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Applying Social Science Concepts to Business: E-Book Edition

February 1, 2010

[Cross-posted at bill | petti]

Sunday’s Wall Street Journal reported that Amazon has stopped selling Kindle versions of all Macmillan titles. John Sargent, Macmillian’s CEO, recently went to Amazon’s headquarters to try and negotiate new terms for the sale of e-books published by his company. In general, the publishing industry has been unhappy with Amazon’s insistence that most books be priced at $9.99. Apparently, the discussions resulted in Amazon pulling all Macmillan e-books from it’s website.

I am a firm believer that the historical knock on the social sciences is unwarranted and that many of the theories, frameworks, and concepts found in the various disciplines are widely applicable in the real world, business in particular. So when I read about the Amazon-Macmillan dispute I was struck at how a number of social science concepts shed quite a bit of light on these developments; namely Albert Hirschman’s concepts of exit, voice, and loyalty as well as signaling and the indirect use of force.

So what do these concepts have to do with e-books? Glad you asked.

In his classic Exit, Voice, and Loyalty, political economist Albert Hirschman provided an elegant framework for analyzing the options available to individuals when they become displeased with actions of an organization. According to Hirschman, individuals have three options: they can be loyal to the organization, they can exercise voice (e.g. protest, negotiation), or they can exit the organization (e.g. join a new group, shop at a new story, etc). The framework is quite elegant and can easily be applied to both explain and predict the behavior of consumers in a market or citizens in a political system.

Since the launch of Amazon’s Kindle, book publishers have tried to exercise their voice vis-a-vis Amazon and their pricing requests, but to little avail. Until now, voice and loyalty seemed the only realistic options. Sure, there are other e-book retailers out there, but success of Amazon’s Kindle and the attractive prices they set for their customers provided the retailer with a huge advantage in terms of a distribution channel. However, with the launch of Apple’s iPad, book publishers now have a more realistic exit option. Not only is Apple a potentially powerful sales channel, but they have agreed to pricing terms that are more favorable to publishers than Amazon (Apple will take 30% of whatever price publishers choose to charge, leaving the price point up to individual publishers).

When individuals have the option of exit, we should see typical market dynamics at work–i.e. customers can shop around to various suppliers to find the products they want at the price they want, with competition among those suppliers driving the quality of products higher and the price for goods lower. This is why we generally abhor monopolies, since by nature they stifle market dynamics and leave customers with only the options of loyalty or voice, meaning they lack much leverage. With the launch of a new and potentially powerful sales channel, publishers now have a more realistic exit option that can be brought to the table in negotiations with Amazon.

However, rather than alter the current pricing terms with Macmillan as a result of this new exit option, Amazon stopped distributing Macmillan’s e-books altogether. The question, of course, is why? I would posit that Amazon was trying to send a signal to dissuade other publishers from also trying to renegotiate terms. Now I have no information as to what Sargent may have proposed and if any ultimatums were given, so what follows is purely an intellectual exercise.

We can view Amazon’s move as a deterrent threat to other publishers who, emboldened by Apple’s entry into the market, may attempt a similar renegotiation. By harshly punishing one actor (i.e. refusing Macmillan access to a valuable and dominant sales channel) that attempted to change the status quo (Amazon’s preferred pricing structure), Amazon hopes to send a signal to other potential actors to not attempt something similar. This is a great example of signaling and the indirect use of force, two related concepts that economists (such as Michael Spence and Thomas Schelling) and political scientists (such as Robert Jervis and James Fearon) have fleshed out over the past 40+ years. Rather than having to expend resources forcing every potential adversary to either change their behavior or maintain the status quo, an actor can choose to send a signal to all potential adversaries by making an example of one of them. Not only can an actor make a threat to punish their adversaries, but they can also demonstrate that they have both the capability and the will to do so by carrying out such a punishment on one adversary.

This dynamic is accentuated in systems where one actor faces challenges from many potential actors versus just one. Barbara Walter has looked at why some states decided to deal with separatist groups and factions in a violent manner versus through negotiations. The key variable: the number of potential separatist groups that may also seek self-determination. As the number of potential adversaries increases the probability of solving these disputes through negotiation decreases. When faced will many potential challengers, governments will choose to demonstrate their willingness and ability to put down rebellions in order to deter other separatists groups from similar challenges. In other words, having reputation for resolve when dealing with adversaries becomes more important when you face many potential threats than just one.

In the case of Amazon, it could be that seeing the potential for many actors to attempt to renegotiate the current pricing structure it was decided that they should send a signal to the rest of the publishing world that attempts to change the status quo would not only fail, but would result in sever punishment (i.e. the loss of a popular sales and marketing channel). My guess is that this likely won’t work for two reasons: 1) as mentioned earlier, the publishers actually have someplace else to go–they can exit the current relationship and cast their lot with Apple; and 2) Amazon is heavily reliant on the book publishers. Without their titles the allure of a Kindle decreases. The threat may not be credible, or at least sustainable for long.


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Petti is Associate Director of Insights and Analytics at Alexion . Previously, he served as Lead Data Scientist in the Decision Sciences group at Maritz Motivation and a Global Data Strategist and Subject Matter Expert for Gallup.