The Book Publisher Antitrust Suit Point by Point

Today Penguin filed its answer to the Department of Justice antitrust suit against Apple and the US book publishers (MacMillan and Penguin). Prior to this both Macmillan and Apple  responded to the suit. The Penguin response is 75 pages long, so I won’t be going over it point by point. But it is particularly enlightening in that it restates the government  allegations and responds to each of them. While I was reading the documents, it struck me how much it really addressed the big issues of this litigation.  Penguin did a lot more than simply make the obligatory categorical denials to each of the 103 government  allegations.

Antitrust law is exceptionally arcane and frequently difficult to understand even  by those who specialize in such matters. There are so many exceptions that have been carved out over the years that it is always difficult to determine what the outcomes are likely to be. I know. I have been a plaintiff in 3 suits and a consultant to the Federal Trade Commission in an antitrust investigation, all of them  against  – would you believe? – the book publishers.

Let’s go over some of the key allegations and the Penguin responses.

United States allegation #2.  The government asserts: that e- book sales have been increasing “ever since Amazon released its first Kindle device in November of 2007…..One of Amazon’s most successful marketing strategies was to lower substantially the price of newly released and bestselling e-books to $9.99.”

Penguin response: Penguin admits that e-book sales have been increasing and further  “admits that Amazon’s below-cost selling of certain newly released and best-selling e-books for $9.99,… was a successful strategy for locking consumers into its proprietary Kindle platform and raising a significant barrier to entry.”

[My comment. This is a very revealing response by Penguin. Framed as an admission of the government’s allegation, it includes some  twists on Penguin’s part that go to the heart of their defense. The government implies that Amazon is simply pursuing a typical market strategy to offer  lower prices and  sell more books. Penguin emphasizes that the practice is very selective and that the strategy was initiated to lock consumers into purchasing Kindles and keeping other potential competitors from entering the market. In other words, Penguin is pointing out that the real threat to competition is Amazon, not them.]

US allegation #3. “Publisher defendants feared that lower retail prices for e-books might lead eventually to lower wholesale prices for e-books, lower prices for print books, or other consequences the publishers hoped to avoid….Publisher Defendants teamed up with Defendant Apple which shared the same goal of restraining retail price competition…”

Penguin response: Penguin admits that they had concerns about Amazon’s pricing practices. They point out that Amazon was selling some of these books “well below the prices paid by Amazon to Penguin…for these titles.” They believed that Amazon’s practices were “anti-competitive and detrimental to the long term process of expanding opportunities for developing authors and creating more content.” They also point out the Government’s complaint  “is careful to avoid stating, prior to Apple’s entry, Amazon’s share of eBook sales was 80 to 90 percent.”  Penguin goes on to argue  that Amazon’s practices  were “undercutting the margins and incentives of other booksellers, fostering a perception of eBooks as lower cost commodities, and threatening the viability of book publishers and authors, as well as other bookselling outlets vital to the marketing and promotion of books.”

[My comment. Penguin pointedly mentions  that the government avoids bringing up an inconvenient fact:  that Amazon had 80-90% of e-Book sales prior to Apple’s entry. Again, they are emphasizing that the real competitive danger lies with  the “monopolist-Amazon” and that the result of the publishers – Apple relationship was to increase competition, not to restrain it.]

US allegation #5. The government alleges that Apple and the publishers “jointly agreed to alter the business model governing the relationship between publishers and retailers. Under the old “wholesale” model, “publishers sold books to retailers, and retailers, as the owners of the books, had the freedom to establish retail prices.” Under the new model, “publishers would take control of retail pricing by appointing retailers as ‘agents’ who would have no power to alter retail prices set by publishers.”

Penguin Response. Penguin denies there was any agreement  among the publishers to change the pricing model. They again reiterate their position that “the allegation that there was a ‘robust retail price competition’ before  the adoption of the agency model ignores the indisputable fact that the ‘competition’ was nothing more than the below-cost, predatory, market-domination strategy of a monopolist distributor [Amazon].”

[ My comment. This gets to the heart of the government’s case that the publishers jointly conspired to establish a system that fixed prices at a higher level than would otherwise be the case. Certainly if  the government can establish the factual basis for such a joint agreement, then they will be in a very strong position. Penguin claims here and repeatedly in their answer that there was no joint agreement and that they were simply responding individually  to the anti-competitive practices of  the “monopolist”, Amazon.]

