Price elasticity and profit maximization strategies for digital e-book sales

¶ … Bury Price Elasticity Service

Business Proposal for Will Bury Price Elasticity, Incremental Costs

Digitally recorded books (e-books) and digital content face several significant challenges from a price elasticity and market pricing perspective. The barriers to entry from digitizing content alone are low (Starkweather, 2004), with differentiation existing at the marketing, packaging, delivery technology and pricing strategy level. The intent of this proposal is to define how Will Bury will be able to increase revenues, determine the profit-maximizing quantity of music, use the concepts of marginal cost and marginal revenue to maximize profit, and also define a profitable mix of pricing and nonpricing strategies. Barriers to entry, product differentiation and cost reduction strategies are also profiled in this proposal.

Profit Maximizing Quantity

The profit-maximizing quantity of the e-books is defined using the following series of assumptions. First, it is assumed that the pricing strategy will be on a per-copy licensing (PCP) to optimize value-based pricing based on the popularity of recent titles relative to those which have been in distribution for months and years. Second, it is assumed for purposes of this business proposal that the demand curve for digital content including e-books is flat, and that per unit pricing changes will have little if any effect on volume purchasing (McConnell, Brue, Flynn, 2009). Third, it is assumed that fixed per unit costs are the price of storage amortized across all titles and the $5 per title loyalty fee forecasted for each copyrighted title added to the series that are being sold.

The Profit Maximizing Quantity of the e-books is defined through the use of the Total Cost -- Total Revenue method as there are fixed costs per unit for copyrighted books, a small fixed costs measured in literally in cents ($.03) for storage of the e-books and a flat demand curve which equates to little variation in profit maximizing quantity. Assuming that there are initially 1,000 e-books offered for download at between $3 to $5 with the higher-end units being the most recent titles, and further assuming the target revenue of $200,000 per year is the revenue objective, the profit maximizing quantity is approximately 67,000 downloads in the first fiscal year of the Will Bury eBook Download Service.

In highly inelastic markets, there is greater flexibility to increase prices over time and gain market share as a result of the price/quality relationship (McConnell, Brue, Flynn, 2009). Raising prices will drive down the price maximizing quantity and over time it is proposed that pricing be increased on popular titles as analyzed from the initial sales data. Pricing competition with competitors in an elastic market is secondary to the perceived value and differentiation of the digital product or services itself (Tsai, Kuo, Lin, Kuo, Shen, 2010).

Marginal Cost and Marginal Revenue for Profit Maximization

Inherent in this business proposal is the need for Marginal Cost (MC) and Marginal Revenue (MR) calculations. Per unit MC for the e-books is $5 for copyrights and $10 per unit labor, worst case. It is assumed the process to create a digital e-book is relatively complex, therefore will require $10 per hour from a labor standpoint. This $10 per labor hour figure is also seen as an investment in quality, as an errant or poorly recorded video will eventually lead to the company losing sales and eventually its reputation. Having the e-books recorded properly, while expensive and driving up the MC, will also lead to long-term stability of MR over time as well. With productivity per hour for encoding an e-book being approximately 500 pages per hour, a trained technician can produce about three books an hour, twenty four in a working day. Cost per labor for a day is $800, and when allocated from a MC standpoint across all books, equates to $33 per e-book. Based on analysis from previous studies and industry data, it is assumed an e-book will be rented an average of twenty times a year per title (Starkweather, 2004). This takes the cost down to $1.65 per unit, and when combined with copyright fee amortized across all titles, ends with a MC of $1.90 per book ($1.65 labor cost of transcription + .25 copyright costs). At this MR level, the lowest-cost book will generate 37% gross margin. As the market is highly inelastic, MR increases can be attained through selective price increases on the most popular titles (McConnell, Brue, Flynn, 2009).

Mix of Pricing and Non-Pricing Strategies

As the market is inelastic for e-books (Starkweather, 2004) and therefore susceptible to price increases that will not be responded to by competitors, the potential exists for creating product bundles and implementing on-pricing-based strategies of consumer choice by allowing them to create the bundles on the website based on their interests (Zhu, MacQuarrie, 2003). This approach to non-pricing competitive positioning is critical for driving up MR at no incremental MC. Pricing strategies need to concentrate on continually moving up the demand curve to capture profitability from competitors who will most likely mis-read this market and drop prices quickly, inciting a very unprofitable price ware that could lead to consolidation of the market. The barrier to entry is the customization of e-book bundles with a focus on how to create greater value by fulfillment and quality assurance of orders in real-time. This will also be a point of differentiation.