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The Fall and Rise of Market Segmentation

English: The Supreme Court of the United State...

English: The Supreme Court of the United States. Washington, D.C. Français : La Cour suprême des États-Unis. Washington D.C., États-Unis. ‪Norsk (bokmål)‬: Høyesterett i USA. Washington, D.C. (Photo credit: Wikipedia)

By this time, it would be hard to find a node in the blogosphere that is not in triumph over the recent drubbing publishers took before the Supreme Court. The case, Kirtsaeng v. John Wiley & Sons, was a technical one, but it touched on the all-important issue of first-sale rights, and for that reason it sparked visions of the ultimate goal of total destruction of the publishing industry. The Kirtsaeng whipping comes on the heels of the rout handed to publishers in the Georgia State case, which essentially ruled that creative works are protected by copyright except when fair use can be invoked, which is always and everywhere. The Georgia State case is now winding its way through the appeals process, but the publisher plaintiffs seem to me to resemble Rocky Balboa, fighting to the end but determined not to be knocked to the mat. Lie down, Rocky, it’s over.

The Kirtsaeng case, for those who are cheering but don’t know why, concerned a young gentlemen (Kirtsaeng) who made the not extraordinary discovery that college textbooks sell for a lower price in Asia than in the US. He arranged to purchase books in Asia and then resold them in the United States. The plaintiffs argued that although those books were printed legally in Asia, there were territorial restrictions that prohibited their import into other markets. Kirtsaeng’s argument — that once you bought something you could do whatever you want with it (the principle of first sale) — was supported by SCOTUS. For the publishers, this means that the historical practice of pricing books to their markets (more expensive in the US, cheaper in Asia and Africa) will come to an end. This will not lower prices in the US, but it will increase prices elsewhere.

It’s not really the copyright issues that interest me; it’s the business practice of market segmentation that copyright makes possible. But before getting into that, let’s note in passing that Kirtsaeng created no value in his operations. He created no new content, produced and manufactured nothing, created no new markets. He was an arbitrageur — that is, someone who spots inefficiencies in the marketplace and exploits them. We mostly think of arbitrageurs on Wall Street, where they see that copper is trading for $0.03 higher in London than in Hong Kong and promptly buy in one market and sell in the other. This is the kind of activity that deservedly has come under attack in the past few years (“We are the 99%!”), but when the same action takes place around books, the arbitrageur is hailed as a hero and liberator of the people. It is one of the more noisome aspects of capitalism that sometimes financial rewards are bestowed on people who create nothing.

But, Rocky, lie down, I say, lie down! The issue is not copyright but what you were trying to gain from copyright. With textbooks the calculus is simple. Textbooks are terribly expensive to create, averaging around $750,000 for development costs, thus placing them beyond the reach of any but the privileged students of the First World. Publishers therefore price books in developing markets purely on a marginal basis, meaning that the development cost is borne by American consumers alone and that students in weaker economies only have to pay a mark-up over the variable costs of printing and binding. This is how a Pearson chemistry textbook finds its way to Namibia and a McGraw-Hill text on physiology to India. Publishers segment markets to make their wares more widely available and to maximize their revenue.

Although the Georgia State case appeared to be about copyright, the business issue underlying it is market segmentation. For a publisher, a library is one market segment, classroom adoptions another. But put an electronic text into the library reserve room and allow any number of students to get access to it, and you have allowed one segment to subsume another. There is real money at stake here. An academic book publisher might derive, say, 25% of total revenue from library sales, a similar amount from course adoptions, and perhaps an equal amount or more from the individuals (faculty and staff) affiliated with the university. But that reserve room copy, if it has no restrictions on its use, can supplant both classroom sales and sales to faculty. Thus the segmented market has become whole again, and one copy now serves a university community where formerly several were required.

