Apple entered the e-book market in April 2010, shortly after the launch of its iPad. Amazon launched the Kindle e-reader in 2007 and by 2009, had established a $9.99 price point for e-books. Amazon sold almost 90% of all e-books. The book publishers did not like the $9.99 price, because they thought it was eating into the sales of their hardcover books, threatening the existence of brick and mortar bookstores and threatening their business model. Apple did not like the $9.99 price, because it didn’t want to adopt a low price strategy. From December 2009 through January 2010, Apple met with the top publishers, the Big Six Publishers, to find a way to change Amazon’s $9.99 e-book price point. The result was five of the Big Six Publishers entering into agency agreements with Apple. The agency agreements gave Apple a 30% commission, set a $12.99 to $14.99 price range for e-books and gave Apple MFN status. The MFN clause guaranteed that Apple’s e-book prices would be the lowest retail price in the marketplace and effectively forced the publishers to require all of their distributors, including Amazon, to sign an agency agreement in which the publishers would control the retail prices of books they published. Apple controlled e-book prices at the retail level.
The U.S. Department of Justice (DOJ) filed an antitrust lawsuit against Apple and the five book publishers on April 11, 2012. The book publishers settled and the case proceeded to a bench trial against Apple alone. The district court ruled that the plaintiffs showed by “compelling direct and circumstantial evidence that Apple participated in and facilitated a horizontal price-fixing conspiracy. As a result, they have proven a per se violation of the Sherman Act.” (Opinion pdf page 120).
Sherman Act Violation
Section 1 of the Sherman Act prohibits every contract, combination or conspiracy, in restraint of trade or commerce among the states. 15 U.S.C. §1. The plaintiff must show “(1) a combination or some form of concerted action between at least two legally distinct economic entities that, (2) constituted an unreasonable restraint of trade either per se or under the rule of reason.” (Opinion pdf page 105).
Section 1 prohibits only unreasonable restraints on trade, not all agreements. Antitrust plaintiffs must show that a particular contract is unreasonable and anticompetitive before a violation is found. Agreements that “are so plainly anticompetitive that no elaborate study of the industry is needed to establish their illegality” are illegal per se. (Opinion pdf pages 105-106). Per se means “by itself” or inherently. In antitrust cases, the occurrence of the event makes it a violation. “By contrast, under the rule of reason, the plaintiffs bear an initial burden to demonstrate the defendants’ challenged behavior had an actual adverse effect on competition as a whole in the relevant market.” (Opinion pdf page 106).
Price-fixing agreements are per se unlawful. The district court ruled that the plaintiffs showed by “compelling direct and circumstantial evidence that Apple participated in and facilitated a horizontal price-fixing conspiracy. As a result, they have proven a per se violation of the Sherman Act.” (Opinion pdf page 120).
I blogged about this case in my post, E-book Pricing the Emphasis of DOJ Suit Against Apple and Book Publishers. This case revolves around Apple and book publishers conspiring to change the U.S. book distribution model from a wholesale model to an agency model. In a wholesale model, publishers sell books to distributors at wholesale prices and the retailers set their own prices to consumers. In the agency model, others in the distribution chain are agents of the publisher, so that the publisher controls retail prices. The major points of the district court’s 100 page recitation of facts are discussed below.
The Publishers were unhappy with Amazon’s $9.99 price point and feared that it would have a number of pernicious effects on their profits, both in the short run and long-term. In the short-term, the Publishers believed the low price point was eating into sales of their more profitable hardcover books, which were often priced at thirty dollars or more, and threatening the viability of the brick-and-mortar stores in which hardcover books were displayed and sold. Over the long-term, they feared that consumers would grow accustomed to e-books priced at $9.99 and that the $9.99 price point would erode prices for all books, thereby threatening the business model for the publishing industry. They believed that this low price failed to reflect the true value of many books and also failed to distinguish among books in terms of the effort entailed to create and produce them and in terms of their quality, however one might measure quality.
(Opinion pdf page 15).
The publishers developed a common strategy because they were afraid of retaliation by Amazon if they acted alone. They did not consider themselves competitors on price. They competed for authors and agents.
