The trial for United States v. Apple Inc. begins on June 3rd, with some saying that the case will “effectively set the rules for internet commerce.” The Government alleges that Apple conspired with five publishing companies to increase prices while simultaneously plotting to increase market share vis-à-vis Amazon. The five publishing companies originally named in the suit have since reached a settlement with the Justice Department in which they will pay a collective $164 million to recompense consumers harmed by the price-fixing scheme.
However, Apple has yet to reach a settlement with DOJ, and recent comments by the presiding judge suggest that the tech giant is likely to receive an unfavorable verdict. Denise Cote, a district judge for the Southern District of New York conducting a bench trial in the case, stated on May 23rd that she believed “the government will be able to show at trial direct evidence that Apple knowingly participated in and facilitated a conspiracy to raise prices of e-books.”
The publishing companies originally named in the suit are five of the six largest in the country and, along with Random House (which was not named in the case), published over 90 percent of the hardcover books on the New York Times bestsellers in 2009. DOJ alleges that the motivation for the price-fixing was derived from concerns created by Amazon’s pricing of retail eBooks at $9.99, substantially lower than that of print copies.
The case highlights the differences between the “wholesale” and “agency” models of book selling. In the wholesale model, publishers sold to retailers at a discounted price. The retailers obtained possession of the books and then sold them to consumers at a price controlled by the retailers. Concerns arose for the publishing companies when Amazon, in an effort to promote its new Kindle reader, began to set the price for eBooks at or below the wholesale prices they were paying to the publishers.
In order to address concerns over the low prices being offered by Amazon, the Government alleges that two of the publishers approached Apple about adopting an agency model of pricing. Under this model, the publishers controlled the retail price of the book directly (by setting the retail price and not allowing the Apple to offer discounts) and Apple received 30 percent of each transaction. Thus, as opposed to the wholesale model in which the retailer sets the price, the agency model allows the wholesalers to directly accomplish this task. DOJ alleges that the publishers, with Apple as their distributional vehicle, sought to artificially inflate the price for eBooks in the market.
Also at issue in the case is the status of “most-favored-nation clauses” (“MFNs”). They are included in contracts to ensure that buyers receive the lowest prices from sellers by granting buyers the right to receive the contracted goods or services for the lowest price that the seller offers to any other buyer. In the abstract, MFNs should be procompetitive because they decrease the cost of inputs (and thus should decrease prices paid by consumers downstream) and because they decrease transactional costs. However, there is increasing concern, especially in the DOJ Antitrust division, that MFNs could be employed in an anticompetitive manner. The fear of anticompetitive MFNs is perhaps most acute where the buyer controls a large percentage of the market share for the good or service. When the buyer in an MFN controls a large segment of the market, decreasing prices to other buyers can be become prohibitively costly for the seller, thus preventing lower prices from being passed on to consumers. More nefariously, MFNs could be used to “police” price-fixing conspiracies by ensuring that no rogue firms undercut the price set by the firms. If one firm sought to sell below the fixed price, the buyers in an MFN contract would demand the lower price, likely alerting the conspiratorial sellers to the breach of the price-fixing scheme.
Apple had MFNs with each of the five publishers in this case, and the government alleges that this created an incentive for the publishers to raise prices. MFNs have the possibility to, intentionally or unintentionally, artificially stabilize or increase prices. DOJs case against Apple will be closely watched as the status of MFNs may be greatly affected by Judge Cote’s ruling.