It’s About Time! DoJ Sues Over E-book Price Fixing

On Wednesday the U.S. Department of Justice filed an anti-trust lawsuit against Apple, Hachette Book Group, HarperCollins, Macmillan, Penguin Group USA and Simon & Schuster.  (Note: Hachette, HarperCollins and Simon & Schuster have tentatively agreed to a settlement and, if approved, should be removed from the list of defendants.)

In the past couple years our favorite gadget news sites have sometimes resembled legal reporter sites because of all the inter-company lawsuits, but this lawsuit is significantly different than those lawsuits. It also gives us a view of the effects of digital technology in the book industry, while shedding some light on Apple’s mindset when it comes to competition.

So, what makes this lawsuit different than the slew of patent cases we’ve been bombarded with over the past couple of years? Well, a couple of things. First, it was brought by the U.S. Government and not another company.  The government is going to try to show that the publishers conspired to and did violate the Sherman Antitrust Act (or what we lawyer types refer to as 15 U.S.C. §1). The Sherman Act was passed back in 1890 and was named after its principal author Senator John Sherman (Republican from Ohio). The act allows the U.S. Government to prevent private businesses from engaging in anti-competitive activities. Most notably, it is the law that prohibits monopolies and cartels (multiple companies acting as one).

By the way, when a case brought by the U.S. Government is announced in the courtroom, it is often done by the statement, “The People of the United States vs. ”. It takes a pretty hardened defendant or attorney not to understand the weight of a matter so entitled.

When companies are allowed to become monopolies or when a group of companies conspires to work together, the price of their products tends to rise. That’s when the U.S. Department of Justice is supposed to step in. There have been a number of famous antitrust cases bought by the U.S. against companies such as US Steel, Standard Oil, IBM, AT&T, and Microsoft.

Okay…for the three of you still awake, let’s move on to what happened in the e-book industry that led up to this.

When Amazon released the first Kindle reader, e-books started to become popular. One of the key reasons was that their prices were lower than their paperbound equivalents. That made sense to most people. The publisher no longer had to print books, buy paper stock, or ship and take returns on their books. Amazon also no longer had to purchase and hold them in inventory or put them in a box to ship to their customers. So, by removing these costs, publishers and eBook sellers could retain their profits simply by deducting their cost savings from the price of the book.

Prior to 2010, e-books and paperbound books were sold to resellers at a 30% – 65% discount off the cover (retail) price and the resellers were then free to set their own selling price. So, if a book had a list price of $20 and the reseller paid $8 for it, the store could sell the book at any price it wished with the difference between the selling price and the cost being the gross profit on the item. Consumers could then shop around for the best price on that book.

Amazon began pricing e-books aggressively ($9.99 or lower) in order to increase sales volume and make the Kindle more attractive to purchasers. Not surprisingly, people began to buy e-books rather than their paper-based equivalents—and publishers panicked. You see, they had a problem. While the money made on e-books was roughly equivalent to the sale of a paperback edition, it wasn’t nearly as much as the profits garnered from much higher-priced hardcover editions.

Popular books are generally released in hardcover first, at cover prices ranging from $20 – $50; then six to nine months later the paperback version would retail at $5 – $15. The publishers, who appear to have had a little more foresight than their cousins in music and video, understood that the majority of their customers preferred reading on e-readers and that e-books were soon going to dominate their overall sales. This meant that delaying e-books releases wasn’t going to push people to buy the more expensive hardcover version earlier.

The publishers also considered a sliding scale, with pricing of e-books depending on when they were purchased. So that on the first day of availability, the publisher would list an e-book at $25, and then drop the price as time went on. Once again, this idea was discarded as causing customer confusion and discontent.

The publishers were fearful that Amazon was going to become so dominant in this new marketplace that it would have too much power in their ongoing dealings. Publishers prefer to have at least several resellers sell their products so that no single entity can dictate the terms of their business relationship.

Book sales were already under increasing pressure from other forms of media, and then along came Steve Jobs. He had an idea that would help the publishing industry increase their selling prices, reduce Amazon’s dominance in book (especially e-book) sales, and secure Apple’s own black bottom line. Oh, and if it flew in the face of antitrust laws and competition, so be it.

Apple was about to release the iPad, and while we all recognize it as a hit product now, no one was quite so sure back then. Steve Jobs knew he needed to include books along with music and video in the iTunes market place, but didn’t want to get into a pricing war with Amazon. So he convinced (I have a feeling it wasn’t all that hard to sell) the major book publishers to change from selling their products at a discount off a variable list price to selling them at a fixed price and then giving the reseller a 30% rebate or commission. This is usually called an “agency model”.

