Here’s the quote from the Macmillan letter:

I gave them our proposal for new terms of sale for e books under the agency model which will become effective in early March.

And then later a couple more paragraphs:

Under the agency model, we will sell the digital editions of our books to consumers through our retailers. Our retailers will act as our agents and will take a 30% commission (the standard split today for many digital media businesses). The price will be set the price for each book individually. Our plan is to price the digital edition of most adult trade books in a price range from $14.99 to $5.99. At first release, concurrent with a hardcover, most titles will be priced between $14.99 and $12.99. E books will almost always appear day on date with the physical edition. Pricing will be dynamic over time.

The agency model would allow Amazon to make more money selling our books, not less. We would make less money in our dealings with Amazon under the new model. Our disagreement is not about short-term profitability but rather about the long-term viability and stability of the digital book market.

What do you see in that letter? Almost everyone commenting on this seems to be focusing in on the pricing. And while it’s ultimately about pricing, there’s something very important in there. The term agency model. That’s very important.

Currently most booksellers operate under a merchant model. Macmillan’s letter rhetorically leaves this little bit out while extolling how great the agency model is for a retailer. As a retailer, the agency model could be very very ugly. Macmillan has left that part out. (Not surprising, they are interested in their own P.R., not providing accurate analysis and facts. Amazon won’t do any better.)

Under the agency model, the manufacturer (in this case Macmillan) owns the inventory that a retailer sells. It determines the pricing, as well as a whole lot of other things like which items will be sold by which retailers. The retailer makes money get getting a percentage of sales. Perhaps it has some complications like higher percentages with higher sales, but that’s the basic idea.

With the merchant model, the retailer owns what they have and gets to make the decisions, particularly the pricing decisions. The retailer pays the manufacturer whatever price the two parties can agree on. In some industries, this is a standard price (wholesale) but in Amazon’s case they are pretty big so they have a lot of influence in dictating what prices they want to pay. After paying wholesale and receiving their merchandise, it’s the merchant who sets the prices. They can sell at a retail price that is more or less than the wholesale price, and they do not have to price uniformly with respect to other retailers.

The agency model would be horrible for a large retailer like Amazon. Horrible. Let me give you some scenarios:

It’s summer time. There’s a new blockbuster movie out starring some pretty young Hollywood star (think Brad Pitt or Jennifer Aniston). That celebrity wrote a memoir several years ago that Amazon has in stock. They could use the opportunity to offer those books at a discount in order to move them or as an incentive to sell the official movie novelization and other movie crap (“three for the price of two!”). Except under the agency model, they can’t do this. They would have to sell at the price set by the publisher.

Or try this. An Amazon competitor has a book selling at $1 less than theirs. They cannot price match under the agency model.

Or even the example that’s at the heart of the current dispute: publisher wants to sell at $15.99 and reduce the price over three years from that price to $5.99. After Christmas, the hardcover version (sold under the merchant model) of the book goes into the bargain bins and is selling for $7, but the publisher is stuck on their three year schedule for the ebook version (under the agency model). Amazon is now selling the ebook for more than the hardcover.

Basically, the problem is who controls the pricing, not the specific prices. It’s not that the pricing under agency would be monolithic exactly. Agency model eliminates loss leaders. It’s all about different interests. As a seller of books from different publishers, as well as millions of other products, Amazon’s interests differ from the publishers’ interests. The agency model means that Amazon’s interests would be lower than the publisher interests. All the commentary touches on this part a bit. Amazon is interested in establishing the Kindle as the dominant ereader platform. Macmillan is not. Amazon want the flexibility to set prices for that, irrespective of whatever wholesale price they negotiated.

If it was specific prices, Amazon would never have used their nuclear option. I’m pretty sure of that. They’d just haggle away until they came to an agreement. But to switch to agency model? They have to nip that in the bud. If they’d agreed to the agency model, publishers would have pushed to switch everything to agency model, killing Amazon’s business.

Why am I sure of that? Way back when, I used to work at Expedia as a developer. I didn’t make the business decisions, but I had to understand them pretty well to implement the web site to carry those decisions out. Some of the things that Expedia sells are agency model (a lot of flights, but not all), and some are merchant model (a lot of hotels, but not all). Agency model is why all the online travel agents started charging $5 to book a flight in the early 2000s. The manufacturers, the airlines, cut the commission down to nothing in a lot of cases. Since Expedia couldn’t be flexible on price, they tacked their own charge on top so they could cover costs. That’s also why customers didn’t pay the $5 booking fee when they bought a flight in conjunction with a hotel. Expedia bought hotel room-nights up in bulk and then set their own prices. The company set their own prices and it didn’t need the booking fee to make money.

I spent my entire time at Expedia watching the business side try to switch from the agency model to the merchant model. Travel was dominated by the agency model for its entire existence. Expedia was trying (and sometimes failing) to convert to a merchant model, because that’s where the money would be for them. It allowed them to create packages that airlines and hotels couldn’t or wouldn’t at prices that weren’t available under agency rules.

Now, whether this is good for the consumer (the reader in the case of books), remains to be seen. In some ways it’s two behemoths on one end of the supply chain duking it out over who gets to pillage the consumer. But I am pretty sure I don’t want my neighborhood bookseller to work under the agency model. So if this keeps publishers from adopting that way of selling universally, then I have to side with Amazon. Saving the neighborhood bookstore is not their goal, but as a side effect it helps.

Edited to add: Charles Stross’ take on Amazon vs. Macmillan covers a lot of the same ground as my post. So I’m not the only one focusing on agency model. He doesn’t talk about packaging and price matching that a merchant could do, but covers some other things.