Apple Faces U.S. Suit Over E-Book Price Fixing Allegations

Apple, Macmillan and Penguin could be sued by the U.S. Department of Justice for allegedly colluding to keep the prices of ebooks high after they refused to engage in settlement talks with the latter, according to a report Tuesday. ^[1] Three other publishing houses, Simon & Schuster, Hachette Book Group and HarperCollins, that were also in the DoJ’s cross hairs, are meanwhile ready to settle the dispute outside the court. The DOJ is alleging that the publishers teamed up with Apple to take on Amazon (NASDAQ:AMZN), which was starting to exert a huge control on the publishing industry with its highly discounted ebook editions.

See our complete analysis of Apple & Amazon here

Amazon discounts ebooks heavily…

Traditionally, book publishers sold their content to retailers for about half the cover price of their physical books. Retailers such as Amazon could then price their books as they wished. With physical books, Amazon rarely discounted the books heavily as the industry was already large with plenty of competition and physical books were being sold widely. Moreover, reading an ebook on a laptop or a desktop was difficult for readers and so this market didn’t take off at first.

However, with the advent of ebook readers, users began to take to ebooks in earnest. Amazon came up with its own e-reader, the Kindle, to help drive sales. Further, seeing the huge growth opportunity that the ebook market presented, it started discounting the ebooks heavily in order to rapidly gain a bigger share of the nascent online market.

…much to the chagrin of publishers

Now this had the publishers worried. Not only did the highly discounted prices cannibalize the sales of their higher-priced physical editions but also undermined the value of their content to such an extent that the publishers were concerned about its long-term impact on their business. This brought back memories of the music industry’s death at the hands of the Apple iTunes. Then, the record companies had not realized the impact of the Internet as a disruptive force and before they knew it, Apple’s iTunes had become a phenomenon selling music for 99 cents.

Apple stages a coup

However now, the shocking precedent made publishers wary and wondering what they could do to avoid a repeat of this scenario. At the same time, Apple was readying plans to launch the iPad and Steve Jobs had his eyes trained on the growing ebook market to supplement his iTunes and App stores and drive iPad sales. An unlikely collaboration ensued. Taking advantage of the Amazon-publishers rift, Apple came up with an agency pricing model that let publishers set the prices of their ebooks while Apple kept a 30% cut for every ebook sold on their iBooks platform in return.

One might wonder why the publishers chose to collaborate with another company that could also pose the same threat to their higher-margin physical books business as Amazon in the longer term. Isn’t the whole online market a threat to their core traditional businesses?

We believe that publishers understood unlike their music counterparts that the online market is here to stay. Moreover, it is only going to grow going forward. If publishers did not embrace the inevitable, they could see their businesses suffer even worse. What Apple was giving them was a better control over the pricing of their content and a chance to play a bigger role in this online boom — a chance that the record companies never got.

Also, it allowed publishers a secondary choice of distributors for their online content, thereby increasing competition and therefore, the value of their content as well. Apple, on its part, got a chance to give its mobile ecosystem a more complete feel with the publishers’ support.

The DOJ sees the potential of foul play

But, wait a minute. How is any of this illegal? Allowing Apple to compete with Amazon doesn’t decrease competition.

But surprising as it may seem, increasing competition in this case may lead to an increase in prices – which the DOJ sees as price fixing. Some have alleged that Apple forced the publishers to not let others sell the same ebooks at a cheaper price through a ‘most-favored nation’ clause in their contracts. Essentially, what this means is that the publishers could price their ebooks higher on the iBooks platform but refuse to sell their content to any retailer that deigns to set a cheaper price. The DOJ is of the opinion that this is a fixing mechanism and has raised anti-trust concerns as it leads to higher prices and lower competition. In particular, if the publishers look to have acted in concert, this could be a violation of the DOJ’s interpretation of price fixing.

We believe that a possible resolution of the conflict could be that Apple and the publishers agree to do away with the clause in their contracts that has the DoJ much concerned while being able to retain their agency pricing model. Or the DoJ may force a return to the wholesale pricing model altogether.

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1. Apple, Macmillan Said to Prepare for U.S. E-Books Lawsuit, Bloomberg, April 11th, 2012 [↩]