All e-books resellers are contractually obligated to sell books at the price stated by the publisher.  If resellers discount the price, not only will they will not receive a commission, but they could lose the rights to sell a publisher’s entire library.

Within a month of the iPad’s release and the adoption of the new agency model, consumers were now paying 33% – 50% more for e-books and there was no pricing competition. All resellers charged the same price. Amazon now puts a note by the price of all affected e-books that the price was set by the publisher.

As a result of this industry-wide agreement, some e-books now cost more than they do bound and printed on paper. For instance, you can purchase George R. R. Martin’s A Game of Thrones four-book set as paperbacks for $21.00 from Amazon, but the e-book version sells at a publisher-fixed price of $29.99, the same price it sells for on iTunes, B&N and others.

I believe that Apple and several of the publishers chose not to settle because they know cases like this can go on for years. Eventually they may settle, but they may be able to wait out the current administration in the Department of Justice and get a more favorable settlement, or the case may be dropped entirely.

Anti-trust cases tend to be very complex, with the government bearing the burden of proof.  In order to pursue a violation of this sort, they must allege and ultimately prove that the defendant entered into a contract, combination, or conspiracy, and that it resulted in an unreasonable restraint of trade. While the actual measure is not the “beyond a reasonable doubt” that we’re all familiar with from the criminal trials that often make headlines, it still won’t be an easy case to prove.

Although, it will be some time before a decision of any sort is rendered in this case, it is undisputed that all of the major publishers shifted to a different pricing model around the same time and that it caused the price of e-books to increase substantially.

As for Apple, while it may have been the instigator of this action and certainly has benefited, it still took the publishing companies’ agreement for this to happen. I believe the only real harm Apple will suffer is a diminishment of their reputation among some consumers.

In a public release after the lawsuit was filed, Apple claimed that it did not collude with the publishers and that by opening the iBook store, they have broken Amazon’s monopolistic hold on the e-book industry. They compare their approach to book selling to the way they allow publishers to set prices on apps in the app store.  In my mind, if Apple had opened their iBook store under a standard pricing model, they still would have done well. But the thought of having to compete on price with other e-book resellers wasn’t to their liking. Apple also failed to mention that the sale of music, which is truly analogous to books, through their iTunes store is not under an agency model, but instead follows the more traditional resale model.

As I wrote earlier, anti-trust actions can be very complex, and Apple and the publishers will present a number of defenses and cite cases where minimum pricing has been allowed. I believe those cases to be significantly different than this current action. Perhaps as this case and story unfolds, we’ll keep a running dialog going in the comments section.

If the vast majority of an industry is allowed to work in lockstep on pricing and business terms, it could set a very bad precedent.

Posted in: eBook Readers, News

19 comments… add one

  • Betty Widerski April 15, 2012, 10:41 am

    I wish the Sherman anti-trust act was enforced more widely, e.g., I’m a violist and *every* music supplier sells instrument strings at *exactly* the same price – which for $100 for a professional set I’d like to find some competition. But I guess it depends more on how many consumers are effected whether the government decides to prosecute.

  • Kevin April 15, 2012, 10:47 am

    i believe being allowed to set the price for goods you produce is much better than allowing a retailer to set the price of goods you produce. ebook prices weren’t cheaper before, amazon was simply price fixing them, taking a loss on every book to corner a market so publishers would be held hostage. that’s not how “the market” is supposed to work. publishers should set a price and if they set it too high, people shouldn’t buy their goods, forcing publishers to lower prices. any situation where a middle man has more control than the supplier and buyer combined is a ridiculous situation and should be avoided, even if it means paying 3 dollars more your ebook in the short term.

  • Ken Schoenberg April 15, 2012, 1:07 pm

    Betty, it’s not illegal unless there is some sort of communication between the different companies in an industry. The communication doesn’t have to be verbal or written..there have been cases where “signaling” has been claimed. Most notably the airlines industry.

  • Ken Schoenberg April 15, 2012, 1:18 pm

    Kevin, the publishers have every right to set their own prices. They don’t have to sell their products at a discount to Amazon or Apple or anyone else. They can set themselves up as resellers and sell them direct…as many do.

