owned by Hearst Communications) called “Cosmo Red Hot Reads from Harlequin.” Broadening its reach beyond women’s fiction, Harlequin also began to publish non-fiction in areas such as self-help, health/diet/fitness, relationships, narrative and aspirational content. By 2012, Harlequin had achieved considerable single-title success, with 92 titles enjoying a total of 366 weeks on the New York Times bestseller lists and four of those titles achieving the coveted No. 1 position. The line separating single titles and series books had become increasingly blurred. In an attempt to generate more revenues, some books that were categorized as “single title” began to take on aspects of a series. A prominent early example of this trend included the James Bond series of books, first written by Ian Fleming in the 1950s. After Fleming’s death, a number of authors were commissioned to write follow- on Bond novels, with the result that the Bond book franchise evolved to include other titles such as “Young Bond” and “The Moneypenny Diaries.” Going the other way, some authors of romance series fiction, like Nora Roberts with her 180 New York Times bestsellers, had transitioned away from series writing and went on to become very successful single- title authors. Also, the establishment of online bookstores and the emergence of e-books were pushing the series and single-title businesses closer together. For example, a customer could visit the Harlequin website and download a Harlequin Romance e-book (series product), or they could click through to a different page on the same website and purchase a Harlequin HQN e-book (single-title product). The distinctions between series and single-title businesses that had been meaningful for printed books, which had different formats and different retail distribution channels, gradually became less meaningful for Internet-distributed books and e-books. E-books grew dramatically to become a significant part of Harlequin’s business, with the bulk of Harlequin’s e-book sales coming from digital versions of its print books. By mid-2013, e-books, as a percentage of Harlequin’s revenues, ran slightly above the industry in North America and moderately higher than the industry in the rest of the world. Harlequin also had two digital-first imprints. Unlike traditional imprints, where books would be released initially in hardcover or softcover and later as e-books, digital-first imprints released books in digital format first. Carina Press (“where no great story goes untold”) was able to publish manuscripts that fell outside of the genres of Harlequin’s other imprints. This division broadened Harlequin’s ability to cater to emerging authors and smaller niche markets. Carina Press made extensive use of social media, including Twitter, Facebook and the Carina Press blog. Escape Publishing (“an imprint without restrictions”) was published by Harlequin Enterprises Australia. Escape published more risqué sub- genres that did not fall within Harlequin’s established brands. While promising, digital-first sales made up only a small part of Harlequin’s revenue. PUBLISHING INDUSTRY AND E-BOOKS In the United States, retail sales of trade books — both physical and e-books — reached $13.4 billion in 2012, spanning a broad range of genres including Romance, Mystery, Horror, to Comics & Graphic Novels. Some book publishers focused on single-title imprints or series novels, while others functioned as Internet-only publishers and self-publishers. But while the value of physical books sold in the United States was declining (see Exhibit 3 for U.S. bookstore sales for the past 10 years and Exhibit 4 for the Fo
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Page 7 9B14M027 comparative value of total trade books sold in the United States), U.S. e-book sales had risen from a minuscule $60.7 million in 2008 to a substantial $2.9 billion by 2012. Globally, e-book unit sales had reached 859 million units in 2012, up eight-fold from 104 million units in 2010 (see Exhibit 5). Table 3 provides market share by book format.