Publishers have traditionally used copyright to enforce market segmentation (among other things). The segments can be drawn pretty much along any lines, provided that the license is carefully worded. Most common is geographical segmentation, precisely what was at issue in the Kirtsaeng case. In the library market, the aim was to separate library, classroom, and individual use. Trade publishing markets historically were segmented by time and format — the hardcover ships initially, the paperback follows a year later. Book club rights sliced the market another way, and serial rights (the reprinting of sections in a magazine) reached yet another segment. In the world of digital texts, many of these segments disappear and no favorable court ruling is likely to restore the old demarcations. If publishers want to continue to segment markets, they will have to find new ways of doing it, and they most likely will have to do it without the support of copyright.

The new market segmentation is likely to take place on the level of the individual. Consider that seat you just bought on United Airlines. You sit six across, knees pressed to your forehead, and for this privilege you paid $500. But the person on the left, who is equally uncomfortable, paid $700, and the person on your right paid only $300. Airlines have learned to segment markets in a number of ways, the most important being when you purchase a ticket.

Or think about college tuition. I know firsthand of a student whose parents paid $50,000 to send her to a private university for one year. She had two roommates — one paid $7,000, one paid nothing. Universities, in other words, use means-testing to set prices. Of course, if you are the parent who paid full retail, you won’t like this. How far will means-testing go? Will you pay $3 for a beer, I pay $5, and my wealthy cousin pays $7? It may occur to someone to ask: What’s the point of being rich?

By collecting information on users, all businesses, publishers among them, will begin to introduce new forms of price discrimination, another form of market segmentation. What is lost in copyright protection will be offset — perhaps more than offset — in data analysis. You may someday discover that as a reader of this blog, the special promotion to subscribe to The New York Times costs less than for the readers of O’Reilly’s Radar blog, and the books you purchase on Amazon may cost you one thing, your impecunious friend something else, and less.

As the courts continue to pick the locks of copyright, publishers will at first respond with rage (down, Rocky, down!), then resentment, but then finally with innovation. It is most probable to me that publishers will sign up for membership in the surveillance society, using information technology to develop new profit-making mechanisms for market segmentation. It seems unlikely that the college students who “won” with the Kirtsaeng ruling will like the new paradigm any more than the old one of high-priced textbooks.

Careful readers of this post will see the business opportunities emerging here. Price discrimination through database analysis is a path out of the copyright morass. This new strategy will require new tools and platforms, and my friends in the consulting world will spend many hours at high fees explaining how all this works and how to capitalize on it. There’s nothing so enriching as the loss of a copyright lawsuit.

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About Joseph Esposito

I am a management consultant working primarily in the world of digital media, software, and publishing. My clients include both for-profits and not-for-profits. A good deal of my activity concerns research publishing, especially when the matter at issue has to do with the migration to digital services from a print background. Prior to setting up my consulting business, I served as CEO of three companies (Encyclopaedia Britannica, Tribal Voice, and SRI Consulting), all of which I led to successful exits. Typically I work on strategy issues, advising CEOs and Boards of Directors on direction; I also have managed a number of sticky turnarounds. Among other things, I have been the recipient of grants from the Mellon, MacArthur, and Hewlett Foundations, all concerning research into new aspects of publishing.

Discussion

22 thoughts on “The Fall and Rise of Market Segmentation

  1. Segmentation is normally not about charging some people more but rather about charging some people less so as to make more. It fails when the principle of division breaks down and new technology is often the cause. Globalization has done this in many ways. Note too that shipping books from one continent to another is not doing nothing. And arbitrage pays because it is useful. But I agree that information based segmentation is the new frontier. The fun and hard question is where are the principles of division?

    Posted by David Wojick | Mar 22, 2013, 7:41 am
  2. Dear Joe:
    Are textbook publishers painting themselves into a bit of a dead end? If they practice price discrimination on the individual level you imply above, won’t they then just create more differential pricing for print titles in the secondary resale environment thus undercutting future print sales? If they practice more price discrimination in the ebook segment won’t they just make their customers angrier?

    Posted by chuck hamaker | Mar 22, 2013, 8:29 am
    • They are not painting themselves into a corner; they may attempt to paint their way out of one. Of course, so one knows what kind of responses we will see to new tactics in this regard. But I don’t see any likelihood that publishers will not attempt to segment markets in some way. Put yourself in their shoes. Some people pay retail, others don’t. Don’t you want to reach all customers? If this were not true, wouldn’t we eliminate financial aid for colleges?

