DOJ and Publishers Settle in E-Books Case

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EI Senior Economist Clarissa A. Yeap specializes in empirical microeconomic analysis in the assessment of liability and damages in antitrust, intellectual property and class action matters.

Macmillan recently reached a settlement with the Department of Justice (DOJ) in a suit alleging a conspiracy to raise e-book prices. DOJ alleged that five of the six largest US publishers, Hachette, HarperCollins, Macmillan, Penguin and Simon & Schuster, had conspired with e-book retailer Apple to raise the prices of e-books and limit competition in an e-books market. The proposed settlement requires that Macmillan immediately terminate agreements with Apple and other e-book retailers that restrict discounting and prohibits Macmillan from entering into new agreements that restrict retailers’ discretion over prices. The other four publisher defendants had previously reached similar settlements with DOJ. The case against Apple is scheduled to go to trial in June 2013.

DOJ’s complaint alleged a conspiracy to switch the contractual relationship between publishers and e-book sellers from the wholesale model, where retailers set the price, to an agency model, where publishers set the price. When the conspiracy began, Amazon was the dominant retailer of e-books and manufacturer of e-book readers. Amazon had an incentive to reduce e-book prices to induce consumers to adopt the new technology of e-books and to buy its e-book reader. The publishers, on the other hand, profited only from selling books, not readers, and preferred higher prices for e-books, which would increase their profit margins and reduce competition for their print books. No single publisher acting independently, however, could force e-book prices above the level set by Amazon. Then, in late 2009 when Apple was preparing to launch its new iPad tablet device and e-book retail website, the publishers saw an opportunity to gain control over e-book prices. Taking advantage of that opportunity required the publishers’ collective bargaining power, which was based on their significant share of the market for e-book content, and the cooperation of Apple, a retailer itself. According to DOJ, Apple benefited by eliminating price competition in the e-book retail market that it was about to enter. Also, as the linchpin of the collusive scheme, Apple was able to negotiate larger than usual commissions from the publishers.

DOJ’s conspiracy claims depended crucially on the alleged coordination mechanisms provided by the publishers’ agreements with Apple. According to DOJ, the Apple Agency Agreements allowed the publishers to adopt identical tiered pricing schedules and other key contract terms. Apple played the central role of assuring the publishers that it offered the same terms to all of them and informing each publisher that the others were willing to accept the agreement. DOJ alleged that Apple shared information with each publisher on its negotiations with the others, which it had little incentive to do except to facilitate coordination. In economic models of collusion, a coordination mechanism plays a key role, providing participants with a method of signaling to each other the price that they are each individually willing to accept.

The Apple Agency Agreements also included a form of most-favored-nation (MFN) status that DOJ argued would help to enforce the collusive agreement. The MFN provision stated that each publisher was required to lower the price of every e-book in Apple’s retail website to match the lowest price offered by any other retailer, even if the publisher did not control that other retailer’s price. DOJ claimed that the MFN provision ensured that each publisher had a strong incentive to switch all its retailers to the agency model and adhere to the price tiers defined in the Apple Agency Agreements. A reduction in price by any retailer might lead to a substantial loss for a publisher, who would also have to accept lower prices on its sales through Apple. In the terminology of collusion models, the lost profits act as punishment that is triggered when any participant deviates from the collusive scheme. The threat of punishment helps to sustain the collusive agreement by counteracting each participant’s incentive to reap large gains by undercutting the other participants.

According to DOJ, the defendants succeeded in eliminating retail price competition and raising e-book prices. Shortly after signing the Apple Agency Agreements, the publishers switched all major e-book retailers, including Amazon, to the agency model and prohibited discounting and other price promotions by the retailers. Consumers suffered because e-book prices rose to $12.99 or $14.99 from a pre-conspiracy price of $9.99. The price increases affected a sizeable market: consumers spent $300 million for the publisher defendants’ e-books in 2010. In a related lawsuit, a settlement for $69 million was reached between three publishers, Hachette, HarperCollins and Simon & Schuster, and 49 states. The states’ cases against Apple and the other publishers as well as class actions that include claims for monetary damages remain pending.

The defendants have denied DOJ’s allegations. They contended that Apple negotiated agreements with each publisher individually, and there was no collusion. Apple has strongly objected to the proposed publisher settlements as they would effectively dismantle its contracts before a trial had taken place. Apple argued that DOJ’s lawsuit would bolster Amazon’s market power by disadvantaging a new entrant, rather than increase competition. Barnes & Noble and several authors groups have also objected to the proposed settlements for the same reason. They alleged that Amazon’s low prices hurt traditional bookstores and authors and thus are not in the public interest. DOJ countered that the antitrust laws are meant to protect competition, not competitors, and that high prices due to collusion harm, rather than benefit, the public.

DOJ believes that the Macmillan settlement and settlements with other publishers will quickly restore competitive retail prices for e-books and prevent the recurrence of collusive behavior. Competition in the e-book market will also increase because of entry by new competitors, such as Google and Microsoft. Increased price competition will benefit consumers by lowering prices in the short run and potentially by promoting innovation in the variety and quality of e-books and e-book readers in the long run.