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• 6.1 Market Structure
• 6.2 Expected Impacts
  • 6.2.1 Innovator
    • New Zealand Material
  • 6.2.2 Domestic Agent
  • 6.2.3 Retailer
    • After Sales Service
  • 6.2.4 Consumers/Users
    • Price
    • Availability
    • Pre Sales Service
  • 6.2.5 The Net Book Agreement
• 6.3 Welfare Analysis
  • Summary

6.1 Market Structure

The structure of the market has changed little from that presented in NZIER's report on parallel importing in 1994. The main change has been the introduction of Dymocks as a competitor in the retail market.

The Internet is having an impact on the book market both in terms of the ability of consumers to purchase books directly from overseas and in terms of providing a substitute source of information. Although the size of this impact to date does not appear to have been large, the potential is great.

Parallel importing is already a feature of the book market. A certain amount of unauthorised importing is tolerated by the local exclusive distributors. The reasons for this include that they cannot afford to monitor every book store and enforce the law against every infringer and for small orders the parallel importation of some books does not impact significantly on their business.

6.2 Expected Impacts

6.2.1 Innovator

It is claimed that the lifting of the restriction will reduce the return to innovation and will thus reduce the incentive to create new work. This argument is complicated in the book market by the different owners of copyright in a book. The author has a copyright in the words themselves and the publishers have copyright in the layout and design of the book. Thus there are two sets of creativity that must be considered.

For overseas authors and publishers, the New Zealand market is likely to represent a very small fraction of total sales. The income that could potentially be lost through parallel importing in this country is unlikely to influence the incentive to create new works. This is especially true given that parallel imports are legitimate copies of the work and as such a royalty will be paid by some person in the distribution chain, if one is applicable.

The major complication to this argument is the issue of remainders. These are generally books at the end of their life cycle on which a royalty is no longer payable. At present publishers will not permit books that are remaindered in one country to be exported into another country even if there is a significant demand in the destination country. This ensures that the publisher and the author receive a royalty on all copies of the book sold. Without the parallel importing restriction, publishers would be more cautious in the timing and the volume of the release of their books in different countries, especially if the life cycles of the books in those countries are likely to vary. Again, this is more likely to affect the supply decision rather than the decision to create the product in the first place.

It was suggested by one interviewee that the return to innovators may actually increase as a result of parallel importing because the increased availability of genuine material will reduce the need for alternative options such as photocopying.

New Zealand Material

Not all of the books available in New Zealand are written and published overseas. There is a small but significant publishing industry in New Zealand. How would the removal of the parallel importing restriction affect the incentives on the local copyright holders?

One of the key arguments of the local book publishing community is that the investment in publishing local works by the agents of the international publishers would fall dramatically if the parallel importing restriction were lifted. One interviewee believed that the restriction on parallel importing provided them with a low risk stream of income which allowed them to diversify into the higher risk area of local publishing.

This argument suggests that publishing of New Zealand work is not profitable in its own right and is therefore subsidised by the profits earned by the agent in their importing operation. Once those profits were eroded by the introduction of competition by parallel importers, the investment in local works would be reduced or stopped. One publisher suggested that publishing New Zealand works was 'just profitable'.

However, other interviewees questioned whether the level of investment in New Zealand publishing by these organisations was high anyway or at least was likely to remain high for much longer.

In terms of the returns to New Zealand publishing, copyright holders get 10% in their own market and approximately 5% outside. It was the opinion of one interviewee that if more material was bought from overseas suppliers then more royalties would be paid in the countries of origin and authors would benefit.

It was suggested by another interviewee that there were a range of alternatives to the international publishing agents if a New Zealand author wanted to get their work published. There were companies which specialised in publishing New Zealand work, or self publication was also an option for many.

The possibility of retaliation was mentioned to us. If the parallel importing restriction cut across an international publishers' global marketing strategy, it may be more difficult to have New Zealand published material distributed in other countries.

6.2.2 Domestic Agent

Most of the large international publishing firms have an exclusive agent in New Zealand. They control the distribution of material from those publishers to retailers and other users in New Zealand. A number of the interviewees described the service from these authorised distributors as "poor". Response time from these agents was generally slow and the range of titles was not always as extensive as consumer demand required. An authorised distributor admitted during an interview that "there's no real urgency in the supply chain". Another accepted that some publishers are "bloody awful" in servicing the market.

