On September 6 of this year, U.S. District Judge Denise Cote, from the Southern District of New York, enjoined Apple after having issued a judgment against Apple over antitrust practices in e-book pricing. Accompanying this judgment, Cote issued an injunction restricting Apple’s interactions with publishers for the next five years and ordered the appointment of special compliance auditors to ensure that Apple complies with the order of the injunction.
The State of the Empire: Amazon’s Monopoly
Up until the launch of Apple’s iPad and iBookstore, Amazon had dominated the e-book retail market, having sold nearly 90% of all e-books. Amazon launched its first e-reader, the Kindle, in 2007, which gained widespread acceptance. Amazon quickly became the market leader in the sale of e-books and e-readers.
Amazon maintained its leadership by adopting a “$9.99 or lower” retail price, making it difficult for competition within the e-book industry. At the time, Amazon had a wholesale pricing model with publishers referred to as the “Big Six” (Hachette Book Group, Inc., HarperCollins Publishers LLC, Holtzbrinck Publishers LLC, Penguin Group (USA), Inc., Simon & Schuster, Inc. and Random House, Inc.).
Amazon’s wholesale pricing model made it difficult for competition by allowing Amazon to purchase e-books from publishers at the wholesale price and then sell the e-books at a price of its choosing. This model allowed Amazon to sell New Releases and New York Times Bestsellers at a “$9.99 or lower” retail price, which often matched or was below the wholesale price. Amazon took the loss and kept its e-book retail prices at “$9.99 or lower.”
Talk of Rebellion: Publishers’ Fears
Amazon’s pricing strategy began to cause the publishers’ great fear for both short run and long-term profits. The publishers feared that in the short run the low price of the e-books would eat into the sales of hardcover books, the more profitable area often priced at thirty dollars or more. The publishers also feared that consumers would eventually grow accustomed to the e-books being priced at $9.99 and that price point would deteriorate the prices for all books, threatening the industry’s business model. With Amazon’s growing power in the book distribution business and consumers’ potential demand for even lower wholesale prices for e-books, Amazon would begin negotiating directly with authors and literary agents for rights, cutting out the publishing industry all together.
Publishers, afraid and unsatisfied with Amazon’s pricing policy, decided to take matters into their own hands. Acknowledging that none of them independently could convince Amazon to change its pricing strategy, the Big Six, excluding Random House, began to meet and discuss collective bargaining tactics they believed would motivate Amazon to raise its prices. Apple Inc., 2013 WL 3454986 * 6.
The publishers eliminated existing discounts on wholesale prices of e-books, which would force Amazon to sell their New York Times Bestsellers at a loss. When Amazon failed to change its pricing policies, the publishers began windowing (making the more expensive hardcover version of some of their most popular book titles available to the public before the lower priced e-books). Windowing is considered to be a risky decision because it alienates a portion of the audience; however, Publishers continued windowing and encouraged others to do the same because, if they felt that if they didn’t, “Amazon’s $9.99 predatory pricing w[ould] continue, and [they’d] lose”. Apple Inc., 2013 WL 3454986 * 8. Amazon, however, took the loss and continued to price at $9.99.
Formation of the Rebel Alliance: Apple Joins the Industry
Apple seized the moment and brilliantly played its hand. Taking advantage of the Publisher Defendants’ fear of and frustration over Amazon’s pricing, as well as the tight opportunity created by the impending launch of the iPad… Apple garnered the signatures it needed to introduce the iBookstore at the Launch. United States v. Apple Inc., 12 CIV. 2826 DLC, 2013 WL 3454986 * 3 (S.D.N.Y. July 10, 2013).
As of 2009, Apple’s customers were only able to read e-books through third party software (apps). However, with Apple’s presentation of the iPad, Apple hoped to launch its very own iBookstore. The presentation of the iPad was set to be January 27, 2010 and the authorization to develop the iBookstore was given in November of 2009, leaving little time to create an up-and-running bookstore. Apple Inc., 2013 WL 3454986 * 10.
Apple acknowledged that it could not price the e-books above what Amazon was pricing and still compete. Apple, however, was not willing to bite the bullet, like Amazon, and operate at a loss by fronting the different between $9.99 and wholesale prices. Therefore, it was in Apple’s interest to have Amazon raise its retail prices.