Table 3: U.S. market share by book format in 2012
Format Share (units)
Trade paperback 30% Hardcover 27% E-book 22% Mass-market 12% Other bindings 7% Audio book 2%
Source: U.S. Census Bureau, www.census.gov/econ/currentdata/dbsearch?program=MRTS&startYear=2010&endYear= 2013&categories=451211&dataType=SM&geoLevel=US¬Adjusted=1&submit=GET+DATA Book publishers, such as HarperCollins, Hachette, Simon & Schuster, Penguin Random House, Macmillan and Harlequin, generated $14.4 billion in revenues in 2012 in the United States. Of this figure, $7.5 billion came from sales to physical retail outlets (down 7 per cent from the previous year), and $6.9 billion came from sales of print and e-books through online retailers (up 21 per cent from the previous year).6 As shown in Exhibit 6 Harlequin was smaller than the largest publishers, but with its focus on women, it also had more consistent and higher margins. The Internet revolution continued to dramatically transform the book business. Founded in 1995, Amazon originally functioned as a distributor of physical books ordered over the Internet, challenging the traditional bricks-and-mortar book retailers (i.e., the local mom-and-pop shops, as well as the big-box national book retailers like Barnes & Noble and Chapters). Following the aggressive introduction of its Kindle e-reader in 2007 and the development of a large library of electronic books, Amazon emerged as the major player in the e-book segment. In an effort to compete, traditional retailers like Barnes & Noble deployed online e-book distribution (B&N.com), and some publishers (including Harlequin) sold the books they published through their own website, both as downloadable e-books and as print books. Even so, as shown in Exhibit 7, Amazon continued to dominate book distribution in the United States and Canada. The situation was further complicated because, as well as being the biggest distributor for both physical books and e-books, Amazon.com had its own publishing imprints, including Montlake Romance®,7 a direct competitor for Harlequin. The electronic book, enabled by e-book readers, was reshaping the landscape of the book publishing industry. Electronic formats like Adobe’s PDF, ePub,8 and the proprietary KF8 format used by Kindle® had enabled the production of electronic documents, including books. Introduced in 1993, Adobe’s Portable Document Format (PDF)9 was one of the first electronic formats. However, few people were prepared to read books on computers, so the expansion of the electronic book business awaited the development and widespread adoption of dedicated portable e-book readers and then tablets.
6 www.nytimes.com/2013/05/15/business/media/e-book-sales-a-boon-to-publishers-in-2012.html?_r=0, accessed December 2, 2013. 7 www.apub.com/imprint-detail?imprint=6; accessed December 2, 2013. 8 A popular open source publishing format employed by Harlequin for its e-book distribution. 9 PDF was a proprietary format until 2008 when Adobe granted royalty free access to all its PDF patents.
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Page 8 9B14M027 Currently, a wide variety of different e-reader options existed, each one providing different reading experiences. In the dedicated e-reader category, Amazon’s Kindle product (introduced in November 2007) offered an electronic-paper display, a high-resolution monochrome screen that was not backlit. It had a long battery life — a week’s worth — and books could be downloaded to it wirelessly. Amazon’s more- recently introduced Kindle Fire featured a full colour, backlit, anti-glare screen, and was designed to compete with Apple’s high-resolution “retina display” line of iPads (first introduced in April 2010) and other tablet devices capable of displaying e-books. Amazon reported that its customers purchased 3.3 times as many books after buying a Kindle. To establish its proprietary Kindle as the dominant e-reader platform, Amazon often priced e-books below their cost. For example, an e-book with a suggested retail price of $25 would cost Amazon about $12.50 from the publisher, but Amazon might sell it for $9.99. Several large publishers had attempted to replace this so- called wholesale-pricing model with an agency model that would prevent Amazon from discounting their books. Recently, under pressure from the U.S. Department of Justice, these publishers abandoned the attempt to control the retail price of their books. The number of e-readers and tablets sold had risen rapidly in the past few years, with an estimated installed base, in 2012, of 28.2 million e-reader devices and 75 million tablet devices,10 and the proportion of tablets was expected to increase even further. Data from mid-2012 suggested that readers used a variety of different e-reader and tablet brands to read e-books, with Amazon’s Kindle and Kindle Fire being the most popular (see Exhibit 5). Some observers believed, however, that readers would increasingly gravitate towards reading their e-books on tablets, using brands such as Apple, Samsung, ASUS and others. Digital Rights Management (DRM) One problem impeding the distribution of e-books was piracy – or, put more politely, the sharing of digital media. After witnessing what had happened to the music business during the first decade of the 21st century, when copyrighted songs (in standardized MP3 format) were made widely available “free” through peer-to-peer file-sharing sites like Napster and uTorrent, publishers worried about a repeat performance in the book business as it moved toward digital distribution. Consequently, until digital rights management (DRM) concerns could be addressed, many publishers remained cautious of the way their books were made digitally available. DRM was technically complicated and encompassed topics such as viewing platforms, intellectual property protection and what it meant to “own” digital content. Even in the face of these problems, the transition to e-books was certainly well underway. As the wave took hold, publishers — and, indeed, individual authors, who used self-publishing websites and sharing networks — could reach millions of potential readers, cutting out the physical printed product and radically transforming the distribution process. For readers, owning an e-reading device gave them to access content whenever they liked, as long as an Internet connection was present. E-readers also provided a way to carry multiple books without having the physical bulk of the printed product, and it afforded more privacy when reading books.