US allegation #8.  The government alleges that after executing the new trade model with Apple, “the Publisher  Defendants all then quickly acted to …[impose the new model] on their other retailers. As a direct result, those retailers lost their ability to compete on price, including their ability to sell the most popular e-Books for $9.99…”

Penguin Response.  Under the new model, “price competition has moved from the retail level to the publisher level. Price and non-price competition both among publisher and among eBook retailers has exponentially increased as a result of the move to the agency model.

[My comment.  Penguin’s apparent argument that price competition continues to be robust because it is practiced at the publisher level, as distinguished from the retail level seems to be a bit of a strain, even if true.  But they do point out that outside of the very limited class of best sellers that Amazon had been selling for $9.99, there is increased price competition. And furthermore the government has not considered the competitive benefits of more players in the market selling more types of electronic readers and even more types of book formats, like enhanced e-Books that did not exist until the iPad.]

Ok. That’s enough for this blog. The complaint goes on with numerous allegations of specific facts that the government hopes  will prove  their case. Probably the most conspicuous allegations (at least from the point of view of publisher tittle-tattle are #39-45, where the government describes repeated meetings  attended by publisher CEO’s at fancy New York restaurants. The government complaint fails to show exactly what was discussed over Chardonnay but insinuates that this was the venue where the agreements were made.

I hope this gives you a little flavor of what the issues are in this case and how the two parties frame those issues.

 

My Letter to the Department of Justice

Everyone in book publishing has been talking about the anti-trust litigation and proposed settlements initiated by the United States against Apple and 5 major book publishers. The government’s case alleges that the defendants agreed to fix prices on e-books and  that these agreements  had the effect of raising prices to consumers. Most people in our business believe   that the United States’ position is misdirected, that the lawsuit will enhance the market power of Amazon.com and that this is the real anti-trust threat to the industry. The Authors Guild representing authors, the American Booksellers Association representing independent booksellers and now the Association of Author Representatives representing literary agents are on record as opposing the position of the Department of Justice. I decided to weigh in, myself, with the letter below. The DOJ is required to consider these letters, so any of you who wish to express your opinions should write to  John Read at the address below.

John R. Read
Chief, Litigation III Section
United States Department of Justice
450 5th St NW
Suite 4000
Washington DC 20530

Dear Mr. Read:

I am writing regarding the proposed settlement between the three book publishers ( Simon and Schuster, HarperCollins, and Hachette Book Group)  and the United States regarding e-book pricing.

I feel that it is wrong for the Department of Justice to focus its anti-trust efforts against Apple and the major book publishers for their implementation of the so-called “agency model” for pricing. There are restraint of trade issues in our industry, but this litigation is misdirected and likely to exacerbate those issues.

The decision by each book publisher to implement agency pricing was in response to Amazon.com’s policy and practice  of setting prices on e-books below cost in order to drive other potential sellers of these products out of the market, thus giving Amazon a virtual monopoly on the sale of e-books. This strategy was  enhanced by the manner in which Amazon designed and marketed it’s Kindle format editions of e-books,  so that those books could only be read on Amazon’s proprietary Kindle book readers, and only purchased on the Amazon web site.  Amazon  refused to allow other potential competitors in the e-book business to sell Kindle edition titles. At the time that publishers began contemplating implementation of the agency model, Kindle Editions accounted for 90% of  book sales on e-book readers.

Amazon was able to  sustain this otherwise ruinous pricing policy, because it could  offset its losses by driving people to its website where they would also purchase more profitable items.

The dangers implicit in this strategy  can be demonstrated. Amazon has shown its willingness to stop selling titles by publishers who will not agree to Amazon’s trade terms. This happened recently with 5000 Independent Publisher Group titles.  As a result, these e-books  are simply not available to the 60% of  all e-book readers who read e-books on their  Kindles.

Amazon’s policies have already had a devastating effect on community based bookstores including the recently bankrupt Border’s, Barnes and Noble, and the thousands of independent booksellers across the country.

The United States should be pursuing policies that discourage excessive concentration in industries, particularly when that concentration will reduce  the free dissemination of ideas in the country. The current litigation and settlement agreements against the major book publishers is doing quite the opposite.

