Apple and five of the "Big Six" trade publishers are reportedly under investigation by the Department of Justice for antitrust violations. The point of concern is the five publishers' staggered but identical move to an agency rather than a wholesale pricing model, not just for Apple, but for all e-book retailers – a move that caused e-book prices for consumers to rise.
But the DoJ's investigation and a related civil lawsuit touch on issues bigger than rising e-book prices or even collusion between publishers. The cases are also about who has the right to sue e-book publishers, the nature of publishers' bilateral interactions with Apple and other retailers, and whether it's even possible for a true agency model to exist for virtual goods like e-books.
In an interview with The Wall Street Journal's Thomas Catan, Justice Department antitrust official Sharis Pozen outlines the framework guiding the agency's investigation. The real issue, Pozen says, isn't the agency model, but secret agreements between competitors.
"We don't pick business models – that's not our job," Pozen told the WSJ. "But when you see collusive behavior at the highest levels of companies, you know something's wrong. And you've got to do something about it."
Pozen points to the DoJ's 2010 case against Apple and other technology companies, who in a settlement agreed to refrain from any agreements not to poach each other's employees. The ultimate effect of such agreements doesn't matter; the point is that they're deals at the top of companies to refrain from fully competing with each other – and freeze out companies who don't agree.
Pozen's comments to the WSJ confirm what IP and antitrust experts have told Wired: this is much bigger than agency pricing alone.
"Plenty of business practices raise prices that aren't antitrust violations," says Donald Knebel, an IP and antitrust attorney affiliated with Indiana University's Center for Intellectual Property Research. "Agency pricing is perfectly legal. But something isn't an agency relationship just because you call it that."
Knebel says there are three major points of law at stake in both the class-action suit and the Justice Department investigation against Apple and the five publishers:
- Whether and how the agency model applies to virtual goods;
- Whether Apple and publishers engaged in a "hub-and-spoke" conspiracy or simply "conscious parallelism";
- The status of the "most-favored nation" clause, common to many legal contracts today, which Apple used to ensure that books could not be sold elsewhere at a lower price than in the iBooks store.
There are two legal models that could apply to the publishers' sale of e-books. One is agency; the other is retail price maintenance. In a genuine agency model, the agent doesn't own or bear legal responsibility for the stock; the seller does. Price maintenance simply allows the original seller to set a floor for final customer prices that retailers have to observe as part of their agreement.
According to Knebel, the usual legal tests for whether a retailer is acting as a publishers' agent hinge on issues of liability that don't apply to virtual goods. There is no physical possession of the stock, there are no storefronts catching fire. Knebel says this issue has never been adequately determined in court, even with software in a virtual app store, let alone e-books in a virtual bookstore.
In fact, one of the only points where agency model is being tested in court is Penguin's attempt to dismiss customers' class-action lawsuit over e-book pricing. Penguin's lawyers claim that because Amazon and Barnes & Noble act as its agents, the booksellers' agreements with customers apply to Penguin as well. Since both Amazon's and BN's terms of service include a waiver of a right to sue, customers can't bring a class-action suit against the publishers.
On the one hand, this umbrella could imply that Penguin and other publishers really do have an agency relationship with their digital booksellers. On the other, it puts the cart before the horse; a judge first has to determine that an agency relationship actually exists before deciding whether publishers are covered by the umbrella of retailers' TOS.
Let's suppose that all of this is upheld: A real agency relationship exists, and owners are covered by their agent's TOS with customers, even if they aren't explicitly listed. That means that any app store that includes forced arbitration protects not just the store from lawsuits, but all of the developers and publishers as well. Given recent accusations of fraud in Apple's app store for iOS, those implications are troubling.
With the entire software industry moving to app stores for both desktop and mobile devices, it would be nearly impossible to sue any software developer if the app is sold through an Apple-style agency model and the store contains a mandatory arbitration clause. That's what's at stake.
Even if agency pricing for virtual goods is perfectly legal and acceptable, publishers colluding to more or less simultaneously switch to agency pricing is not. Publishers almost certainly did not meet together in a room to deliberate about how to use Apple to screw over Amazon, or even how to all switch to agency pricing. They probably didn't exchange e-mails or phone calls or communicate with one another in any way. If they did, the case for collusion would be much simpler.
But they didn't necessarily have to. This is why Apple's involvement in these agreements is so crucial. Apple could have served as the "hub" in a "hub-and-spoke" conspiracy, performing shuttle diplomacy between publishers. For example, if Apple said to publishers, "I have an agreement that MacMillian will go first in insisting on agency publishing with Amazon if you will agree to do it after us," that would point to a hub-and-spoke conspiracy.
