BETTING ON BLOCKBUSTERS: LESSONS FROM BOOK AUCTIONS

the Program on Negotiation at Harvard Law School(www.pon.harvard.edu)

The U.S. book industry is in trouble. Most major U.S. publishing houses cut jobs and froze salaries at the end of 2008. Publishers Weekly magazine predicted that 2009 will be "the worst year for publishing in decades." Yet even as ambitious editors move their Manhattan power lunches from trendy restaurants to diners, they rely again and again on an expensive, high-stakes tool: the book auction.

Though some writers manage to negotiate contracts on their own, and a growing number self-publish, many rely on well-connected literary agents to deal directly with editors. In exchange for 10 percent or 15 percent of their clients' earnings, agents serve as matchmakers between the manuscripts (or book proposals) they love and the editors whose tastes they have learned over lunches and literary functions.

After taking on a client, an agent pitches her book to editors at different publishing houses. A lucky writer might get one offer and a modest advance. If a writer is very lucky, multiple editors clamor for her book, in which case the writer's agent might hold an auction via phone or e-mail.

Book auctions have proven extremely lucrative for authors and agents -- and extremely risky for publishers. Yet even as they fight to operate in the black, many publishers continue to spend exorbitant amounts in high-profile auctions.

The pros of book auctions ...

In the midst of a recession, why do publishers continue to blow their budgets on auctions? Why not bid more conservatively on a larger number of books?

Because the "blockbuster strategy" works fairly well, writes Anita Elberse in the Wall Street Journal. Consider that books, like movies and TV shows, are risky commodities: It's impossible to know whether a particular title will appeal to consumers' changing tastes. Given this uncertainty, editors pounce on books similar to recent hits, a tendency that agents use to drive up prices.

For publishers, spending lavishly to acquire and heavily promote a small number of highly promising titles and then using the proceeds from big sellers to fund less flashy books has proven to be a more effective business model than placing a larger number of smaller bets.

Of course, paying high prices at auction also carries a risk. Publishers often overbid, a fact that they learn only after a book sells poorly. Not only does the publisher suffer financially in these cases, but the writer also may have trouble selling his next book, and the agent's reputation could diminish as well.

At the heart of this lose-lose-lose scenario is a well-documented phenomenon in auctions: the "winner's curse." When parties are bidding on a commodity of uncertain value, the winner typically will pay more than the commodity is actually worth. It's the losing bidders in the middle range who generally make the most accurate estimates. Many book auctions result in publishers spending huge amounts on promotion and marketing in a desperate attempt to recoup their investments. The current state of the publishing industry suggests that the model that relies on book auctions and hefty advances needs an overhaul.

The book industry isn't the only one that relies on high-risk auctions. If auctions are out of control in your field, consider whether the following three strategies could lead to better outcomes:

1. Negotiate instead. Struggling to stay afloat, some publishing houses are exploring alternatives to the current model. Most notably, in April 2008, HarperCollins launched a unit called HarperStudio that, rather than paying advances to writers, promises them as much as 50 percent of their books' profits. Because the unit doesn't pay advances, it doesn't participate in auctions.

In September 2008, HarperStudio publisher Robert S. Miller, an industry veteran, described on his blog how it felt to be skipping book auctions: "In the beginning, we missed the adrenaline rush and the thrill of outspending our competitors. But as anyone who has ever gone to an estate auction off some roadside in Vermont knows, this also means that we aren't buying things in the heat of the moment, furniture that we start regretting before we've barely lifted the broken pieces into the back of the car."

2. Hold a "negotiauction." Negotiating one-on-one with agents and writers works fine for small publishers, but auctions could be a hard habit for major publishers to break. If a house routinely declined to participate in auctions for blockbuster books, agents would stop sending that publisher the most promising manuscripts on the market, writes Elberse.

When you're wary of auctions but need to participate now and then, a hybrid negotiation-auction process may be your best bet, Harvard Law School and Harvard Business School professor Guhan Subramanian writes in his forthcoming book, "Negotiauctions: New Dealmaking Strategies for a Competitive Marketplace" (Norton, 2009). In a negotiauction, several potential buyers have the chance to negotiate individually with a seller for a coveted asset; the buyers also engage in one or more rounds of competitive bidding to narrow the field. A negotiauction process can help bidders gain more accurate information about an asset than an auction would allow.

3. Avoid the winner's curse. When a seller isn't open to negotiation, you must decide whether to enter an auction and, if you decide to enter, how much to bid. In such cases, Subramanian advises you to determine whether you have an "edge," or comparative advantage, over other bidders.

Specifically, evaluate whether you have an edge in terms of (1) your ability to assess the value of the commodity, or (2) the skills and resources you can use to maximize the commodity's value. If you do have an edge over other bidders, you should be able to bid comfortably up to a set limit. If not, you should bid conservatively or stay out of the game. In the publishing world, for instance, an experienced editor who works for a large company with strong distribution channels is likely to have an edge in an auction for a mainstream title, but perhaps not in an auction for an edgy novel by a young writer.