In Defense Of The DOJ’s Antitrust Lawsuit Against Apple And E-Book Publishers

[Update: All the publishers settled, prompting credits to customers, but Apple fought it, and in July 2013 lost at trial. Now comes the inevitable appeal.]

Big waves were made yesterday with the United States Department of Justice (DOJ) filing an antitrust lawsuit against Apple and five of the six largest publishers of trade books in the United States, together comprising over half of the New York Times fiction and non-fiction bestseller lists. Here’s the complaint.

The lawsuit alleges (as best can be summarized in one sentence) that, after Amazon introduced $9.99 pricing of popular e-books, Apple conspired with the publishers so they would all simultaneously move from the “wholesale” model (where retailers set their own price after buying at a set price from distributors) to an “agency” model that gave publishers the power to dictate retail prices, after which they coordinated a price hike (with Apple’s permission) to force Amazon to raise its prices or lose access to all those books. Three of the publishers have already agreed to a tentative settlement, while Apple, Macmillian, and Penguin have vowed to fight.

Macmillian’s CEO said the company would have settled, but the DOJ’s terms were “too onerous” and “could have allowed Amazon to recover the monopoly position it had been building before our switch to the agency model.” Keep that in mind for what follows.

The lawsuit has been expected for a long time. Given prior disclosures about pre-suit settlement discussions over the case, a number of consumer antitrust class action lawsuits have already been filed on behalf of e-book purchasers. (Ed Oswald, who thinks Apple should “surrender” the federal case, has been following those cases for a while, check his archives.) If you really want to know the ins-and-outs of antitrust law applicable to the case, read this brief filed by Apple as part of their motion to dismiss the consumer cases, and this brief filed by the plaintiffs in response. I’ll get to my thoughts on the merits of the consumer cases and the DOJ case in a moment.

Few issues in recent memory have produced so much commentary — I suppose that’s what happens when a story hits writers, bibliophiles, techies, and Apple fans and foes all at once — and there’s so much out there about the role of these companies in the e-book market it’s hard for me to even suggest where to begin. Of the many issues of law, business, and the future of book publishing raised by the case, I write to develop just one of those issues: why the DOJ was right to bring it

Even before it was filed, the antitrust claims were controversial, with Steven Pearlstein aptly summing up the core objection to the claim:

What looked to consumers like a great bargain at $9.99 a book looked to others in the industry suspiciously like predatory pricing, or selling below cost today in order to gain a monopoly and raise prices in the future.

So which is better: a market in which Amazon uses low prices to maintain its e-book monopoly and drive brick-and-mortar bookstores out of business, or one in which the major book publishers, in tacit collusion with Apple, break Amazon’s monopoly and raise prices?

More than a month ago, Scott Turow, President of the Authors Guild, echoed the view sentiments that if anyone was a bigger threat to a thriving book market, it was Amazon:

Just before Amazon introduced the Kindle, it convinced major publishers to break old practices and release books in digital form at the same time they released them as hardcovers. Then Amazon dropped its bombshell: as it announced the launch of the Kindle, publishers learned that Amazon would be selling countless frontlist e-books at a loss. This was a game-changer, and not in a good way. Amazon’s predatory pricing would shield it from e-book competitors that lacked Amazon’s deep pockets.

Critically, it also undermined the hardcover market that brick-and-mortar stores depend on. … For those of us who have been fortunate enough to become familiar to large numbers of readers, the disappearance of bookstores is deeply troubling, but it will have little effect on our sales or incomes.  … For new authors, however, a difficult profession is poised to become much more difficult. The high royalties of direct publishing, for most, are more than offset by drastically smaller markets. And publishers won’t risk capital where there’s no reasonable prospect for reward. They will necessarily focus their capital on what works in an online environment: familiar works by familiar authors.

It’s not a trivial objection. Some authors complained bitterly when Amazon played chicken with Macmillan, briefly pulling all Macmillian books from its store when Macmillian wouldn’t play along with the $9.99 pricing, only to relent.

Truth is, as much as I liked paying $9.99 for every new title as a customer, it was hard to see how that would support a thriving and diverse book market in the future. It indeed looked like a short-term ploy by Amazon to bring consumers to the Kindle and eliminate publishing houses as middlemen. In addition to being predatory pricing that could have turned into a price hike, the arrangement was likely bad for the book industry as a whole, because those “middlemen” sometimes serve an important functions in the funding, marketing, and distribution of author’s works.

Thus, before we talk about the Apple–Publisher antitrust violations, we first need to address the potential for an Amazon monopoly. If you’re sitting in the offices of the DOJ’s Antitrust Division, there are two things you have to keep in mind: the law and the market.

