Let's consider for a moment that you're in product development and trying to target a release price for your new widget. It cost you $100,000 to develop the widget (fixed project costs), $10,000 per batch to product the widget (fixed production costs), and $1.50 per widget to distribute and sell.
Assuming you have a total predicted market size of 1,000,000 units, and can product widgets in batches of 100,000, this means you spend:
- $0.10 per widget on development
- $0.10 per widget on production
- $1.50 per widget on distribution and sales
So each widget costs you $1.70 in total. If you're selling them for $9.99 a piece, you're pulling in $8.29 in sheer profit with every sale. This is a pretty healthy margin, but it could be better.
Instead of producing physical widgets, you determine a way to create virtual ones. Your total development costs stays the same - $100,000. Production costs drop to effectively 0, though, as you can produce literally millions of copies for just the cost of computing power. Distribution and sales also drops to just transaction fees - $0.25 per sale.
In all, your total cost per widget has dropped to $0.35. If prices stick at $9.99, then your profit has grown to $9.54 for every sale.
If you're still selling 1,000,000 units in each paradigm, this means your shift to virtual goods has brought in a net of $1.25 million in additional profit.
Unfortunately, you've also lowered the barrier to knock-offs and pirates ...
The Publishing Industry
The above is a bit of a convoluted example, but it essentially mirrors what's happened to the publishing industry over the past few years. Originally, printing books was prohibitively expensive unless you did so in massive quantities. Publishers would print several thousand copies at a time to get the cost per book down to a manageable amount.
If you tried to replicate a book (i.e. copy it and sell a knockoff) it often cost more to print at the same quality than the book was selling for initially. Books had their own built-in barriers to privacy, so copyright disputes were relegated more to plagiarism than wholesale reproduction of goods.
Over time, though, the industry changed. The advent of print-on-demand publishing meant vanity publishers could produce batches of as few as 1 book for a fraction of what it would have cost to set of a 1-book offset printing run.[ref]Offset printing usually requires a massive setup fee to print the manuscript. Ordering in large batch sizes helps distribute this thousands-of-dollars cost across thousands of books, dropping its impacts to pennies per copy. Print-on-demand shops don't require such a setup fee, allowing you to print a single copy for a few dollars.[/ref] Print-on-demand isn't nearly as cost-effective as offset printing (you might pay $3 to manufacture each copy rather than $0.15), but if you're keeping your quantities low it's a cheaper alternative.
Later, even print-on-demand found trouble as electronic publishing began to take over. Now, the effective cost of producing a second - or thousandth - copy of a book is nil. Keeping books priced at almost $10 per copy means publishing houses with large sales volumes are making nearly cover price on each sale in profit.[ref]When you're talking about thousands of copies and a new writer with a low fee, publishers are only losing a few cents on each sale in fixed costs. The rest goes to cover the overhead related to acting as an agent and marketing the product - real costs for sure, but beyond the scope of what I'm trying to discuss.[/ref]
Lowering the Barrier
Fortunately for publishers, digital goods are easy and cheap to reproduce in both large and small volumes. Creating a batch of millions of copies costs no more than creating a one-off copy for a dissatisfied customer.
Unfortunately, it's also easier for pirates and thieves to make copies of digital goods, too.
In the early days, reproducing a printed book at similar quality to a publisher required both a copy machine and a lot of skill. Bindings were tricky, covers were tricky. Creating a forgery of a professionally-printed book wasn't cheap or easy, so very few took the time to do it.
With print-on-demand, total profits began to rise for publishers, but so did the number of knock-offs available in the market.
With digital publishing, margins initially became astronomical. So did the numbers of illicitly-reproduced digital copies.
It's hard to compete with free, so publishers' prices have been forced downwards. Gone are the days of $24.95 pre-sales; when new books come out, I often sign up for advanced electronic copies on Amazon.com - sometimes for as low as $0.99.
By driving down the cost of doing business, the publishing industry has inadvertently driven down the barrier to competition as well. Thieves readily steal, reproduce, and subvert the sales of quality works by big names. Novices can jump in and sell their unedited, sometimes grossly unpolished manuscripts on the exact same markets that carry classics like Joyce and Hemingway and modern greats like King and McCarthy.
Optimizing further has produced diminishing returns for publishers, and they're now just beginning to catch up with a market that ran away with the ideas they were working to iterate upon. Institutions of digital rights management (DRM) intended to protect author and publisher copyrights have all but failed to keep up with the rapid pace of digital development.
Ironically, I was asked recently by a friend to help publish their book. They didn't want to spend a lot on production, and wanted to target electronic publishing so they could keep costs down while cheaply reproducing as many copies as they could sell. At the same time, they emphasized their need to protect copyright and "make it as hard for someone else to steal the book and make copies as possible."
In this new world of electronic reproduction and distribution, this request might be impossible to fulfill. A billion-dollar industry has been trying to figure it out for years.
Maybe there just isn't a way to do it.