As a result of these factors, the legitimate channels are sometimes bypassed in favour of parallel importing even under the current restrictions. Often such parallel importing occurs with the knowledge of the authorised distributor but if the order only involves small quantities this is generally permitted. However, the authorised distributors do intervene and threaten court action on some occasions.

If the parallel importing restriction was lifted, there are a number of possible outcomes. In the first scenario, the domestic agents would operate in competition with international sources of books. They would have to improve service and be more competitive on price to stay in business. Secondly, the international publishers could close their New Zealand offices and would supply the New Zealand market from another country, most likely Australia. This would reduce the number of publishers on the local market but could provide opportunities for local publishers to increase their share of the market. The third possibility is that an alternative distributor will set up domestically to compete with the international publishers' authorised distributors. If competing distributors do emerge, it has been suggested that prices could rise as the discounts offered to competing distributors would be smaller than those offered to a single distributor. However, the more likely scenario is that the New Zealand distributor would source their material from a major warehouse operation who has received a large volume discount from the publisher.

In reality a mix of the three scenarios is likely to occur. A number of interviewees suggested that some of the major retail players could move into distribution if parallel importing allowed them to access overseas material.

6.2.3 Retailer

There are a range of retailers in New Zealand from the major chain stores of Whitcoulls, London Books and Dymocks to the small specialist book stores. Under the current restriction all retailers must source their material from the authorised distributor of each of the publishers.

This is, at times, restrictive for both the large retailers and the small retailers. Without the parallel importing restriction, it is possible that the larger retailers would source their stock from outside New Zealand to take advantage of the discounts available. Both large and smaller retailers may order from overseas when a title is not readily available in New Zealand. It was suggested that the prices would not be competitive for small retailers because of the inability to negotiate discounts.

This was disputed by a small, specialist bookshop. They believed that purchasing from warehouses in the US and the UK would be cheaper than buying from the New Zealand distributor even at relatively small volumes.

If retailers were going to order regularly from overseas, one requirement would be for them to upgrade and computerise their stock systems. This is likely to disadvantage small retailers who wouldn't have the volume to justify the investments necessary.

The removal of the restriction could also allow the market to evolve in ways that it can't currently develop. For example, in Australia there are specialist academic book shops. The removal of the restriction could create the opportunity for such a niche operation. Currently institutions cannot deal directly with domestic agents of book publishers, they are directed to order through book stores.

A removal of the ban could also encourage large chains of retail stores to open in New Zealand in competition with the existing players. The change in the parallel import restrictions would allow the chains to take advantage of volume discounts and pass on those savings to consumers even in small markets like New Zealand.

After Sales Service

The sales or return policy is an important service sometimes offered by authorised distributors to retailers. When it is offered, it places the risk of unsold stock with the publishers. Retailers are able to order stock without fear of being stuck with it if the title is not as popular as they estimated. This service could be withdrawn if parallel importing were permitted. One of the reasons for this is that if the freight cost would be much greater if the publisher's agent was located in another country, and secondly, it would be possible for a retailer to order the title from the authorised distributor, as well as a parallel importer and return unsold copies to the authorised distributor, while pocketing the profits from all of the books sold. The authorised distributor would take the downside risk but would not benefit completely from the upside risk.

This shifting of risk could have several consequences. First of all retailers would be more cautious about holding stock, especially those titles where there is some uncertainty about their popularity. Thus the range of titles that will be available for consumers to browse could fall. One retailer agreed this could happen but suggested the "quality" of the books available would increase.

We would expect this policy to have a relatively greater impact on small retailers as they are likely to be less able to carry the no return risk. However, this intuition was not backed up by a small, specialist book store that we talked to. They believed the cost savings from sourcing material from overseas warehouses would more than make up for the loss of the sale or return option.

In fact, one small bookstore considered that small bookstores were under more pressure from the current restriction because they were more likely to be competing, unsuccessfully, with the Internet. Unless they can become more price competitive vis-à-vis Internet bookstores, many small bookstores will not be able to survive.

6.2.4 Consumers/Users

There are a number of different types of consumers or users of books that need to be considered when assessing the impact of a removal of the parallel importing ban. There are the retail consumers who purchase books for their personal use but there are also specialist users such as libraries or universities who deal in large quantities of books for their "commercial" purposes. The impact on each of these users will be different. Even within the description of a retail consumer, there will be buyers with different characteristics. Where possible the following discussion will assess the impacts on each of these users.

