Question:
I work in the public library field. Vendors supplying libraries with electronic resources that are mature products (and will only be sold to libraries) have one way to grow revenue: price increases. Every library that can subscribe already does; new university and public libraries are not launching to replace ones that close or consolidate. Librarians and their patrons want the online platforms to continuously improve the UI and update features, in addition to keeping up with the explosion of content.What is a reasonable annual price increase percentage to provide a company their sustainable return? My gut instinct is that the vendors will need to increase their price a little over the CPI to be sustained. Maybe a rate tracking average AA intermediate bond rates over the long term is a reasonable starting point.
Most libraries are publicly funded and their budgeting processes cannot work with fluctuating and unpredictable rates of increase, so most vendors have settled into a 4-5% annual increase rate. What does a microeconomist say?
Answer:
You have posed an interesting question. Before answering your question, though, it is helpful to take a short detour into economic theory to understand how prices in a market like the one you describe are set.
Vendors supplying electronic resources to libraries are effectively monopolists. That is their product is distinctive, if not unique, so they have a degree of pricing power. This means that they have to worry about how the price they set affects the number of libraries that purchase their resource.
Most of the cost of producing an existing online resource is the fixed cost of assembling it. This has already been incurred, however, so doesn’t affect the vendor’s decision (in economics terminology, it is a “sunk cost.”). There are likely costs of maintaining and updating the data, keeping software up to date, keeping servers up and running, and possibly (as you suggest) improving the UI or otherwise making the product more appealing. To a first approximation, these costs don’t depend on the volume of sales. So the annual cost of providing the resource is fixed, call it C. As a result, the marginal cost of supplying any one library is zero and the average cost of supplying all users is decreasing as more libraries by the product.
Demand for the resource depends on its price. Each library has a fixed budget and purchases a bundle of resources that are intended to meet the needs of its users. The more it spends on any one resource the less it has to spend on others. Some libraries will value a particular resource more than others, so that we can describe the demand for the resource as a decreasing function of the price. The lower the price, the more libraries will conclude its value to users exceeds what they have to pay.
Assuming the vendor charges all buyers one price, the marginal revenue (the additional revenue) from each additional sale is less than the price, because gaining an additional sale requires lowering the price, which reduces the revenue from all the libraries that were already purchasing their resource. As a result the marginal revenue curve, graphed as a function of the quantity sold is below the market demand curve, and the vendor maximizes revenue by aiming to sell the quantity at which the marginal revenue from the last sale is zero (equal to their marginal cost). In other words, assuming they know the market demand they set a price at which sales correspond to this quantity. And they will continue to offer the product so long as total revenues exceed their marginal cost of supplying the resource.
Now we can think about the question you posed: how much can vendors increase prices from year to year? Assuming nothing else changes, then market demand for their product is likely to increase at the same rate as library budgets. But if the vendor can make improvements that make their product more valuable to libraries it can aim for something larger than the rate of increase of library budgets. On the other hand, if new and more attractive resources are continually emerging then perhaps it must increase prices more slowly to retain its share of the market. How much they invest in updating their resource is also something they can vary to maintain profit margins.
A more realistic model would recognize that vendors make decisions over several years, and have to plan to recoup the up-front costs of creating the resource, or that they may seek to add features or coverage that makes them more attractive to libraries, and that they consider the trade-off between the costs of these activities and the effects on their bottom line.