Apple’s executives began to study the e-book industry in late 2009. Apple’s research indicated that the book market was bigger than the music market in North America and that the e-book market was growing at an exponential rate. Apple wanted to announce an e-bookstore at the iPad launch, but had only two months to get the e-bookstore in place. It decided to focus its efforts on the Big Six Publishers. The Big Six Publishers are Random House, Penguin, Simon & Schuster, HarperCollins, Hachette, and Macmillan.
Apple met with each of the Big Six Publishers in New York in December 2009. Apple knew that the Big Six Publishers were unhappy with Amazon’s $9.99 e-book price point. Apple did not want to adopt a low price strategy. Hachette and HarperCollins proposed an agency model, which Apple initially rejected, but then adopted. Apple already used the agency model in its App Store to sell apps.
Apple proposed an agency model with a 30% commission. The publishers would control e-book pricing and Apple would make a profit without having to compete on price. No windowing e-books would be allowed. “Windowing” is delaying the release of the e-book version following the release of the hard copy version. The publishers previously used windowing to try to force Amazon to raise its $9.99 e-book price point, without success. To keep publishers from setting prices too high, Apple developed a tiered pricing program with caps. The prices would range from $12.99 to $14.99 for e-book versions of hard back books. To keep from being underpriced by competitors, Apple required the publishers to move all of their e-tailers to the agency model. The effect was to remove retail price competition.
Apple later proposed an MFN clause guaranteeing that Apple’s e-book prices would be the lowest retail price in the marketplace and dropped the requirement that publishers place all e-tailers on the agency model. The effect was the same – forcing book publishers to enter into agency agreements with all e-tailers. Apple gained control over the price of e-books when five of the Big Six Publishers signed its agency agreement. Random House was the only one of the Big Six that did not agree to the scheme. Random House did later sign an agency agreement, but only after the other five pressured Amazon into compliance with the agency model.
The MFN effectively forced the Publisher Defendants to change their entire e-book distribution business to an agency model if they wanted to take control of retail pricing. Any other course would be a race to the bottom in e-book prices and would give the Publisher Defendants a fixed share of a far too small revenue stream.
(Opinion pdf page 53).
Publishers actually received less per e-book under the agency model than the wholesale model, so there was no financial incentive for them to agree to the agency model unless the model met longer term goals, such as breaking Amazon’s $9.99 price point.
Thus, in less than two months, Apple had signed agency contracts with five of the six Publishers, and those Publisher Defendants had agreed with each other and Apple to solve the “Amazon issue” and eliminate retail price competition for e-books. The Publisher Defendants would move as one, first to force Amazon to relinquish control of pricing, and then, when the iBookstore went live, to raise the retail prices for e-book versions of New Releases and NYT Bestsellers to the caps set by Apple.
(Opinion pdf page 82).
Macmillan gave Amazon an ultimatum to either sign an agency agreement or not receive Kindle versions of Macmillan’s new releases for seven months. When the other four publishers who signed the agreement with Apple also demanded Amazon sign an agency agreement, Amazon felt compelled to enter into agency agreements with all five publishers. If Amazon didn’t sign the agency agreements, Amazon customers would not have access to many popular titles, hurting Kindle customers and impairing the attraction of the Kindle device. Shortly thereafter, Amazon complained to the Federal Trade Commission regarding the publishers’ actions. The five publishers also forced Google to accept an agency model for the e-book business it was planning.
The iBookstore opened in April 2010. After that, the price caps set out in the Apple/publisher agreements became the new retail prices for those publishers’ e-books. Prices on some hardcover books were also raised, to get the e-book version into a higher tier. The prices increased suddenly and uniformly. The publishers also sold fewer books after the price increases.
Thus, consumers suffered in a variety of ways from this scheme to eliminate retail price competition and to raise e-book prices. Some consumers had to pay more for e-books; others bought a cheaper e-book rather than the one they preferred to purchase; and it can be assumed that still others deferred a purchase altogether rather than pay the higher price. Now that the Publisher Defendants were in control of pricing, they were also less willing to authorize retailers to give consumers the benefit of promotions.
(Opinion pdf page 98).
Antitrust laws are meant to protect both individual consumers and the public. That’s why the district court articulated the harm to consumers.
This case is U.S. v. Apple, Inc., No. 12 Civ. 2826 (DLC), U.S. District Court, Southern District of New York.