Price

The tendency will be for prices to fall if the parallel importing restriction is removed. However, prices may not fall in all segments of the market. Competition will be increased for the titles that are likely to be most popular with consumers, because parallel importers are likely to be able to source such titles from other markets at a price low enough to be able to compete with domestic agents.

Many interviewees also stated that the price of non-main stream material would fall as well. Sourcing material from overseas warehouses could provide significant savings over those provided by the domestic agent. Even small bookstores felt they could get a better deal by ordering from overseas. One interviewee mentioned that there were specialist suppliers that would deal in single copies and because of their overall buying power were able to offer competitive prices even with transport costs.

The price of less popular titles or those that are more expensive in other countries, may stay the same or may increase with the removal of the parallel importing restrictions. The competition in the popular titles may reduce competition in less popular areas and provide stockists of those titles with a degree of market power. If the price of the titles overseas did not provide a constraint on the exercise of that power, the prices in New Zealand may rise.

Contrary to the belief of buyers, the local publishers believed that the prices in New Zealand would not fall if the restriction was removed. They maintained that the prices of New Zealand sourced books were competitive with overseas sourced material and as discussed above they did not believe non-exclusive distributors could get the same price discounts that were currently available to exclusive dealers.

A comparison of the price of a small number of titles allows us to identify whether New Zealand prices are competitive with those paid by consumers overseas. Using a methodology similar to that used by the Australian Prices Surveillance Authority, we asked a major New Zealand retailer to provide us with a list of the top 100 selling books in New Zealand. We then sent the list to overseas retailers and New Zealand distributors to get international price comparisons. Table 2 presents a summary of the results of the survey. Further details are provided in Appendix F. We received responses from different sources for each of the countries but have only presented a comparison of the New Zealand price and the lowest price from each of the countries surveyed. The Australian and United States prices are mainly retail prices while the UK prices are mainly recommended retail prices.

New Zealand consumers appear to be paying more, on average, for books than each of the comparator countries. It is noted that the exchange rate has an obvious influence on this outcome.

These comparisons may not, however, be strictly valid. These are the recommended publishers prices or retail prices for books in New Zealand stores now. It would have been the exchange rate conditions prevailing at the time that would have influenced the price charged for book in New Zealand. So, we must investigate whether the prices of these books (or similar books six months ago) were the same. Table 3 presents the same comparison using the average exchange rate for the month of September 1997 instead of December 1997.

A major price driver for the book market, especially in a country like New Zealand that is a large distance from the main publishers, is transport costs. Interviewees told us that cost of air freight was previously prohibitive to parallel importing. Now even small retailers are able to transport material relatively cheaply. For example, the freight charges for books from Amazon books the US Internet bookseller is a minimum of $US4.00 plus $US1.95 per book (which is about $NZ 10 for a single book).

Even without lifting the restriction, it appears that the Internet is providing some price competition. This is mainly at the specialised end of the market. If the restriction remains in place prices will continue to be squeezed and smaller bookstores may be unable to compete. This will adversely affect those book buyers without access to the Internet.

The price sensitivity of consumers in New Zealand varies considerably. At some "price points" the quantity sold can be increased dramatically by reducing the price. A retailer told of one book which had its price reduced by 50% and the volume multiplied by 16. This effect is most pronounced in paperbacks, fiction and children's books. In general one retailer believed there was a pent up demand in the book market that would be satisfied if prices could be reduced, however, they admit that at least part of the demand response to price changes is due to advertising. Other parts of the market are relatively less sensitive to the price like academic books and specialised material.

Availability

For some users of books, price is not the major consideration. The availability and timeliness of delivery of the material is the primary concern. Academic institutions, libraries and some private individuals have particular preferences for books that are unlikely to be filled by mainstream retailers. These are normally low volume orders that are not being dealt with adequately under the current system. Private individuals currently have the ability to parallel import books that they require through whatever source available to them. For many, this means the Internet. Many interviewees commented on the range of books available through this avenue and the price competitiveness of it. However, not all book consumers have access to the Internet and many are understandably cautious about sending payment by electronic means.

For libraries and academic institutions, the parallel importation option is technically not available. Even individual lecturers are unable to import personal copies of academic texts because it does not fit the definition of "personal use". However, we talked to several organisations who regularly used an overseas distributor to source their material. They suggested the overseas distributor had a wider range than the New Zealand agents and provided a quicker service. Using this service was also cheaper than sourcing material locally for those with sufficient volume. This was backed up by other interviewees, including a small bookstore.