10 Scott Devitt, Andrew Ruud, Nishant Verma, “Amazon.com,” Morgan Stanley Research North America, February 13, 2013, p. 4.
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Page 9 9B14M027 Economics of E-Books As shown in Exhibit 8, printed book and e-books had dramatically different economics. When e-books were first introduced hardcover bestsellers with a cover price of $27.99 in print generally had the same suggested retail price for the e-book version, although retailers often discounted both. To encourage adoption of its Kindle e-reader Amazon sold many titles below their wholesale cost. Some publishers lowered their e-book cover prices relative to their print price for the same book when they attempted to implement the agency model. With the agency model the publisher established the selling price and the e- tailer negotiated for a set percentage of that price (usually 30 per cent). Even though the agency model was eventually disallowed by the Department of Justice many publishers continued with the practice of suggesting a lower retail price for the e-book format of the same book. Harlequin had never adopted the agency model although the company did suggest lower (10 per cent to 15 per cent) retail cover prices for the same title in e-book format. For legacy reasons authors’ royalties on print books were a percentage of the cover (suggested retail) price – for single titles the percentage varied dramatically by author but was generally in the 8 per cent to 15 per cent range; for series the percentage was a more standard 8 per cent to 10 per cent. For e-books authors’ royalties were a percentage of the publishers’ net receipts (i.e., wholesale revenue); generally between 20 per cent and 25 per cent. With e-books, publishers had no printing costs, no returns, and no distribution or freight expenses to worry about. However, publishers still had fixed costs for author management, editing, marketing and digital warehousing. E-books eliminated the need to estimate print runs per title, thereby eliminating the problem of lost revenues resulting from stock-outs of print copies, or, conversely, of being overstocked and returning unsold copies for full credit. Because of the radically different costs and risks involved, many traditional publishers, including Harlequin, developed digital-only offerings; that is, imprints available as e-books only. Because the economics of the two types of publishing were so different, e-books held the potential to radically realign the industry. Distribution of E-Books Amazon was a major player in the distribution of both printed books and e-books, accounting for 29 per cent of the entire industry’s sales in the first quarter of 2013. But, as shown in Exhibit 9, Amazon stood out as the dominant distributor of e-books. In part, Amazon’s dominance in e-book sales was attributable to its dominance in e-readers, with about 50 per cent of the installed base. Barnes & Noble, with its Nook e-reader, also stood as a noteworthy player in e-books, with just over 20 per cent of sales and about 15 per cent of e-readers. Walmart, once a dominant bookseller due to its many points of sale, was not a factor in the e-book market. Sony and Kobo offered e-bookstore websites largely in an attempt to support their e-readers, but they were very small players. The rest of the market was largely fragmented, with no single player accounting for more than one per cent of the industry’s sales. From its very inception, Amazon had caused problems for traditional book publishers, most notably by pricing books well below the cover (suggested retail-selling) price. The consolidation of distribution power in the hands of a powerful player, Amazon, had sparked industry consolidation amongst the traditional publishers, most recently with Penguin and Random House merging their operations in an attempt to build scale. Some publishers had also attempted to develop alternative channels for the distribution of e-books by working with Apple’s iBooks; however
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Page 10 9B14M027 this effort, with its agency pricing model, ran afoul of regulators in 2012 when the U.S. Department of Justice secured a court ruling that found Apple had colluded with the five major publishers (HarperCollins, Hachette, Simon & Schuster, Penguin Random House, and Macmillan) to organize a price-fixing scheme. Several recent startups were experimenting with the Netflix subscription/streaming model for the distribution of e-books.11 Sproutkin was targeted at the children’s market ($24.99 per month),12 as was Amazon Kindle Free-Time ($4.99 per month with and Amazon Prime subscription).13 Other start- ups like Oyster14 offered broader libraries and an “all-you-can-read” model; for a monthly subscription fee the customer had access to the entire library. Because these services had to pay the publisher the full wholesale price of each book streamed to their customers the economic viability of this model was questioned by some observers. These services also competed with public libraries that purchased copies of e-books and lent them (electronically one at a time) to their members, often at little or no cost. The e-book phenomenon affected not only the downstream distribution part of the business but also the