Based on the law, was Amazon, which controlled 90% of the ebook market prior to the Apple iBooks “agency” agreement, a monopoly? Maybe so, but it’s exceedingly hard to hold companies liable for abuse of a monopoly power. Having a monopoly isn’t illegal, what’s actually illegal under § 2 of the Sherman Act is “the possession of monopoly power in the relevant market and the willful acquisition or maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident.” United States v. Grinnell Corp., 384 U.S. 563, 570­-71 (1966)(emphasis added). The case against Amazon would be a “predatory pricing” claim, and that’s a lot harder to prove than you’d think; since Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993), virtually no plaintiff has actually prevailed on a predatory pricing claim. (See this article, p. 2.)

In the market, was Amazon going to be a persistent monopoly? If there’s one thing we seem to have learned about the tech industry, it’s that monopolies don’t seem to last very long. Some of the tech industry monopoly cases have resulted in successes. In 2004, Novell, for example, scored a settlement from Microsoft worth over half a billion dollars for claims relating to their NetWare software, but just last December went to trial with their claims over WordPerfect and ended up with a hung jury. By and large, though, the industry moves quickly enough that what feels like a monopoly is often gone within the next few years, nothing like the Trusts of a century ago. The fact that Macmillian had already forced Amazon to back down was an indication that, despite its huge presence in the e-book market, Amazon’s power was limited, and was open to attack from competing platforms like iBooks — even without the illicit agreements.

Which brings us to Apple and the Publishers. If even half the DOJ allegations are true, then we know this much: Apple and the Publishers certainly thought they were doing something illegal. Meeting only in person, using cell phones instead of business phones, deleting emails, et cetera. It’s all salacious stuff. And in the end, they probably had good reason to worry: in antitrust law, “combination” claims are better claims than monopoly claims.

In my humble opinion, Apple and the publishers have only a small chance of getting the case dismissed in light of the specific allegations of collusion in the DOJ’s complaint and the Second Circuit’s opinion in the online music price-fixing case. Let’s quote part of it:

Under Section 1 of the Sherman Act, “[e]very contract, combination . . . , or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is . . . illegal.” 15 U.S.C. § 1.  The crucial question in a Section 1 case is therefore whether the challenged conduct “stem[s] from independent decision or from an agreement, tacit or express.”  Theatre Enters., Inc. v. Paramount Film Distrib. Corp., 346 U.S. 537, 540 (1954).  Although parallel business behavior “is admissible circumstantial evidence from which the fact finder may infer agreement,” it does not itself constitute a violation of the Sherman Act, because it is “consistent with conspiracy, but just as much in line with a wide swath of rational and competitive business strategy unilaterally prompted by common perceptions of the market.”  Twombly, 550 U.S. 553-54 (internal quotation marks omitted).

… [D]efendants claim that the conduct alleged in the complaint “would be entirely consistent with independent, though parallel, action.”  Appellee’s Br. 20.  Under Twombly, allegations of parallel conduct that could “just as well be independent action” are not sufficient to state a claim.  550 U.S. at 557.  However, in this case plaintiffs have alleged behavior that would plausibly contravene each defendant’s self-interest “in the absence of similar behavior by rivals.” 7 Areeda & Hovenkamp § 1415a (2d ed. 2003); see also Posner, supra, at 100.  For example, it would not be in each individual defendant’s self-interest to sell Internet Music at prices, and with DRMs, that were so unpopular as to ensure that “nobody in their right mind” would want to purchase the music, unless the defendant’s rivals were doing the same.  For these reasons we hold that the SCAC states a claim under Twombly.

According to the DOJ, the publishers all signed identical agreements with Apple in the course of three days, agreements under which all of the publishers, in concert, raised their prices from the Amazon-imposed $9.99 to higher prices and coordinated “tiers” of pricing. That’s not “parallel” conduct — it’s a classic example of a “combination” designed to raise consumer prices. The fact that Apple was right in the thick of it, demanding a 30% royalty while allegedly assuring each of the publishers that several other publishers were all doing the same thing, is icing on the cake, and is by itself likely enough to get the case to the jury.

But that’s not the only reason I think the case is appropriate. As I mentioned before, if you’re sitting in the offices of the DOJ’s Antitrust Division, there’s two primary issues you keep in mind: the law and the market.

In terms of the law, the DOJ’s case is solid: if the facts alleged are true, then the law is as favorable to the DOJ’s claims against the Apple and Publishers as any antitrust plaintiff will ever get.