The local publishers stated that their provision of books that they currently do not have in stock is fast and any title can be made available within 10 days. Anecdotes from buyers did not back up this claim.

Availability of material was the primary concern of the Australian government when it introduced a time limit on the parallel importing restriction on books. If a publisher did not release a lead title in Australia within 30 days of its release any where else in the world, the parallel importing restriction did not apply. For titles other than lead titles, the limit was set at 90 days. An evaluation of this rule showed that titles were being released much quicker into the Australian market but other factors such as the price had not changed significantly if at all.

The overall impact on the availability of material from a removal of the parallel importing restriction is again uncertain but is likely to lead to a greater range of books. For material such as academic books, the removal of the restriction will allow institutions to order class sets directly from overseas. Under the current restriction, the lack of supply and the high prices mean that students are choosing less appropriate books for their studies. It was suggested that there could be benefits in terms of human capital development from allowing a better match of books and educational requirements.

For popular titles, the availability is likely to increase as described in the price section. For material between the two extremes of popular titles and specialised material, the impact availability is uncertain. One argument is that the "middle" will be squeezed out as fewer retailers or distributors are willing to stock these titles. The counter argument is that provided there is sufficient demand for the titles, there will be an organisation willing to supply them.

Whether the lifting of the restriction will result in the availability benefits described will depend on the amount of control the publisher has over the distribution network. If the international publisher wishes to support its New Zealand agent, then it may refuse to supply a New Zealand order directly. This currently occurs in some instances. If an order is placed directly with an overseas publisher, e.g. on the Internet, the standard reply informs the buyer to deal with the New Zealand agent. However, the New Zealand agent rarely stocks the material being ordered. If the material is distributed by a wholesaler that is not restrained by the international publisher, then parallel importing benefits will be possible.

Overall, it appears that the New Zealand publishers would hold less stock but the range available to the consumer would increase as bookstores would be unconstrained in their ability to order material from overseas to fill consumer demand.

Pre Sales Service

The level of stocks held by bookstores is an important pre-sales service provided to consumers. There is a risk that the removal of or the reduced availability of the sales or return option for retailers under parallel importing will mean that stock available in stores will fall. Without the sale or return option, the retailers would carry more of the sales risk and in response may carry less stock.

Whether the reduction in stock actually occurs will depend to a certain extent on the preferences of consumers. If consumers have a preference for browsing in stores which have a large quantity of stock, then stores which offer this service will benefit. If, on the other hand, consumers prefer to trade off the levels of stock held by a store for a lower price, then it is possible that bookstores with fewer titles on display will develop. Retailers currently feel that they offer a service that consumers want and will continue to provide it.

Another pre-sales service that many believe would dissipate if parallel importing restriction was lifted is promotional and marketing activity. Publishers believe that the consumer will be worse off if the amount of marketing activity undertaken by the agents of the international publishers was to decrease. However, a reduction in such expenditure per se does not necessarily imply an efficiency loss. The current level of such promotional activity undertaken by publishers was not seen as extensive. Most of this was undertaken at retail.

For institutions, the publishers also offer a range of other services including research and reviewing of academic texts, chasing overseas authors to produce material in time for publication to coincide with New Zealand semesters, providing free teaching aids such as teacher manuals, overhead slides, CD ROMs, etc. They also believe that buyers need the information provided by publishers about the different editions of books that are available and what is most likely to be suitable. Without this information, they believe buyers will be unable to make informed purchasing decisions. With increased price competition resulting from parallel importing, the publishers feel that these services would be reduced to the detriment of buyers. Other interviewees indicated that the overseas suppliers were able to supply these services and provide a lower price.

6.2.5 The Net Book Agreement

It is interesting to compare the arguments presented in defence of the current parallel importing restriction with the arguments presented in support of the Net Book Agreement in the UK. The agreement, which can only be described as resale price maintenance, had been in place for almost 100 years before its collapse in September 1995. In 1962, the agreement was determined by the Restrictive Practices Court not to be against the public interest. In support of this decision the judge argued that the uncertainty caused by the removal of the Agreement and the price competition that would result would have a destabilising influence on the market for books to the detriment of the public. The judge suggested that some booksellers would offer discounts on a narrow range of popular books if the Agreement was dismantled. Other booksellers would have to respond to remain competitive and would therefore reduce orders of other books. This would reduce the size of future orders with publishers, creating uncertainty which would translate into reduced print runs therefore increasing publishing costs. The outcome would be higher prices paid by consumers, less stock carried by retailers and a narrow range of available titles as publishers contracted (Utton, 1997, p.4-5).