      Posted by Joseph Esposito | Mar 22, 2013, 8:46 am
  3. One implication behind what you’re saying here is that Kirtsaeng will hasten the demise of print. In the short term, we’ll see more and more intrusive use of user-locked partly-digital books, but one outcome of this adjustment will be fewer new physical editions and copies.
    You’re saying this in another way in your discussion of the information-gathering value of digital, but Kirtsaeng makes the print edition more of a liability.

    An important point about the market-intelligence potential of e-books: right now, that potential is being completely captured in trade publishing by Amazon and Apple. If they do intend to capitalize on this value, scholarly publishers will have to be careful not to hand over the customer relationship to third parties who don’t like to share.

    Posted by Skott Klebe (@skottk) | Mar 22, 2013, 9:18 am
    • Scott – Your last point is an excellent one for both scholarly publishers and academic organizations that develop educational content. Associations that are struggling to retain membership, and deliver value for their dues, have been all to eager to use Amazon and Apple without realizing how much it may further devalue membership in the long run..

      Posted by Vin | Mar 28, 2013, 4:36 pm
    • I also see more e-books and more textbooks in paperback in US Bookstores under this ruling.

      Posted by Stephen | Apr 15, 2013, 7:28 pm
  4. So I’m wondering whether grey markets are not a common phenomenon in the US? Here in the Uk/Europe we experience them all the time. For a while the UK was regarded as a pot of gold for car manufacturers because they could get away with charging much higher prices here than in Europe. Because of various EU laws, enterprising dealers and buyers worked out that you could order a UK spec car from a dealer in the EU and pay the lower price, then pick it up and drive it back to the UK with no loss of rights or warranty etc. I recall the clamour from the car makers when they got caught doing this, and after the dust settled, there was more parity in the car prices. The sky didn’t fall. Likewise, in looking around for a camera lens, I’ve been exposed to the grey import market that operates there. Of course you don’t get the warranty or anything like that, and technically, you are buying a pre-owned item, so any issues you have with the item are strictly between you and the seller, not the manufacturer. But my point here is this; do we have any evidence that this activity is any more than a marginal enterprise practised by a small number of clued up individuals?

    Posted by David Smith | Mar 22, 2013, 9:26 am
  5. Joe, thank you for such a thoughtful analysis. Economists will tell you that market segmentation (or price discrimination) leads to a more efficient marketplace where more people are able to purchase your goods and services at a price-point that meets their ability and willingness to pay. But a psychologist will tell you that people hate price discrimination because it pokes at our very notion of fairness. While information transparency can help individuals shop around for better prices, the effect of this transparency is an erosion of market segmentation. You can’t have it both ways.

    I agree that in the absence of third degree price discrimination (discriminating by market segment) pushes sellers toward the fourth degree (discriminating by individuals); however, this assumes that you have enough knowledge of that individual to make a reasonable price estimate. An alternative to solving the erosion of market segmentation through copyright law is to move commerce into contract law, whereby each purchaser is required to sign a legal document accepting the terms of the agreement and by creating information architecture to prevent sharing or resale–this is the norm of the software market.

    Posted by Phil Davis | Mar 22, 2013, 9:52 am
    • Hating reality is a surprisingly popular pastime, but however irrational it may be the wellspring of innovation.

      But all market segments are composed of individuals. We are just looking for new principles of division.

      Posted by David Wojick | Mar 22, 2013, 5:32 pm
  6. Joe, a really good piece and a breath of fresh air after all of the pieces I have read following the SCOTUS decision. One aspect not mentioned in anything I have read… why did publishers begin offering lower cost editions in a number of markets, and particularly in Asian markets? Having been very much inivolved in these “choices”, I can attest that – beyond recognition of the lower purchasing power in these markets – the prime original driver was to combat piracy, and I would argue that following this legal rulling, and the natural decision by publishers to no longer offer local lower priced choices, creative “entrepreneurs” such as the now often glorified Mr. Kirtsaeng will undoubtedly find ways to make money off of someone else’s property, “legally” or otherwise…
    Patrick

    Posted by Patrick Hansard | Mar 22, 2013, 10:00 am
  7. In the 1980’s STM publishers charged libraries differential subscription prices based on geography. An annual subscription cost a UK library 100 pounds and the same title cost a US library $500. When challenged the publishers all screamed they would go out of business. They simply raised everyone’s prices and you known where prices are now. The first sale doctrine is simple and straightforward. I don’t see very little impact on publisher sales. Amazon’s sale of used textbooks does far more damage to a publishers revenue.