The real issue is the market, and the DOJ got it right: the DOJ’s demand of the companies is genuinely aimed at improving the consumer market while recognizing the fast-paced reality of the content publishing industry. Here’s what Attorney General Holder said the settlements demanded:

If approved by the court, this settlement would resolve the Department’s antitrust concerns with these companies, and would require them to grant retailers – such as Amazon and Barnes & Noble – the freedom to reduce the prices of their e-book titles.  The settlement also requires the companies to terminate their anticompetitive most-favored-nation agreements with Apple and other e-books retailers.

In addition, the companies will be prohibited for two years from placing constraints on retailers’ ability to offer discounts to consumers.   They will also be prohibited from conspiring or sharing competitively sensitive information with their competitors for five years.   And each is required to implement a strong antitrust compliance program.

The settlement doesn’t compel the publishers to use a wholesale model or a retailer model; instead, it mostly just limits what they do for the next few years, particularly the next two years. As Tim Carmody says at Wired’s Epicenter, “In fact, in five years, we may end up with exactly the same kinds of agreements publishers and retailers have today. But that will be a decision made by the market, not by any real or perceived conspiracy between publishers and a single retailer that imposed that model on the market.”

That’s exactly what the DOJ should be doing: halting the collusive agreement for a time, and then allowing the market to flourish naturally. The problem here isn’t that the agency model is objectively a bad way for the book market to be structured, but that the agency model arose as the result of illegal collusive deals. Whatever the marketplace demands, the structure setup by Apple was not a functioning free market but an anticompetitive ploy.

It is just as Theodore Roosevelt said at the Convention of the National Progressive Party in 1912:

Wherever in any business the prosperity of the business man is obtained by lowering the wages of his workmen and charging an excessive price to the consumers we wish to interfere and stop such practices. We will not submit to that kind of prosperity any more than we will submit to prosperity obtained by swindling investors or getting unfair advantages over business rivals. …

It is utterly hopeless to attempt to control the trusts merely by Antitrust Law, or by any law the same in principle, no matter what the modifications may be in detail. In the first place, these great corporations cannot possibly be controlled merely by a succession of lawsuits. The administrative branch of the Government must exercise such control.

That’s what the DOJ did today, and they should be applauded for it.

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  • Laura

    I understand that the collusive behavior of Apple and the Big Six publishers was probably illegal, but the final TR quote doesn’t actually pertain.

    The publishers made *less money* from each book sold on the agency model than they did from wholesale pricing. Agency pricing was not meant to raise/guarantee their profits but a move, made at a loss by the publishers, solely to stop Amazon’s predatory pricing and its future control of book publishing and retail.

    Perhaps that doesn’t make a difference to the DOJ, but it’s galling that to get people to grasp what is at stake here, we will basically have to wait until Amazon cements its power in these areas and then finally does all the stuff that is the ultimate goal of any monopoly: raises prices & “rationalizes” or streamlines the market to reduce cost. The latter means paying authors less and trimming away all poorly-performing products by focusing one a very few big hits. People think that that’s what big publishers do now, but they ain’t seen nothing yet. When there’s only one big publisher and one big bookseller then author they decide they don’t care about might as well give up before he or she starts writing.

    • http://www.litigationandtrial.com/ Max Kennerly

      Thanks for the thoughtful comment. Those are good points, and I think it’s undeniable that Amazon’s predatory pricing provided the initial impetus for the collusive agreement to switch to an agency model. That said, there are two issues to keep in mind.
      First, the fact that the publishers were paying more to Apple than they were to Amazon is part of what implicates Apple’s antitrust liability. The Department of Justice alleges that the sudden switch to an agency model with such a high royalty to Apple doesn’t make sense outside of the collusive agreement, and I think they’re right. Apple will have serious problems trying to avoid liability for serving as the “hub” of a hub and spoke conspiracy.
      Second, I agree with you that Amazon likely intended to raise prices at some point, though the extent to which they were going to is a little bit unclear, and depends upon what their final objective was. (Raise prices of Kindles? To serve as a loss leader to other parts of the business? To sell ebooks at or near cost and then make money on the float, much as they do with most of their merchandise?) But this exact same argument applies to Apple and the publishers. As the Department of Justice alleges, and as I think can be reasonably inferred, the publishers didn’t switch their pricing model just so they would end up paying a higher royalty to Apple forever. They switched so that they could combat Amazon’s low pricing, and once that was out of the way they could slowly start ratcheting prices back up in tandem.
      That last fact – the fact that the publishers worked in tandem to set up the system and clearly intended to keep working in tandem in the future given the pricing tiers to negotiate with Apple – is what likely sinks them, and is part of why I agree with the DOJ’s decision to prosecute.
      As I mentioned in the post, the Department of Justice isn’t banning the agency model forever, it is more intervening to allow the anti-competitive effects to dissipate and let the market come to its own decision in the next few years. I think that’s appropriate, that I would far prefer that solution to a deal hammered out among supposedly competing CEOs at a posh Manhattan restaurant.

