Judge Rules that Apple Conspired to Raise E-Book Prices

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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.

After a closely-watched trial, Judge Denise Cote of the Southern District of New York ruled that Apple had colluded with the five largest publishers in the United States to raise e-book prices. In Judge Cote’s opinion, Apple played a pivotal role by providing the mechanism for collusion in the form of Apple Agency Agreements that included a Most-Favored-Nation (MFN) clause. That collusion, a per se violation of the antitrust laws, caused e-book prices to jump from an average of $9.99 per book to $12.99 or $14.99 in the space of a few weeks. The five publishers, Hachette, HarperCollins, Macmillan, Penguin and Simon & Schuster, had all previously reached settlements in this case without admitting wrongdoing. Apple was the only defendant that proceeded to trial and has already announced its intention to appeal Judge Cote’s ruling to the Second Circuit.

In her written opinion, Judge Cote explained how Apple and the five publishers took advantage of the opportunity provided by Apple’s launch of its iPad tablet to achieve their common interest in eliminating competition and raising prices for e-books. At the time of the conspiracy in late 2009 to early 2010, Amazon was the leading retailer of e-books and charged a retail price of $9.99 per book, which the publishers uniformly considered to be too low. At this time, Amazon and the publishers operated on a wholesale model where $9.99 was close to the average wholesale price of e-book content. Amazon, which wanted to gain market share in the expanding market for e-books and consequently gain dominance for its Kindle e-readers, was willing to earn low margins and even absorb losses on e-books priced above $9.99 at wholesale. The publishers were concerned that the low prices set by Amazon would become the standard for e-books and threaten the prices of books sold at brick-and-mortar outlets, particularly hardcover books that were priced substantially above Amazon’s e-book price. The publishers also worried that Amazon’s growing dominance would enable it to negotiate lower wholesale prices in the future or even compete directly in e-book publishing. Apple was preparing to launch e-book content on its iBookstore as a complement to its launch of the iPad. It had an interest in eliminating competition from low-priced e-books from Amazon and in limiting competition in retail e-books in the long term. When the publishers suggested the agency model as an alternative to the wholesale model, Apple recognized the opportunity to construct a form of agency contract that would cause an industry-wide shift to a world with higher prices for e-books. Apple could achieve this shift only with the cooperation of the five major publishers who accepted the terms of the agency contracts.

According to Judge Cote, “Apple seized the moment and brilliantly played its hand. … It provided the Publisher Defendants with the vision, the format, the timetable, and the coordination that they needed to raise e-book prices.” The primary mechanism of the collusion among Apple and the publishers was the Apple Agency Agreement, which Apple entered into separately with each of the five publishers. By moving from the wholesale model to the agency model, the publishers achieved their goal of regaining control over retail prices. The agency agreement included price tiers based on the pricing for other book formats and price caps at $12.99 to $14.99 for newly released books. Apple would receive 30% commissions from the sales of e-books. The 70% remaining to the publishers would range from $9.10 to $10.50, which was only slightly more, at best, and less at worst, than the $9.99 or higher wholesale price they were then receiving from Amazon and other retailers. The publishers were willing to accept these terms for the perceived long-term benefits of raising e-book retail prices, rather than for their short-term effect on profits. They were willing to cede a sizeable commission to Apple and agree to other terms because they understood that they could not unilaterally raise retail prices without the coordination provided by Apple and the timely coincidence of its iPad and iBookstore launches.

Judge Cote’s opinion states that the MFN clauses in the Apple Agency Agreements were the key provision that enabled the conspirators to shift the industry as a whole to higher retail prices. The MFN clause stated that each publisher was required to lower the price of every e-book on 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. This meant that any price change by a retailer other than Apple would result in steep losses to the publishers after they paid Apple its 30% commission. The MFN clause ensured that the publishers would move all other e-book retailers to the agency model with the same pricing structure to avoid having to lower retail prices of e-books sold through Apple. Indeed, the publishers acted in concert to pressure Amazon to move to the agency model shortly before the launch of Apple’s iPad and iBookstore. The publishers also offered Google, a new entrant to e-book retail in early 2010, the agency model as its only option for e-book content despite initial discussions that implied other options. This behavior ensured that there was no retail price competition for e-books, with retail prices effectively set by the Apple Agency Agreements. Apple achieved its goal of eliminating competition for its iBookstore and the publishers achieved their goal of maintaining high prices for e-books and protecting the value of print books.

Judge Cote found substantial direct and circumstantial evidence that “Apple not only willingly joined the conspiracy, but also forcibly facilitated it.” The judge ruled that Apple was in per se violation of Section 1 of the Sherman Act as a direct participant in a horizontal price-fixing conspiracy. The judge later issued an injunction banning Apple from entering into distribution agreements with the publishers that include MFN clauses or other limits on discounting. Apple contends that because it was in a vertical relationship with the publishers, per se liability is inappropriate. It has vigorously challenged the ruling and plans to appeal.