    What the publishers don’t have the right to do under law is to conspire to set pricing and sales methods. As for Amazon being a monopoly, that wasn’t the case especially when you consider how small the industry was. Barne’s & Noble, Apple and Sony among others were all entering the market.
    Do you believe Apple wouldn’t have sold a ton of books through its iPad? BTW, there is also a law against pricing a product so as to run competitors out of business. It’s called predatory pricing. That wasn’t the case with Amazon though. Look at the current pricing of a standard e-book it’s $13…take away the 30% commission and you come up with a cost of $9.10. Amazon was selling those books for $9.99 or an .89 profit. Face it, that type of margin just doesn’t work in the Apple scheme of things and they colluded to get more and they didn’t care that all consumers would now be paying more because of it.
    If the publishers wanted to make more they could have increased the price of their books or reduced their discount to the resellers. The publisher is always in control of how much money they make per book sold.

  • Steven Horvat April 15, 2012, 1:55 pm

    I have concluded that with the past, and present failings of the Apple company, I will no longer be using their products to the fullest. I will no longer support an Immoral company, I will not be apart of their brand and if at all possible including iTunes. Steve Job’s took his Que to leave while he still can, I am going to do the same… just… not die or anything.

  • Ken Schoenberg April 15, 2012, 3:19 pm

    I want to clarify something about manufacturer/publisher fixed pricing. There are many times where a manufacturer like Apple or Sony want to control the prices their products are sold at. They do that through a number of methods, contracts with their resellers, not honoring consumer warranties if the item is purchased from an unauthorized reseller and stripping resellers of the marketing dollars if they sell below the Manufacturers Suggested Retail Price. The courts have found that to be a legal practice in the past. But in those markets consumers still have a choice, they can buy a computer from a different manufacturer (HP, Sony, Dell, etc.) or they can buy a TV from Samsung, Vizio, etc. The e-book case is different because ALL of the major publishers got together and decided to fix their pricing model. That means consumers have to choose basically between not reading most of the popular books or paying the higher price. The problem gets worse as we get into the world of textbooks, because the consumers there have no choice. They must buy the book for their course.

  • you k who April 15, 2012, 6:58 pm

    I can’t wait till the government takes over everything. That way it will all be oh so fair. Ill get all my stuff for free and well all party like we all work for the GSA!

  • Rd April 15, 2012, 8:39 pm

    @ Steven Horvat , Good luck finding a replacement tech
    Company that has exceptional “moral” qualities . LOL

  • Sandee Cohen April 16, 2012, 7:41 am

    @Ken Schoenberg

    Thank you for one of the best explanations of the situation.

    The day the suit was announced my broker asked me about it. I told him “of course there was collusion” but I couldn’t explain it as well as you did.

    I also didn’t add how difficult it will be to prove it.

  • Jane P. April 16, 2012, 5:02 pm

    @Ken Schoenberg
    Kudos for a great summary of the situation.

    When I original read about Job’s meeting with the publishers about changing the marketing model for ebooks, I did wonder about anti-trust laws …

    And if the publishing companies believe that Amazon.com will eventually monopolize the e-book market, then … they can and should file a law suit of their own (which probably won’t hold water). The big problem is that while it is widely assumed that Amazon plans to drive out all competition and corner the market, unless Amazon does something illegal or actually becomes a monopoly, they probably can’t win a law suit.

    The thing about Amazon.com: they understand how to invest in the future. For instance, all those years they “invested” in the development a state of the art online sales and national distribution system, they did not turn a profit. The same can be said for taking a loss in the ebook sales. Amazon’s now in a position to dominate the eBook business.

    Can the publishing houses adjust their core business to meet this challenge? They obviously were hoping that Apple’s strong support for an “Agency model” would negate that alternative.

    So, I agree with the anti-trust suit.

    Now, I gotta say that I dislike Amazon on so many levels regarding ebooks.

    Amazon’s biggest sin was to shun ePub. They developed their own platform. Why? Purely predatory reasons: purchase their hard ware (kindle), and be tied, forevermore, to Amazon for all ebook purchases.

    The idea behind ePub was to allow anyone owning a eBook reader to purchase, to borrow, and/or to obtain books out of copyright from a variety of sources. ePub supports the very essence of free market competition: consumers select from a variety of ebook readers (based on cost, quality, features), and then select from a variety of ebook venders (based on cost & availability). This promotes innovation and in the eBook readers and competition for ebooks.

    Amazon hit the market with an ugly, shitty and expensive e-reader, but offered economical ($9.99) eBooks which could only be viewed on the Kindle. (Strangely enough, they also have this loyal following which refused to say anything negatively about Kindle.)