publisher’s relationships with their authors. No longer did an author need to convince a publisher to print and publish their book. Of course, vanity presses had always existed, where the author paid for the production and printing of their own book, but while vanity press authors achieved the goal of seeing their work in print, rarely did these self-published books sell enough copies to recoup the setup and production costs. With the digital revolution, self-publishing became economical, easy and increasingly popular. It provided a publishing pathway that did not require a traditional publisher. The barriers to becoming a published e-book author were minimal. Self-Publishing and E-Publishing Web-based providers, like Lulu.com15 and Createspace16 (owned by Amazon), provided authors with different self-publishing services to create, lay out and format a digital version of their book. Once created, the book could be distributed in digital format on sites like Kindle Direct Publishing17 and Smashwords. These sites usually did not charge for listing the book, but they did take a portion of the selling price, and they did charge for value-added services (e.g., cover art, editing, etc.). Most of these “publishers” had print-on-demand capability and could provide buyers with either digital or print versions. Print books cost $13.99 and up per book, and e-books sold in the $.99 to $5.99 range.18 While self-publishing allowed anyone to become published, it created a problem for prospective consumers: that is, how to identify a quality book consistent with their reading interests. Separating the wheat from the chaff posed a monumental problem when there was so much chaff. To address this problem, sites that distributed self-published books allowed readers to add online recommendations, ratings and reviews of the books they had read. Authors could also pay a fee to submit their work for
11 www.publishingtechnology.com/2013/03/five-contenders-for-the-netflix-for-books-crown-line-up/ 12 www.sproutkin.com/ 13 www.amazon.com/gp/help/customer/display.html?nodeId=201240110 14 www.oysterbooks.com/ 15 www.lulu.com/, accessed December 2, 2013. 16 www.createspace.com/, accessed December 2, 2013. 17 https://kdp.amazon.com/self-publishing/, accessed December 2, 2013. 18 D. Carnov, “Self-publishing a book: 25 things you need to know,” CNET Review, June 13, 2013, accessed December 2, 2013
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Page 11 9B14M027 third-party reviews.19 In an attempt to gain some recognition, many self-published authors promoted their own book on social networks and in the blog-o-sphere. Self-publishing remained in its infancy, truly self-published e-books currently accounted for only 1.1 per cent of new book units and 0.7 per cent of new book revenues.20 Stephen King, the well-known and prolific horror story author, tried self-publishing a few of his books but reverted to using a traditional publisher. Although accomplished authors did not necessarily need the editorial or promotional value-add that was provided by traditional publishers, they did need a traditional publisher to harness a broad physical distribution network and point-of-sale prominence for the print version for their latest book. Traditional publishers also helped to garner positive reviews and create “buzz.” Importantly, authors also receive advances on royalties from publishers. E-book sales had increased across all genres, especially romance fiction. However, some recent research had suggested that e-books’ popularity might be slowing — after several years of rapid rises — perhaps because there was still a majority of readers of all ages who preferred a physical copy of a book. E-BOOKS AND HARLEQUIN’S FUTURE As Mohsen completed her review of e-books, she turned her attention to Harlequin’s recent performance. As shown in Table 4, Harlequin’s overall sales had remained essentially flat since 2000; however, there had been a significant shift from series to single-title. In 2000, series writing represented more than 80 per cent of unit sales and 75 per cent of Harlequin’s revenues. Revenues from its single-title business had doubled from 2000 to 2012. By 2012, single titles accounted for roughly 40 per cent of units and almost 45 per cent of revenues.
Table 4: Harlequin Revenues and Operating Profits (in thousands of Canadian dollars at 2013 exchange rates)
Source: Company records. Exhibit10 compares Harlequin’s business models for its book series offerings, its single-title books, and its e-books. Harlequin was aware that a significant transition had occurred in its physical book businesses as digital formats had gained momentum, and Mohsen pondered what opportunities and threats e-books posed for Harlequin’s business. Could this trend help to reinvigorate the series business? How would it change Harlequin’s relationship with authors and with distributors, especially Amazon? Was “digital first” a strategy that Harlequin should pursue more aggressively? Would e-books reach a tipping point, making self-publishing attractive to established authors? Mohsen focused on these questions as she thought about her upcoming presentation to Harlequin’s management team.
19 www.publishersweekly.com/pw/diy/, accessed December 2, 2013. 20 Bowker data from 2011.