Andy Ross

Andy Ross Agency

Monopoly, Monopsony, and Oligopoly in Book Publishing

Most of  us got into   book publishing because we wanted to make a life  immersed in great ideas and great literature and to share those ideas with others. So how come during the last few weeks all we are hearing about are arcane economic theories explaining restraint of trade?

Several weeks ago the Anti-trust Division of the Department of Justice announced that it had been conducting an investigation into whether the 6 largest US book publishers had combined with Apple to fix prices on e-books. Today the DOJ filed a lawsuit against  Apple,  Macmillan, and Penguin USA alleging that they had made agreements to restrain trade and keep retail prices for e-books higher than they would otherwise be under free competition.   At the same time three other major publishers; Simon and Schuster, Hachette Book Group, and HarperCollins; announced that they were settling with the DOJ to avoid this litigation.

The issues aren’t all that complicated. Several years ago the major publishers changed the way they sold books to retailers. Previously they used a “wholesale” model in which the publisher set a low wholesale price in which books were sold to retailers and the retailer could set its own price, usually higher, so that the retailer made money on each sale. Seems reasonable. However  Amazon.com started  aggressively selling e-books below cost in order to keep other potential competitors from getting into the e-book business. Amazon  used a proprietary format for their Kindle Edition e-books that could only be sold through Amazon. Essentially if you wanted to buy e-books to read on your Kindle Reader, there was only one place you could shop.

Back in 2010 about 90% of all e-books were being sold in the Kindle format and only  by Amazon. Publishers, authors, and other booksellers were understandably  concerned about Amazon’s power in the marketplace and decided to do something about it. The major publishers adopted a new business model where the publisher  would set the retail price and give the retailers a 30% commission but only under an agreement where the retailer couldn’t sell at a  discounted  price.

The DOJ is arguing that this arrangement (called “the agency model”)  keeps prices artificially high for consumers, and they are seeking to end it. The 3 publishers who are settling with the DOJ have agreed to allow retailers to discount e-books below the suggested retail price.

This is a victory for Amazon.  Now they can return to their  practice  of heavily discounting e-books and discouraging competition. Amazon can afford to sell books at or below cost. They know that customers coming to the Amazon site for a cheap e-book are likely to pick up some other more profitable products at the same time.

Everyone else in the book business is alarmed and I think consumers should be too. In the short run, there are going to be some good deals for e-books on Amazon. But  Amazon’s   potential for monopoly power raises some pretty ominous questions. In a word, Amazon has not been shy about removing “buy” buttons from titles by publishers who won’t cave to Amazon’s  terms, terms which are becoming  increasingly unsustainable to publishers as Amazon consolidates its market power. Several weeks ago Independent Publishers Group announced that it could not agree to Amazon’s new and draconian demands for favorable terms. As a result Amazon refused to sell Kindle editions for 6000 IPG titles. As of now, those books are still not available at the  Kindle Store.

A lot of people in our business are throwing around words that are not often used at literary cocktail parties. We say that Amazon.com is gaining monopoly power. A monopoly is a market arrangement where a single company controls all sales and distribution of a particular product. At the moment, Amazon is not a monopoly. It’s market share of e-books is down to about 60%, due to the entry into the market of major players like Apple and Barnes and Noble. To some extent this is a result of  the  the agency  pricing model that the DOJ is seeking to undermine . If   Amazon is successful at cutting out the other competitors by aggressive price competition,  it  will once again have a monopoly on the sale of e-books with the help and support of the Department of Justice.  A most ingenious paradox. Your tax dollars at work.

At the moment, we have an oligopolistic structure in the sale of e-books. An oligopoly is characterized by a small number of producers or distributors. Almost all e-books in the US are being sold by Amazon, Apple,  Barnes and Noble, Google, and Sony. A lot of industries are oligopolistic. And it doesn’t necessarily pose problems for competition as long as the parties are not acting in concert to control prices or limit supplies.

There is another relevant economic concept: Monopsony. This is distinguished from monopoly  because it describes  a market with only one buyer that forces sellers to accept lower than socially optimal prices. The decision  by the Department of Justice to litigate against Apple and the book publishers  will help establish  a market for e-books  where Amazon will be the only  seller of e-books (a monopoly) but also the only buyer of e-books from the publishers ( a monopsony).

This  is a truly alarming  situation for an industry that can only thrive in a diverse marketplace. We are, after all, in the business of disseminating ideas. And a monopoly of the marketplace of ideas is an enormously troubling development for those of us who see books as something more than just another consumer product.