Apple began contacting the Big Six and made clear that it would be meeting with each of the Big Six CEOs. At the time, Apple knew the Big Six wanted to pressure Amazon to raise its e-book pricing above $9.99, publishers were searching for ways to place that pressure, and were willing to coordinate their efforts to achieve that goal.
Following a script, Apple conveyed in each of these meetings that it hoped to be able to begin selling e-books through an e-bookstore within the next 90 days as a feature on a new web-enabled machine. Apple Inc., 2013 WL 3454986 * 12.
Apple began negotiation with the publishers and came up with the following terms that would bring an end to the reign of the “evil empire”: publishers would no longer be allowed to window their e-books; Apple would obtain a 30% commission (the same it was taking from its app store); Apple would protect its sales with a MFN (Most-Favored-Nation) clause, which allowed Apple to match the lowest retail price listed in any competitors e-bookstore; and Apple would be embracing the agency pricing model (which would allow the publishers to dictate the retail price of their e-books) under restraining pricing tiers (Three basic tiers were formed: (1) $12.99 for new release hardcovers priced between $25 and $27.50, (2) and $14.99 for new releases priced between $27.51 and $30, and (3) with $16.99 and $19.99 for new release priced higher than $30).
These terms would allow Apple to compete with Amazon on a level playing field. At the same time, Apple’s entrance into the market would give the publishers a bargaining chip to force Amazon to raise its prices.
The Empire Strikes Back: Application of Antitrust Law
Cotes found that the customers suffered by Apple’s actions in conspiring with the publishers to fix prices in the following ways: (1) they were forced to pay more for e-books, (2) they bought cheaper e-books rather than the ones that they would have preferred, or (3) they declined to purchase e-books altogether. Cotes pointed to the decline in sales of e-books during this time as an indication of this suffering.
Under Section 1 of the Sherman Act “every contract, combination . . . , or conspiracy, in restraint of trade or commerce among the several States” is outlawed. 15 U.S.C. § 1. The Department of Justice had the burden of showing that a (1) combination or some form of concerted action between at least two legally distinct economic entities that (2) constituted an unreasonable restraint of trade either per se or under the rule of reason. Overall, the circumstances must demonstrate a unity of purpose or common design and understanding, in an unlawful and anticompetitive arrangement.
The court found that Apple and the publishers conspired together to fix prices and rejected the defenses that Apple brought forth. During the trial, Apple argued that the evidence did not exclude the possibility that Apple acted in a manner consistent with its lawful business interests. Apple Inc., 2013 WL 3454986 * 46. In order to compete, Apple had to impose the MFN clause and an agency model and was not intending to conspire to fix prices. Apple further argued that a finding of antitrust infringement would only lead to a discouragement of businesses from entering into other markets.
The court rejected Apple’s arguments and held that Apple had violated Section 1 of the Sherman Act by conspiring with publishers to fix the price of e-books. The court, then enjoined Apple from the following prohibited conduct: (1) Apple is barred from making special retail pricing deals with publishers (MFN clauses) and from making deals with publishers that will impact those publishers’ price dealings with other distributors; (2) Apple must wait between two and four years to make direct deals with publishers in the future (timeline specific to each publisher); (3) Apple is barred from bullying or retaliating against any publisher refusing to enter into an agreement with Apple relating t the sale of e-books; (4) Apple is required to have Chinese walls in regards to communication with other publishers about the terms of its negotiations; (5) Apple must treat e-books like apps; (6) Apple has 10 days to turn over information that “reasonably suggests” that publishers were violating any of these rules; and (7) Apple must form an audit committee whose full-time job will be to make sure that Apple complies with the term of the injunction.
Return of the Jedi: Apple will Appeal
In a statement to TechCrunch, Apple announced the following, “Apple did not conspire to fix e-book pricing. The iBookstore gave customers more choice and injected much-needed innovation and competition into the market. Apple will pursue an appeal of the injunction.”
It is essential to remember that the antitrust laws were enacted for the protection of competition not competitors. Apple Inc., 2013 WL 3454986 * 59.
In an industry where Amazon previously controlled 90% of the market, the outcome of this case suggests the spirit of antitrust laws was not served. We shall wait for Apple’s appeal with A New Hope.