Year 2000 2002 2004 2006 2008 2009 2010 2011 2012 Revenue ($ thousands) 442,000 448,000 414,000 430,000 437,000 440,000 450,000 450,000 422,000 EBITDA 60,000 76,800 59,500 55,000 67,400 76,300 80,000 84,400 76,800 Depreciation & Amortization 5,000 5,000 6,000 5,000 5,000 4,000 4,000 3,700 4,100 Operating Profit 55,000 71,800 53,500 50,000 62,400 71,900 76,000 80,700 72,700 Margin % 12.4% 16.0% 12.9% 11.6% 14.3% 16.3% 16.9% 17.9% 17.2%
The Ivey Business School gratefully acknowledges the generous support of Pierre Lapointe in the development of this case.
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Page 12 9B14M027
EXHIBIT 1: E-BOOK PENETRATION BY GENRE (U.S. – ADULT FICTION GENRE)
Source: Bowler Q4 2012 custom report prepared for Harlequin.
(top bar)
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EXHIBIT 2: HARLEQUIN AND AMAZON E-BOOK WEBPAGES
Source: Company files.
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EXHIBIT 2 (CONTINUED)
Source: Company files.
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EXHIBIT 3: U.S. BOOKSTORE SALES*
* Note: these figures are for total sales in U.S. bookstores and may include sales of items other than books (for example home décor, gifts, toys, stationery). Source: www.census.gov/econ/currentdata/dbsearch?program=MRTS&startYear=2010&endYear=2013&categories= 451211&dataType=SM&geoLevel=US¬Adjusted=1&submit=GET+DATA; accessed December 2, 2013
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EXHIBIT 4: U.S. TRADE BOOK AND E-BOOK SALES (VALUE)
Note: “Ext.” is Extrapolated data from BookStats. Source: Company files.
EXHIBIT 5: ESTIMATED SHARE OF E-BOOK READINGS, BY DEVICE
Source: Bowker Market Research as quoted in www.publishersweekly.com/pw/by-topic/digital/devices/article/54705-kindle- share-of-e-book-reading-at-55.html.
e Re ade rs Q2 2011 Q3 2011 Q4 2011 Q1 2012 Q2 2012 Desktop/Laptop PC Only 10% 10% 5% 6% 6% Sony Ebook Reader 2 2 1 1 1 Kindle by Amazon 48 47 44 39 37 Kindle Fire 0 0 9 16 18 iPod/iPod Touch/MP3 Device
3 3 2 2 2
Smart Phone 0 0 3 3 3 iPhone 5 4 3 3 3 Nook/NookColor by B&N 15 17 14 14 14 iPad 8 10 9 12 12 Other Device 7 7 8 4 4
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EXHIBIT 6: COMPARISON OF MAJOR BOOK PUBLISHERS (reported in U.S.$ millions;
except Harlequin, which is reported in millions of Canadian $ at 2013 exchange rates)
Source: Company files.
2008 2009 2010 2011 2012
Random House Revenues 2,414 2,476 2,410 2,256 2,817 eBooks as % of revenues 0.1% 0.9% 7.5% 16.0% 22.0% eBook sales in $MM 2.9 22.6 180.8 361.6 619.7 EBITDA 192 197 228 239 427 % of revenues 8.0% 8.0% 9.5% 10.6% 15.2%
Pe nguin Revenues 1,316 1,608 1,636 1,623 1,694 eBooks as % of revenues 0.5% 2.3% 6.0% 12.0% 17.0% eBook sales in $MM 6.6 37.0 98.2 194.8 287.9 EBITDA 157 159 188 192 184 % of revenues 12.0% 9.9% 11.5% 11.8% 10.9%
Harpe rCollins Revenues 1,390 1,140 1,270 1,202 1,190 eBooks as % of revenues NA NA NA 11.0% 15.0% eBook sales in $MM NA NA NA 132.2 178.5 EBITDA 160 17 106 93 86 % of revenues 11.5% 1.5% 8.3% 7.7% 7.2%
Simon & Schuster Revenues 858 794 791 787 790 e-Books as % of revenue na na na 17% 23% EBITDA 88 50 68 92 89 % of revenues 10.3% 6.3% 8.6% 11.7% 11.3%
Harlequin Revenues 437 440 450 450 422 EBITDA 67 76 80 84 77 % of revenues 15.4% 17.3% 17.8% 18.8% 18.2%
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EXHIBIT 7: TOTAL U.S. BOOK MARKET SHARE BY RETAILER, FIRST HALF OF 2012
Amazon 27% Barnes & Noble (and B&N.com) 16% Audio e-book websites 6% Other e-commerce 6% Independent bookstores 6% Resale and thrift 5% Walmart 4% Warehouse clubs (e.g., Costco) 3% Target 2% Books-a-million 1% Supermarket and grocery 1% All other channels 23%
Source: http://publishingunleashed.com/2013/01/11/book-vs-ebook-sales/.