The Justice Department vs. Book Publishers: What This Really Means

The Anti-Trust Division of The Justice Department announced  this week that it is considering filing charges against Apple Computer  and 5 of the largest book publishers for violating anti-trust laws. The issue, at least as far as I can determine, is whether there were illegal agreements  made between Apple and the  5 publishers to  fix  the retail price on e-books.  It is illegal under anti-trust law to make agreements to “restrain trade”.

I know a little about anti-trust law. When I was a bookseller, I was involved for about 20 years in various anti-trust lawsuits having to do with unfair competition by chain stores. I won’t go into detail here about anti-trust except to say that the laws are incredibly arcane and usually hinge on “facts” that are murky at best. And I do not know the specific facts of this case that would either incriminate or exonerate the putative conspirators.

So let’s talk about what this means in the real world. Here’s the back story. In 2010 when Apple was poised to release the iPad, Amazon controlled about 90% of the e-book business. Amazon sold books in the proprietary Kindle format which could only be read on Kindle readers. If you had  a Kindle reader (and at that time most e-book consumers did), you had to buy your e-books from Amazon.

As is their wont, Amazon began selling newly released best selling e-books at $9.95, below their cost which was typically about $12.50. This was anathema to publishers for a number of reasons. 1) The prices were so low that it had the  potential effect of eviscerating  sales of the print on paper editions. Publishers recognized that e-books should be cheaper, but not that cheap. 2) Related to this, publishers felt that Amazon’s selling below cost would discourage entry of other  potential vendors in the e-book business. This would leave publishers  completely beholden to one vendor, Amazon, whom they have never really felt comfortable with.  3) Finally this kind of pricing would put into the heads of consumers that there was an inherent  value to an e-book of $9.95. Presumably Amazon had no intention of selling below cost forever and they would  eventually use their monopolistic power to  force publishers to reduce the prices on  e-books books.  Amazon would  then have a sustainable business model. But publishers probably wouldn’t.

Enter the Apple iPad. At last the publishers hoped that they could break the Amazon monopoly by throwing themselves into the arms of  the only company with the resources to compete successfully against Amazon. Apple Computer    has the highest capitalization of any company in America, probably the world. Compared to Apple, Amazon is a mere street peddler.  Apple and the publishers worked out an alternative system for selling books that was similar to the  relationship iTunes had with music publishers.

Most products for sale in  retail stores are purchased   at “wholesale” for a low price, and the retailer can set any price they want. Thus the old saw that all you need to know in retail is: “buy low, sell high”. But Amazon had the resources to buy low and sell lower,  to sell below cost for as long as it took to drive out the weaker competition. After all, they could make up  the lost profits by selling more Kindle Readers and driving business to their other products. Cameras, shaving cream, what have you.

Apple and the six largest trade publishers adopted a new model. Rather than giving a lower wholesale price to a vendor and letting the vendor set the retail price, under the new “agency” model, the publisher would set the retail price of the book and give the vendor (say Apple or Amazon) a 30% commission on the sale. There were many complicated deals made (that may or may not have been legal) that would force Amazon to accept this new “agency” model. Amazon would have to sell the e-books at the same price as their competition, thus defeating what has always been Amazon’s competitive strategy.

The Justice Department argues that this new “agency” model  is bad for the consumer because it tends to insure that e-books are selling at a higher price than they otherwise would if  the retailer was able set its own price. Publishers argue that the “wholesale” model would create an unhealthy monopoly by Amazon  that would not be in the long term interest of book buyers and society at large.

Yesterday, the Author’s Guild weighed in on this issue. The president of the Guild, Scott Turow, sent a letter    to all of its members calling the decision by the Justice Department to challenge Apple and the 5 publishers: “grim news”. As most of the followers of this blog know, I have frequently expressed my own concerns about the sometimes  unhealthy power of Amazon in the book business.

Turow was speaking for the interests of authors, but he makes some powerful points about the ultimate impact of a de facto monopoly by Amazon. He is concerned, as are publishers, that predatory pricing of e-books will attenuate the ability of physical bookstores to compete. He says that it is as if: “Netflix announced that it would stream new movies the same weekend they opened in theaters.”