    • Parker

      Remember, too, that part of the publishers’ objective was to curtail discounting which was causing cannibalization from their cash cow hardcover sales. Instant read and cheap was a powerful draw, compared to cheap but slow hardcovers shipped from an online discounter, or instant and not as cheap purchased locally.

      I think the DOJ acted correctly by addressing a negative, collusionary price fixing case that existed today, as opposed to worrying about a potential future monopoly boogeyman.

      As far as a future that would see Amazon “trimming away all poorly performing products” it hardly seems likely when said products cost next to nothing to maintain. One of the stunning changes wrought by ebooks is that no book need ever go out of print again. It may be digital only, but at least the low print run backlist titles will have a haven going forward.

  • http://post404.com/ Randall Arnold

    Beautifully put. Love the objectivity and attention to core details.

  • Chepito

    What did you think of Section IV.B of the settlement? It seems to be a limitation on predatory pricing:

    Section VI.B permits a Settling Defendant to negotiate a commitment from an e-book retailer that a retailer’s aggregate expenditure on discounts and promotions of the Settling Defendant’s e-books will not exceed the retailer’s aggregate commission under an agency agreement in which the publisher sets the e-book price and the retailer is compensated through a commission. In particular, Section VI.B grants Settling Defendants the right to enter one-year agency agreements that also prevent e-book retailers from cumulatively selling that Settling Defendant’s e-books at a loss over the period of the contract. An e-book retailer that enters an agency agreement with a Settling Defendant under Section VI.B would be permitted to discount that Settling Defendant’s individual e-book titles by varying amounts (for example, some could be “buy one get one free,” some could be half off, and others could have no discount), as long as the total dollar amount spent on discounts or other promotions did not exceed in the aggregate the retailer’s full commission from the Settling Defendant over a one-year period. This provision, which works with Sections V.A and V.B (which enhance retailers’ ability to set e-book prices), allows a Settling Defendant to prevent a retailer selling its entire catalogue at a sustained loss. Absent the collusion here, the antitrust laws would normally permit a publisher unilaterally to negotiate for such protections.

    • http://www.litigationandtrial.com/ Max Kennerly

      I’d have to read it more carefully — based on the descriptions I’ve seen, it is designed to keep the publishers from going back to Apple and then essentially replicating what Amazon did by running predatory pricing. The difference there is that, while Amazon is a single entity, the publishers are multiple supposedly competitive entities, and if they colluded to create predatory pricing against Amazon, that would run afoul of antitrust law. In any event, it’s another limitation that expires after a fairly short time frame, and so largely works to let the market settle down for a little bit.

      • Chepito

        I disagree. Why is it placed under “permitted conduct” in the settlement (activity that the publishers probably negotiated to allow it to do, rather than limiting conduct). It talks about permitting a retailer to ” to prevent a retailer selling its entire catalogue at a sustained loss ” And why is it described as “protections” that the publisher could negotiate for?

        “the antitrust laws would normally permit a publisher unilaterally to negotiate for such protections.”

        It seems like it is designed to prevent any retailer from selling each publisher’s line of books at a total loss. There can only be discounting if the publisher’s line is profitable. So under this type of contract, Amazon and others can only discount in a non-predatory manner. You are permitted to prevent a retailer from going into the red.

  • http://twitter.com/mercedeskat45 Carole M. Di Tosti

    The TR quote is perfectly apt. He was a champion of the anti-trust laws. Of course, Rockefeller (Standard Oil) was not. To him and other corporations, competition is a “sin.” That’s what the elites feel. See pg. 75, The Unseen Hand.

    So is it possible? The public will win? OMG. WTF? If the free markets were allowed to operate without collusion, price-fixing and monopolistic action, our economy would be thriving. Innovation drives change and growth…very different from price-fixing, collusion and conspiracy to end free markets…with mergers and acquisitions and short selling and rumor milling to drive stock prices down (something the ratings agencies do beautifully) amongst other things which ended some Wall Street firms like Bear Stearns and LB. Too bad the DOJ can’t use anti-trust laws against banks that are too big to fail or intervene when there are mergers that eliminate competition. If this admin. DOJ can do it…yeah!!! Certainly, under the Bush Admin. ha, ha, ha…it was an ELITE FREE FOR ALL AND THERE WAS NO “SIN” FOR THEM TO WORRY ABOUT!

    See paragraph 2 of this article I wrote BEFORE THE SUIT WAS FILED:
    http://technorati.com/business/article/justice-department-threatens-to-sue-apple/