EXHIBIT 8: COMPARATIVE ECONOMICS PRINT VERSUS E-BOOK
Major Single Title
Hard Cover - print e-Book
Cover Price (suggested retail) $27.99 $18.99* Publisher’s Share 49% 70% Publisher’s Revenue (wholesale price) $13.72 100% $13.30 100%
Manufacturing Cost ($1.92) 14% minimal Cost of Returns ($1.37) 10% 0 Author Royalty ($4.20)+ 30% ($3.33)^ 25% Distribution ($0.76) 5.5% 0 Contribution to fixed costs $5.47 40% $8.40 75%
Source: Case writer estimates based upon http://glossi.com/Goodereader/31339-good-e-reader-magazine-july-2013
Series Romance Fiction Paperback eBook
Retail Price (suggested) $5.25 $4.99 Publisher’s Share 50% 50% Publisher’s Revenue (wholesale price)
$2.63 100% $2.50 100%
Manufacturing Cost ($0.45) 17% minimal Cost of Returns ($0.55) 21% 0 Royalty ($0.53)+ 20% ($0.60)
^ 20% Distribution (variable) ($0.20) 8% 0 Contribution to fixed costs $0.90 34% $2.40 80% * Typical of agency model pricing. + author royalties based upon percentage of (suggested) retail cover price. ^ author royalties based upon percentage of net receipts to publisher (i.e., wholesale price).
Source: Case writer’s estimates. F
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EXHIBIT 9: U.S. E-BOOK SALES BY SELLER, FIRST HALF OF 2012
Seller Share URL
Amazon 62% http://www.amazon.com/books Barnes & Noble 22% http://www.barnesandnoble.com/ Apple iBooks 10% accessible through iBooks app Sony 2% https://ebookstore.sony.com/ Kobo 1% http://store.kobobooks.com/ Google and others ~3%
Source: http://publishingunleashed.com/2013/01/11/book-vs-ebook-sales/, accessed December 2, 2013.
EXHIBIT 10: COMPARING HARLEQUIN’S SERIES, SINGLE TITLE AND E-BOOKS BUSINESS MODELS
Source: Case writer’s estimates.
Se rie s Single -title e Books
Editorial
Emphasizes consistency within established guidelines
Requires separate judgment on potential consumer demand for each manuscript
More leeway to accept books outside of established guidelines due to a wide variety of imprints
Rights Uses standardized contract
Can be a complex process, involving subrights, hard/soft deals, advances and tying up authors for future books
Digital royalties are higher
Author Management
Less dependent on specific authors
Vulnerable to key authors changing publisher
Very vulnerable to key authors changing publisher, if key authors believe they can self- distribute
Production Uses consistent format with focus on efficiency
Emphasizes package, size and format — cost control secondary; can be published first in hard or soft cover depending on popularity of author
Only restrictions are issues specific to eReader formats (colour or no colour, for example)
Marketing Builds the imprint/series
Builds each title/author May rely more on online reviews to drive sales
Supermarkets, drugstores, mass merchandisers, big- box bookstores.
Bookstores (all types) Online bookstores
Large direct mail Book clubs and mass merchandisers
Direct to consumer over websites
Selling
Emphasizes servicing, rack placement, and order regulation
Cover, in-store placement, critical reviews, special promotional tactics (e.g., author signings)
Online reviews in additional to offline advertising
Order Regulation/ Information Systems
Utilizes very sophisticated shipping and returns handling procedures
Historically has not received much attention, and hence, is not as sophisticated
No restrictions on number of copies
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0 7 , 2 0 1 4 t o D
e ce
m b e r
2 2 , 2 0 1 4 .
U se
o u ts
id e t h e se
p a ra
m e te
rs is
a c
o p yr
ig h t vi
o la
tio n .
23
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