James Mishler wrote a fantastic break down of publishing costs and issues. I just want to add a couple small things or elaborate on a few issues.
The PDF price war is definitely getting worse. People want PDFs for nothing, essentially, and many people will argue that PDFs aren't worth anything on one hand, yet complain if a PDF isn't available along with a print book. So clearly, it's not that PDFs aren't wanted, and they must be useful. I think another thing that has emerged is a POD price war. As James rightly points out, game consumers want prices that are very low in relation to cost of production and all other costs to get a book into the store. Now with POD, we have people offering POD products often at cost of printing or barely over it. Thus we are already starting to see complaints in the pricing of POD products where someone can simply go to Lulu, use their cost calculator to see that a book costs 5.68 to print and the publisher is charging 15 bucks. My GOD they are making money hand over fist!! They're gouging us! Right?
No. So I'd add to what James says about consumers feeling entitled to low PDF prices by stating that people are now feeling entitled to low priced POD books. We are in this shape for probably one main reason. That reason is the people who price their POD books for nothing have a cost of $0 to produce the book, because they either write it themselves, had volunteer writers, did the art themselves, or had volunteer artists. They just want to sell as many of the books as they can cheap, as a vanity press, without the worries of recovering production costs. People see these very low prices and wonder why a product of similar page count can't be so cheap, too. more than that, people are now starting to expect that the POD books be priced for nothing much like PDF books.
Ok, so assuming a publisher hires out this work, why should a POD book be priced at, say, 3 or 4 times the amount Lulu charges to print it? Well, if you go back and look at the price breakdown James gives for how much it costs to produce a book, then also figure that sales volume is very, very low for these POD books, these specialty hobby products must be sold at these rates to cover production costs within a reasonable amount of time.
James mentioned that these days a company really is lucky to sell 500 copies of a book in distribution. Even that is optimistic. Many small publishers are looking more at 200 copies. Mind, this is in distribution, not at Lulu. Sales at Lulu generally will be much lower, though in a few cases lately we are seeing more sales in a shorter time. I don't think that is sustainable.
I want to give a cost breakdown of a theoretical book, using a typical model many small publishers are using. Let's say that I'm sending a 140 page book into distribution, with an MSRP of $20. Here are the costs only of getting it there per unit. These are very close approximates, working backwards.
Retailer buys it from the distributor for about $10
Distributor buys it from the consolidator for about $8
Consolidator takes 18% of the $8, plus a shipping fee, paying the publisher around $6.30
The publisher may be able to get printing done for about $3.30 per unit, and we should add maybe 50 cents per unit for shipping, just as a rough estimate, to bring total "profit" per unit to around $2.50 per unit.
Ok, so what has happened here? We've made enough on our print run to cover the initial investment, but we haven't made enough to recover that investment. In other words, if you think of the money for the print run as a "loan" we make enough to reinvest it in another print run, with a little left over to pay off that investment, but not enough to expand. This is all assuming your production cost was zero. Virtually nobody who bothers to get their book into distribution will have a development cost of zero, so out of those "profits" you better be able to recover cost of development, which for a small print run is at a bare minimum double the cost of your print run, and likely more. If you also consider that many of these print runs will not sell the same number on the second printing, or third, etc. you can see how you might be luckily to just break even in the end, unless you get really really lucky and have a product that turns into a modest hit.
Add all this together, and it is still no surprise that even many of the well known small press publishers are essentially hobby publishers. Almost no one makes a living at this, and they all do it for the "fun." In the end James is right that consumers don't need publishers. I also think he's right that the situation can't change, because for it to change one thing that would have to happen is that consumers would have to be both willing and able to pay higher retail prices.
I will add, though, that the only reason hobby publishers can keep publishing is because they are at least breaking even. If the current trend of valuing PDF and POD books at nothing continues, then the only people who will be able to keep publishing are those who have all volunteer writers and artists. Whether that is good or bad I suppose each person can decide for herself/himself, but it definitely will mean less new material out there.