Deconstructing Pop Culture

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Amazon Price Stabilization in the Secondary Market

August 7th, 2009 by David Kronemyer · 2 Comments

Anyone can sell their used books and CDs on Amazon.  Prices strictly are what the market will bear.  There is no point in being anybody other than the lowest-price seller.  This market –clearing price frequently is as low as $.01.  Amazon also provides for a modest shipping allowance.  After deducting Amazon’s commission and the actual cost of packing and shipping the seller’s gross margin is just pennies.  If the seller has any cost basis in the product other than zero then it is likely the seller actually will sustain a loss on the sale.

Not everything sells for $.01.  Most titles sell for 25% – 50% of their original list price.  Depending on elasticity of supply and demand prices can be higher than the original list price.  Many sellers believe scarcity justifies an astronomically higher price.  These titles however never will sell because on margin the value of the information is less than the asking price.  One of the most salient features of consumer entertainment software (books, CDs, DVDs) is that it can be duplicated, or the informational or entertainment content extracted, at marginal cost.  It is not uncommon for Google News to provide hypertext links to over 1,000 sites per story.  Knowledgeable websites such as www.wikipedia.com distill (with varying degrees of success) the knowledge content of every conceivable topic (to the extent Wikipedia is deficient, there are thousands of other sites to fill the gap).  The web site www.hulu.com gives away copies of television shows and clips readily are available on www.youtube.com.  Once Google finishes digitizing every book there is then the value of a physical copy of a work in principle could decline to zero.  These are just a few examples; the $.01 title on Amazon is a precursor to this effect.  As a general rule of thumb if the used price is much higher than the original list price then there will be little demand for the title.

The existence of this active secondary market creates a dilemma for the original creators of the work – the proprietor of the copyright, who may be the author of the book, the band who recorded the CD, or their corporate assignees.  There is a copyright law principle called the “first sale doctrine,” which means that only the original retail sale of the copy attracts a royalty.  Subsequent resales of used copies are non-royalty-bearing.  This is one of the main factors permitting a secondary market for used copies to exist to begin with.  As a consequence every time a used copy is sold for less than the retail price it displaces a potential retail sale and thereby destabilizes the market for royalty-bearing copies.  Reciprocally if a used copy is sold for more than the retail price then it misallocates the entrepreneurial rents potentially realizable from the sale.

There may be many reasons why this doesn’t matter.  The author may be dead and his/her estate inconsequential; the cost of looking to the publisher for royalties is less than the amount of royalties that practically could be obtained.  The band may have broken up or never recouped the amount of any advance and recording costs paid by the record company.  Repeated successive editions of a work (e.g. a college text book) tend to reduce the price of earlier editions to zero.  The vast majority of works simply no longer are consumer-demanded except by a very small minority probing the esoterica of a given subject.  Perhaps only one out of a million copyrights survives its initial release.  Nobody wants the title, even if it is priced at $.01, and on margin demand falls off quickly or is nonexistent if the title is priced even pennies higher.

For active bands or writers, on the other hand, this presents a real theoretical problem.  Not only are there economic issues, but cheaply-priced goods also intrinsically derogate from the perceived value of the work, thereby impairing the creator’s future prospects.  There is a practical solution to the surfeit of copies in the secondary market, which is that the creator or owner of the work actively can intervene in the secondary market by buying up used copies, to the point where a first-sold royalty-bearing copy presents the lowest-price alternative to the consumer.  The creator of the work should continue doing so until the price to the consumer equals or exceeds the amount of the anticipated royalty-bearing unit (with an allowance for transaction costs).

There remains the possibility that a perceived increase in demand for secondary-market copies will increase the number of secondary-market copies available, potentially driving up the buyer’s cost.  Practically however this does not seem to be the case; only rarely are more than say 100 used copies of a secondary-market title listed for sale.  Amazon is not a perfectly efficient marketplace and only motivated sellers tend to use it.  The vast majority of potentially-demanded secondary-market copies simply seem to disappear, thus capping the secondary-market buyer’s potential liability.

In many cases copies can be repurposed.  CDs for example can be re-sold by the artist at performances for something approaching a retail list price.  In this case the creator will capture and retain a margin that may be considerably higher than the royalty payable on the first sale of a copy through a distributor.  If the price for used copies consistently exceeds the list price this should be a signal to reissue the work (duplicate more copies for first sale).

The same principle pertains to some extent to items for sale on eBay, although eBay’s offerings are more diverse.  The biggest enemy of most manufacturers of durable goods is everything they’ve previously sold.  For manufacturers of long duration it would be impractical to stabilize the secondary market.  Most goods become obsolete, not more valuable.  There is however a thin tier or tranche of sellers who are competing directly in the marketplace with recently-sold in-demand durable goods, which may be sold on eBay for significantly less than the retail price.  This not only reduces the volume of the seller’s potential sales but also depreciates from the perceived value of the goods.  These sellers are making a serious error by not actively stabilizing their secondary markets.