    Posted by Dan Tonkery | Mar 22, 2013, 10:08 am
  8. Is the US an outlier in not having a geographic qualifier its first sale code?
    I ask because the EU directive on Copyright in the Information Society seems to me to answer the Kirtsaeng question quite clearly in Article 4[2]

    “The distribution right shall not be exhausted within the Community in respect of the original or copies of the work, except where the first sale or other transfer of ownership in the Community of that object is made by the rightholder or with his consent.”

    As Breyer and Kagan point out, there’s nothing explicitly related to geography in 109 of the US code, whatever the intent of the legislators.

    What about other countries outside the EU?

    Posted by Skott Klebe (@skottk) | Mar 22, 2013, 10:31 am
  9. Many other industry that sell goods in multiple countries use market segmentation without having the advantage of a special legal prohibition on cross-border imports. The leakage in such markets is something that lots of other businesses know how to account for in their pricing decisions, but it does not force them to abandon market segmentation. It seems ridiculous to assert that publishers, alone amongst retailers of goods, cannot figure this out. In my opinion much of this rhetoric is extreme hyperbole, designed to create one more justification for the ever-increasing prices charged by commercial publishers. See my response to this attempt to scare us all into paying more at http://blogs.library.duke.edu/scholcomm/2013/03/20/the-quest-for-super-property/.

    Posted by Kevin Smith | Mar 22, 2013, 11:13 am
    • Kevin should read more slowly. I said the opposite of what he thinks I did.

      Posted by Joseph Esposito | Mar 22, 2013, 11:17 am
      • How is that Joe? It seems like you did say that geographical segmentation for textbooks was dead. Did you not? It seemed like your starting point.

        Posted by David Wojick | Mar 22, 2013, 5:27 pm
  10. Best not argue or challenge copyrights. Few people have real, authentic credentials to claim ownership. The whole topic of stealing or marketing work that is not one’s own, is just wasteful. Copyrights, internationally protected by law, seem the challenge, herein these reports and comments. Law shall forever bit adieu to those who want unmerited income from another person’s insight to document. The best way to remember the highest authority that protects an author’s “moral” and “material” interests is thus: Easter, in the year of my birth, became the most important year for Prince Charles, too. For in that year, the United Nations adopted the Universal Declaration of Human Rights, which Article 27 (1) and (2) protect everyone’s right to enjoy scientific advancement. However, royalties from markets of copyrighted material go to the author.

    Posted by Beverly Jo Jones | Mar 27, 2013, 11:16 am
  11. Many living in the USA and UK/Europe don’t realize that the cheaper editions of books on sale in India and other such countries are on poor quality paper, have poor printing (and I point towards both academic books and fiction) and the price differential is often not fair enough to justify such differences. Also, the latest edition of a book is frequently not available in Asian countries till almost the next edition is out. So the capitalism of knowledge still holds good.

    Posted by Sagar Singh | Mar 29, 2013, 12:31 am
  12. Thanks Joe. My ebook company Publerati offers a new segmentation model where those who pay are helping provide access to those who cannot. A bit like some major museums who want to assure wider cultural access. Traditional copyright law publishing market segmentation would inhibit this new idea.

    Posted by publerati | Mar 29, 2013, 7:17 am
  13. I wonder if publishers could make money by selling discounted paperback textbooks using the lower quality paper (for example, a $100 textbook in hardback might sell for $35 in soft cover with less special feature add-ons, etc) the USA. Students are poor anyway, and with the rising costs of college, this may be a way to offset it a little. The publisher may make up on volume.

    Posted by Stephen | Apr 15, 2013, 7:14 pm

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