An innovative 21st-century business model fell victim to 19th-century antitrust law, as the U.S. Supreme Court refused to consider
Apple complained the decision by the Second Circuit Court of Appeals could scare others away from entering into so-called "vertical" agreements allowing companies to sell their wares on new electronic platforms. But the government successfully argued Apple's vertical agreements facilitated a good old-fashioned horizontal conspiracy among publishers who wanted to lift e-book prices above Amazon's hated $9.99.
The die may have been cast back in 2010 when the late Steve Jobs showed off his company's new iPad by purchasing an e-book from the new iBookstore for $14.99. Why would anybody pay $14.99 when Amazon was selling the same title for $9.99, a reporter asked?
Jobs paused, according to a lower court's accounting, and with a “knowing nod” said "the price will be the same” because publishers will force Amazon to adopt Apple's pricing scheme. Simon & Schuster’s general counsel later called Jobs' statement “incredibly stupid,” and the government used it as evidence Apple was a co-conspirator with the publishers. That exposed it to per se liability, a much stricter standard than the rule of reason courts use to judge other antitrust claims.
Under the rule of reason, used with most vertical arrangements such as those between retailers and suppliers, companies can present evidence their strategy makes economic sense and benefits consumers. Horizontal agreements among competitors are generally considered per se illegal.
The government's allegations -- supported by 33 states -- drew derision from many critics because Apple was trying to bring competition to a market that Amazon dominated with 90% share and e-book prices fell after it broke in. But the government successfully argued Apple went too far by cajoling five of the six biggest U.S. book publishers into signing identical contracts to offer e-books on its new platform.
The problem Apple was trying to crack was Amazon's strategy of selling e-books below wholesale cost in order to cultivate the market for its own Kindle reader. Consumers got the benefit of Amazon's willingness to split its profits between e-books and traditional paper volumes, but publishers hated it because the lower price of e-books could cannibalize hardcover sales. They didn't see any way out, however, because if they delayed the release of e-books that would only anger their customers and stimulate piracy.
Jobs prodded an Apple vice president, Eddie Cue, to figure out a solution so Apple could offer e-books with the new iPad. Cue quickly determined Apple needed to avoid the wholesale strategy by going to an "agency" model where publishers set the price and Apple collected a 30% commission.
He met with all six of the largest publishers and made it clear he needed them all to go along. He detailed the proposal in e-mails Jan. 3 and 5, 2010: Publishers should peg their prices to hardcover list prices and they needed to shift “all other resellers” to the agency model.
That last provision was legally questionable, so Apple solved it by demanding most-favored-nation status instead, under which they agreed not to sell e-books anywhere else for a lower price. In the negotiations over the price caps, for example, Cue played matchmaker, arranging for the chief of Macmillan to speak with the heads of Simon & Schuster and HarperCollins. Eventually all but Random House signed off.
It was that active role at the center of things that tagged Apple with liability. It ultimately agreed to pay $450 million to settle claims (including $30 million in legal fees) pending the resolution of its Supreme Court appeal. Publishers already settled their claims for $166 million.