Turow goes on to say: “Marketing studies consistently show that readers are far more adventurous in their choice of books when in a bookstore than when shopping online. In bookstores, readers are open to trying new genres and new authors….A robust book marketplace demands both bookstore showrooms to properly display new titles and online distribution for the convenience of customers.”

He also points out that 2 years after the agency model was implemented Amazon’s market share of e-books is down to about 60%.  Barnes and Noble  has successfully entered  the market with its highly regarded Nook. Apple has an excellent e-book store. I can say first hand that the iPad is an insanely good e-reader. You can even buy e-books from your independent store through Google books – and at prices competitive with Amazon.

Last week we wrote about the fact that Amazon stopped selling 6000 titles from America’s second largest small press distributor, IPG, after a dispute over terms. Those books are simply not available to people with Kindle readers. I think this fact tells us all we need to know about what this dispute means to society at large.

Battle of the (E-book) Titans

Ask the Agent has been covering the developing story of the changing models for selling e-books and the struggle for market share between  Amazon and Apple.

An article appeared in the New York Times on March 17 that adds a new and troubling wrinkle to the story.

90% of the retail sale of e-books is now done by Amazon. This would be a monopoly by any reasonable definition. Amazon is cementing its dominance in the marketplace by offering  e-book downloads that can only be read by the Kindle, a media device that is manufactured by Amazon and sold exclusively  through Amazon. Thus if you own a Kindle, you can only buy e-books from Amazon. If you buy e-books from Amazon, you must buy a Kindle to read them.

Amazon has come to dominate internet retailing by aggressively discounting products in order to increase market share. They did this to great effect with books from the very beginning. They have been doing the same thing with e-books. Publishers have been selling e-books to Amazon for approximately $12.50. Amazon has been selling below cost at $9.95 for their  e-book  best- sellers.

If you ask the  major publishers how they feel about this, they will tell you privately, as they have told me,  that they are profoundly troubled by the market power of Amazon and are concerned that the deep discounting practiced by Amazon will devalue  what the marketplace thinks is a fair price for books. Last month the sixth largest American publisher, Macmillan, announced that it was changing its retail terms for e-books to the “agency model” which would not permit Amazon to discount titles. Amazon retaliated by pulling  “buy” buttons for all Macmillan books both electronic and physical.   This lasted only a week, but it should be a cautionary tale regarding the dangers of monopoly power in the distribution of ideas in a society or, in the case of Amazon, in the world.

Enter Apple and the iPad. It is difficult to imagine that Steve Jobs can be considered the friend of the little guy and a force against monopoly. Certainly the clout that Apple exercised with  the music industry in forcing them to accept   the iTunes model has done considerable damage to the music companies and artist royalties. But in publishing, as in Mid-East politics, the principle that “the enemy of my enemy is my friend” rules.

Five of the six largest book publishers fell into the arms of Apple and negotiated a new  sales model that allows the publishers to control the retail price sold to consumers of the book. But Steve Jobs is not Mahatma Gandhi and has imposed his own stringent conditions on the publishers. Under the new agreements with Apple, publishers will not be permitted to allow any other retailer to sell books below the price that is sold by Apple.

Amazon has reluctantly gone along with the new model, but is insisting on having a 3 year contract that would lock publishers into the current arrangement and guarantee that no other retailer will get better terms. Publishers are reluctant to agree to such a contract. The whole e-book market is in flux. Nobody knows what the e-book firmament will be like in three years.

But according to the New York Times, it gets a lot worse. Amazon has only agreed to the new “agency model” for the six largest publishers. The other 10,000 smaller publishers have not yet signed on with Apple. Amazon  has been speaking to them and telling them that they prefer to stick with the old model where Amazon can sell books for whatever price it chooses.

 These same publishers have spoken to Apple and have been told that Apple will only work with them if they sell to all other retailers under the same terms as  they are selling toApple. In other words, there is reason to believe that in order to do business with  Amazon, publishers will not be able to do business with Apple –and vice versa. A tough choice for the smaller publishers and a distressing possibility for the consumer.

The message Amazon sent forth during  last month’s negotiation between Macmillan was eloquent and persuasive.  That message was that  a publisher who doesn’t agree to Amazon’s terms risks having their books not be carried by the largest book retailer in the world.

Book publishers, and particularly smaller book publishers, are clearly getting whip-sawed by the two giants. The stakes are high for both Apple and Amazon. But the stakes are even higher for book buyers and the free marketplace of ideas.