The alternative is that each of the publishers, separately and bilaterally, came to the same agreement with Apple because it was in their individual interest to do so. This is called "conscious parallelism," and it's entirely legal.
The evidence for any such conspiracy, Knebel says, will not be in Steve Jobs' biography or in any public statements he made – those likely won't even be admissable in court, even if they could be clearly interpreted. The evidence will be in e-mails and meeting notes between Apple and the publishers.
If the Justice Department actually pursues an antitrust case, says Knebel, it must believe that such evidence exists.
In a motion to dismiss the class-action suit filed on Mar. 3, Apple's attorneys pushed back hard against this allegation. Apple claims that publishers' first threats to window e-book releases after print releases occurred in December 2009, without Apple's knowledge or before its entry into the e-publishing marketplace. Apple also notes that it had and has no interest in preserving print sales, and therefore no motive to enter into a conspiracy to do so. Since Apple had no substantive position in the e-book marketplace, and its interests diverged with that of the publishers, it couldn't plausibly be considered to be a conspiratorial hub.
Of course, Apple also (implausibly, I would say) argues that it did not consider Amazon a threat to either its electronics or media sales business: "If Amazon was a 'threat' that needed to be squelched by means of an illegal conspiracy, why would Apple offer Amazon’s Kindle app on the iPad? ... Why would Apple conclude that conspiring to force Amazon to no longer lose money on eBooks ... would cripple Amazon’s competitive fortunes?" [emphasis added]
Even in a legal brief, Apple knows just how to smack Amazon around.
The last point at issue is Apple's agreement with publishers that their books be sold at the same price to all other competitors. In contract law, this is called "the most-favored nation" clause.
"The most-favored nation clause has been suspicious under antitrust laws for years," says Knebel. But at the same time, it's extraordinarily common. "Most law firms, including mine, will agree to charge one client the lowest possible price for the same services," he says.
So even though Apple's insistence that HarperCollins, Hachette Book Group, Macmillan, Penguin Group Inc. and Simon & Schuster Inc all charge the same prices for their books at all e-book stores is what seems on its face the fishiest about the whole affair, it's actually the part that, in the absence of a conspiracy, is most hallowed by practice. A change in its status under federal antitrust law would require the largest revision to current legal agreements, in industries widely separated from publishing and software.
When Apple and the five major publishers went to the agency model, the immediate effect was to raise e-book prices. Also, on the whole, it reduced publishers' profits from e-book sales. Amazon controlled 90 percent of the e-book market and was selling e-books below wholesale cost in order to boost sales. Barnes & Noble and Apple were both still new to the market, so Amazon effectively set the prices for the industry.
It would be nice to think that if you unwound the current agreements between publishers and retail stores across the board, prices would fall again and stay low. But that's probably not the case. $9.99 or less for every book was and remains unsustainable for retailers and publishers alike. It was a price designed to boost adoption of reading devices. Now there are many more millions of e-readers and tablets available.
"Over time the consumer market determines the right price," says Mark Suchomel, CEO of the Independent Publishers Group. Suchomel and IPG have been engaged in their own standoff with Amazon over terms of their contract; Amazon, Suchomel has said, has been using its market power to push for rock-bottom wholesale prices.
"The large publishers currently have plenty of competition and consumers have enough choice outside of the publishers affected by the DoJ suit, that they wouldn't have purchased books if they felt the price was too high," Suchomel added. "I don't feel that prices have been artificially manipulated.
"But if a large player with deep pockets decides to undercut the market and temporarily disrupt the economics of it in order to gain effective control of it," he added, "consumer prices will be artificially low until the market is dominated and then prices will most certainly rise more permanently. The only way to keep prices low is to encourage competition in the long run."
Complicating matters further is the fact that agency contracts are more difficult to write and get approved than wholesale ones. In an e-mail, Lori James of AllRomance EBooks writes of her company's difficulty getting contact back under agency contracts:
This is what's so maddening about this back-and-forth: Amazon's wholesale pricing might take a chunk out of big publishers' hardcover sales, but it decimates independent publishers. Meanwhile, agency pricing benefits the big publishers relationships with other big bookstores, but it makes it more difficult for independents.
Setting aside the legalities, all the arguments about competitive and anticompetitive behavior in e-books seem to turn on how best to carve up the e-book pie among 10 or 12 different market actors.
Those battles radiate through the entire industry. Their fire and fury consumes all the oxygen in the room, leaving pricing and market power back in only a few hands. Customers are then free to choose between their offerings. That doesn't sound much like a competitive market to me.