    Although Amazon did annually offer improved versions of the Kindle, it wasn’t until B&N’s Nook and the Sony reader heated up the competition that Amazon began to reduce the price & dramatically improve the quality of the Kindle readers.

    The Apple iPad is neat because it does support ePub (and Amazon), and offers its owners the opportunity to select from a variety of ebook sources. But it is expensive and weighs a lot. Apple, of course, wants it’s 30% cut, and it will be interesting to see how that all plays out after the dust settles from the anti-trust suit.

    Hope that’s not too long. But I gotta vent. :)

  • Dan Pierce April 16, 2012, 5:10 pm

    @Ken Schoenberg

    You mention “predatory pricing”. Wasn’t that what Amazon was doing? Selling e-books at little to no profit in order to corner the e-book market? In 2009, the Kindle was starting to take off and publishers worried that if Amazon gained a large enough market share then they would dictate prices(We will sell the ebook for $10 and give you $3.50 for it, deal with it.)

    Apple does not make its money on content. They don’t sell it for a loss but it’s not a huge cash cow for them. They make money on selling hardware. Apple’s fear was that if the Kindle format became dominant then at some point in the future Amazon could decide that they will no longer need to have a Kindle app on iOS and tell people they need to buy a Kindle in order to read the books. iBooks is an hedge against that happening. Apple most likely didn’t care what the price of the ebooks was, but allowing publishers to set their own prices was probably a condition of getting content into the iBook store.

    The sad fact is the companies are not good or evil. They are amoral.

  • Bob DeLoyd April 16, 2012, 6:08 pm

    Dang, now I know why some EBooks cost more than the printed ones. It didn’t make any sense before because EBooks are digital, I’ve written two EBooks, and take up hardly any space;300-600KB on a computer I already own that I use for a bunch of other media stuff and to do work on. Whereas, with a printed book you have to cut trees down, send them to the paper mill, a printing press, bind the books, then sell and ship them… Oh, and when you’re down it sits on a shelf along with other books…

  • Bob DeLoyd April 16, 2012, 6:11 pm

    Should have been: when you’re done it sits on a shelf along with other books…
    Dang, no way to go back to edit it :(

  • Ken Schoenberg April 17, 2012, 1:21 pm

    @you k who – your comment is a bit nonsensical. The government is not taking over anything. They are enforcing the laws that our economic system is based on.

    @Rd – Unfortunately, they are getting harder and harder to find.

    @Sandee Cohen – Thank you for the kind words.

    @Jane P – Thank you too for the kind words. Yes, I believe that authors and even the publishing industry can learn to adjust to a new marketplace. Their work has been digitally captured for decades now beginning with the advent of the word processor. They’ve actually been the slowest of the three major entertainment industries (TV/Movie, music and books) to come up with a workable plan to meet customer desires.

    As for Amazon and ePub. I wish they had supported it as well, but it wasn’t a big deal to me. There are several other standards that the Kindle does support though including PDF. I, in some ways, can see a technical reason for them doing their own format and not a standard. By having their own format they were more free to add features. Of course, that doesn’t mean they couldn’t have supported ePub as well. One of the dangers of large companies supporting standards like ePub comes about when they start “extending” the standards to make it work for them…all of a sudden the standard isn’t the standard any longer (think about Microsoft and HTML).
    All in all, Amazon didn’t harm the ePub standard and it is widely supported by other devices.

    I didn’t buy the first Kindle. I started with the second and thought it to be a fantastic device. I skipped the third and presently own a Kindle 4G basic (returned a Touch). To me switching brands to a Nook or a Sony wouldn’t be like switching from an iPad to an Android tablet. Once I read a book I don’t often refer back to it so a switch would just mean changing where I buy my stuff in the future.

  • Ken Schoenberg April 17, 2012, 1:41 pm

    @Dan Pierce – Amazon was not selling all those $9.99 books below cost. They are a reseller and make their money from the sale of goods. The current pricing of the Kindle line doesn’t leave much room for profits.
    Let’s look at the current pricing model a book sells for $13 and the publishers give the reseller 30%. 30% of $13 is $3.90. If you apply the same pricing model to the old standard Publisher lists the e-book for $13 and gives a discount to the reseller of 30% (it was more in some cases) then Amazon would be paying $9.10 for each book. If they sell the book at $9.99 they’re making a profit. It would be extremely hard to prove predatory pricing when a reseller is selling e-books profitably. Certainly, there are times when resellers sell items at, or below, cost and a charge of predatory pricing is possible. Predatory pricing is at hard, if not harder, to prove than collusion.