When then disbanded net book agreement came before the Court again in 1997, the same arguments were discussed. The outcome, however, was very different. The ability of small independent booksellers was again a significant focus but the judge decided with respect to services such as back lists that it was ".. improbable that independent book sellers will abandon the features of their business which are attractive to customers merely because sales of certain front-line titles become more difficult to achieve (Judgement, 1997, p.56)" (reported in Utton, 1997, p.11).

Although the net book agreement was slightly different in character to a parallel importing restriction, it had similar effects on the market - it prevented retailers from offering cheaper alternatives to consumers. In this case, the Court found that the public detriments of maintaining the vertical restraint outweighed any benefits.

6.3 Welfare Analysis

We can estimate the welfare impact by using the price differentials provided in the analysis above as a basis for the possible price changes that we could expect to see in the New Zealand market with parallel importing. Obviously the size of the price differential will depend on the exchange rate assumptions made. Given current exchange rate movements the exchange rate assumptions are relatively conservative.

To undertake a welfare analysis we also need an estimate of the quantity of book sold in New Zealand and the additional quantity that is likely to be sold as a result of the fall in prices. We do not currently have those quantity estimate but we can calculate a proxy for that quantity. From the BERL analysis of copyright industries undertaken for the Copyright Council, we know that the annual household expenditure on books in 1995/96 was $642.3 million (BERL, 1997, p.15). If we further assume that the average price of a book in New Zealand is as our sample illustrates at $25.60, the volume of books purchased must be 25 million. If the price of only a quarter of those books falls due to the introduction of parallel import competition, there will be significant welfare effects. As we have not found an estimate of the price elasticity of books in New Zealand we will assume, conservatively, that it is approximately 0.5.

If we assume the price of books will fall by about $3, which is not unreasonable given the price differences illustrated above, then with a price elasticity of 0.5, we would expect quantity demanded to increase by about 5.85% or about 365,000 books¹⁴. Thus deadweight loss associated with the parallel import restriction in the book market is calculated to be about $550,000.

It should be noted that this is a conservative estimate as it assumes that all of the producers' surplus lost when the price falls, stays in New Zealand. As imports of printed matter in 1995/96 were $275.9 million, this will not be the case. Thus the welfare impact on New Zealand is likely to be much higher.

It should also be noted that the service offered by local agents of international publishers is described as poor by many users and is acknowledged by the industry representatives as such.

Benefits of the restriction allowing exclusive distribution networks:

• dynamic efficiency - encouraging innovation, particularly in New Zealand literature.
  It wasn't clear from any of the interviews that innovation would be affected by any change in the restriction. If anything the removal of the restriction could enhance incentives for innovation.
• reducing free riding in pre or after sales services
  Promotional activity in New Zealand by exclusive agents does not appear to be substantial. The retailers believed that most of the advertising was done at their level of the market anyway. A number of publishers, especially those that supplied technical material, believed they provided an information service which benefited buyers but were not willing to give consumers the option of purchasing the information separately. The reduction of such expenditure may thus enhance efficiency if it is not desired by consumers.
• increasing the range of books available
  Only suppliers felt that the range of books available would fall if the parallel import restriction was lifted. Every consumer or user group interviewed felt that in comparison with the current situation the range available to them would be much greater.
• generating output and employment in the book distribution industry
  Discussions with clients of book publishers suggest that a more efficient alternative is available. The majority of books sold in New Zealand are imported anyway, so whether the distributors do it or the retailers do it, doesn't matter.

Summary

None of the arguments presented by the publishers in support of an exclusive arrangement were supported by their clients. Without a change in the parallel importing restriction, book buyers believed the price in New Zealand would remain high, the availability of non main stream books would be low and the Internet would slowly gain market share as local retailers would be unable to compete on price. Investment in New Zealand publishing would remain but the amount done by the agents of the international publishers would fall slowly over time.

If the parallel importing restriction was lifted there would be major changes in the book market in New Zealand. It is likely that the prices would fall and consumers would be able to access overseas material much quicker than previously. Some smaller retailers may come under pressure as they cannot compete on price with the major retailers. The Internet will remain a viable option for individuals unhappy with the services provided by retailers.

Overall, we believe a lifting of the ban in this market would produce a net welfare gain to New Zealand.

14 The percentage change in quantity is calculated by multiplying the percentage change in price and the price elasticity of demand.