    Apple makes a great deal of money on content. They make 30% on every app and book they sell. Based on their financials they are on track to make close to $10 billion in net sales through iTunes, iBooks and the App Store. I believe that amount captures a fair amount of attention at 1 Infinity Loop.

    Companies are not good or evil, but the people that direct and manage them can be either.

  • Steven Horvat April 17, 2012, 2:09 pm

    @Rd

    Well I don’t believe you get how powerful people can be if they even try. I have complete control over my finances, I dictate where and how I spend the funds I feel is necessary. Apple was a great product and and yeah people laugh that I don’t want to deal with them anymore, like I sold my soul or something. They make a great product but there are other companies too, sometimes better then Apple. I have a Nook Color, it does everything I want, It cost 1/2 an Ipad, expandable, apps, movies, and of course, ebooks… most of which I sideload. So go ahead a laugh it up, I’ll be happier knowing I’m not apart of “that” company!

  • Dan Pierce April 17, 2012, 5:16 pm

    @Ken Schoenberg

    I thought I had read that Amazon was, in 2009, buying digital books at $13 and selling them at $9.99 but I am willing to be proven wrong.

    As for iTunes content, sales do not equal profit. From that 30% they have to cover things like promotion, running the iTunes store, iCloud, etc. Even so $10 billion in sales is small compared to the over $100 billion in sales they make in selling hardware and I assure you the margins they have on hardware are quite substantial.

  • Jane P. April 17, 2012, 9:51 pm

    @Ken Schoenberg

    Here is one of the better discussions I’ve read … though long winded (like me).
    http://news.cnet.com/8301-33620_3-57414926-278/of-e-book-pricing-justice-dept-charges-drm-and-pottermore/?tag=mncol;cnetRiver

    This really address my beliefs that we really need to concentrate on eBook distributers dropping DRM and supporting ePUB.

  • Ken Schoenberg April 17, 2012, 10:59 pm

    @Jane P. – I think the sliding price scale is a possibility although I’ll bet no publisher has systems to handle that at the present time. It’s not so easy for large companies to shift the way the do business…both in their minds and their server rooms. They could, however, track their current two-step model.

    Perhaps that’s something they could do down the road. What they could do right now is to adjust their pricing model to take into account their savings and the limitations put on the consumer.

    So, let’s look at a hardcover book that sells at $25. I’m going to take an educated guess and say that printing and distribution costs roughly $5 per book (depending on how many they print, page count, etc.). So…list the e-book HC version at $20 and in both cases give the resellers the 50% discount they normally get. So, resellers could sell the “HC” e-book at somewhere between $10 – $20 and the HC print book at between $12.50 and $25.

    When they issue they paperback version they could then drop the HC e-book version and work the same formula. So let’s say the paperback lists at $9.99 and the printing and distribution costs are $2. They could list the e-book at $7.99.

    Consumers tend to understand that model. It’s not dissimilar from the choices we make on viewing movies and what we’ve been accustomed to with books. We also shouldn’t see e-books priced higher than their paper equivalents. Resellers will be squeezed as the lower list price means a lower sales price, but they too aren’t paying to stock and shipping books to customers.

    I’m not sure if there is a way to save the retail bookstore. Much like retail record stores and video stores I don’t believe enough of the public is interested in purchasing these products from them…even if the prices are the same as the big online resellers. They also have to compete with the big box stores that carry the top 50 books at reduced prices. I used to enjoy going into bookstores, places like Kramer Books in D.C., but there’s really nothing great about the experiences in a Barne’s & Noble store.

    As for the proprietary formats they don’t bother me as much and I believe there is some benefit to them. The capabilities of e-readers is changing relatively quickly with new features and functions added each generation. If there was a standard format it might not be possible for some of the new features. I’m thinking of Amazon’s X-Ray and sync features. I believe that the original ePub formats didn’t support things like font-size, word-spacing or margin sizes. Perhaps an export function would solve the issue.

    Finally, DRM…we all dislike it. In some ways I find it far less bothersome with e-books than with movies or software. I do believe I should be able to lend my book out (and lose the right to access it while it is being shared). I’d also like to be able to donate books as well…perhaps that could be allowed after a certain time had passed after publication.

    With the vast majority of “entertainment” content being produced/published/distributed by a few major companies and a similar landscape for resellers I believe it’s more important than ever that the DoJ be vigilant in enforcing the anti-trust laws.

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