Home » Amazon, Apple, Bestsellers, Big Publishing, DOJ, Ebooks, Legal Stuff, Mike Shatzkin, Pricing, Uncategorized » Auletta’s New Yorker piece is good orientation for thinking about the DoJ case

Auletta’s New Yorker piece is good orientation for thinking about the DoJ case

30 June 2012

From Mike Shatzkn:

Writing about the lawsuit the DoJ has instituted against Apple and five leading publishers is very hard.

I just know the industry. And I know the arguments for “collusion” or “conspiracy” are mostly built on illogic or misunderstanding of what is called “evidence”.

The June 25, 2012 issue of The New Yorker has an article by Ken Auletta called “Paper Trail” which is a sympathetic synthesis that untangles and clarifies a complex web of law and behavior.

3. A lot has been made of the fact that Apple has required the publishers to let them price-match. Now we know that Apple drove the deal. They said to the publishers, “we’ll let you set the price. as long as you don’t make us look like monkeys in relation to the print book price. But, of course, you can’t require us to sell at a price disadvantage, so you have to allow us to match any lower price.” How could Apple, or anybody else, do it any other way unless they were fools? They couldn’t allow themselves to be locked into a price that made them look extortionate to the consumer. They were proposing the terms on which they’d provide their proprietary access to their devices. Isn’t this a reasonable demand?

If the law prohibits this, please change the law.

You can read the rest of Mike Shatzkin’s post at Auletta’s New Yorker piece is good orientation for thinking about the DoJ case . There is a lot more in the post, but I want to focus on the point about the agreement between Apple and the five publishers. I agree that writing about this case is hard, especially for folks, like me, who aren’t lawyers. I encourage everyone to read the whole post and not just the part I’ve excerpted above so that you have a better context for what I’m going to comment on. Unfortunately, the Auletta article that Mike Shatzkin is reacting to is behind a paywall and I haven’t read it.

The best way to untangle this case is to focus on the undisputed facts. Here’s my list:

  1. The agreements between Apple and the publishers stipulated that the publishers would set the retail price of ebooks.
  2. The agreements stipulated that the publishers would ensure that no other ebook retailer would be able to undercut the prices in the iBookstore.
  3. Apple insisted that the agreements would only go into effect if a group of publishers with control of a substantial portion of the ebook market (i.e. 4 of the Big 6) signed up.
  4. The agreements stipulated that the maximum price of an ebook would be substantially lower than the retail hardback book price of the same title and that ebooks would be made available at the same time as the hardback editions (i.e. no windowing).
  5. Apple is not a retailer of hardback books.
  6. After these agreements were executed, the 5 publishers who signed up with Apple forced Amazon and Barnes & Noble to raise the retail price of virtually all of those publishers’ bestselling ebooks by $2 or more per  copy.
  7. Since these agreements were signed, retail price competition among  ebooks from major publishers has almost completely disappeared. The publishers have set the prices for their ebooks at exactly the maximum prices allowed under their agreements with Apple.
  8. It is settled law that in a price-fixing case, the DoJ does NOT have to prove that a specific agreement to raise prices existed. Circumstantial evidence is enough to establish culpability. Certain patterns of behavior that are perfectly legal under normal circumstances become evidence of collusion when a group of competitors have just simultaneously raised retail prices.
  9. Price-fixing is a “per se” violation of antitrust laws. That means that price-fixing can’t be justified as a response to unfair competition.

You can verify that items 1-4 are true by comparing what the DoJ says about the agreements with what Apple says in its response. The two opposing accounts agree on those points. Item 5 is an often-overlooked aspect of the case. I will explain why it is important below. As far as I know, no one disputes items 6 or 7. Please post evidence to the contrary in the comments. You verify items 8 and 9 by reading the DoJ’s primer on price-fixing. That page has an obvious prosecutorial slant, but it covers those two points reasonably well. As with any fact about the law, there are many potential caveats  and settled law can become unsettled in a high-profile case.

It isn’t hard to see, just from looking at my short list of facts, why the DoJ brought the suit. What Apple and the five publishers did looks like price-fixing. That’s not to say that the case is a slam dunk or that there is no possibility that the defendants can win, but those defendants certainly should have anticipated this lawsuit.

Contra Mike Shatzkin, the arguments for collusion and conspiracy aren’t built on illogic or a misunderstanding of evidence. The arguments for collusion and conspiracy are built on the clear evidence in the public record. This entire case against the publishers really boils down to a very simple proposition. As a general rule, a group of wholesale producers with substantial market power can’t enter into agreements that fix retail prices for their goods at levels above those in the open market. The publishers have to prove they are somehow an exception to that general rule.

The case against Apple is slightly different. As the DoJ points out, Apple was able to negotiate total protection against having to compete on price in the ebook retail marketplace. That’s amazing for a new and unproven entrant in the market. But that’s not all. Apple persuaded the publishers to forgo windowing and to guarantee that ebook retail pricing would be substantially less than the equivalent list retail hardback book price. Apple ensured that it would have access to the most sought after books, as early as possible  with the assurance that no other retailer would be able to offer them for lower prices.

In mass market entertainment, the key to success is extract the highest possible retail price from the people who want it “now”. Think about why ticket prices for first run movies are so much higher than the prices for dollar movies. Or take a look at pricing for computer games. Why do people pay more for hardback bestsellers than for they do for the same book when it comes out in a mass market paperback? Spoiler alert: It’s not the binding. People are willing to pay a premium for the earliest possible access to the latest [insert any bankable mass market franchise here].

Apple’s demands were the opposite of reasonable. Under normal competitive conditions, those demands would be laughable from any new entrant to the market. Given that Apple had already taken a dominant position in the distribution of mass market digital music to the detriment of the music producers, you really have to ask why the five of the largest producers of ebooks would  agree to protect Apple from the normal workings of the marketplace. The answer to that question is that Apple enabled to the publishers to tie the retail price of ebooks to the retail price of hardback books.

Of course, under Apple’s scheme, the retail price for ebooks was going to be rigidly enforced, but the list retail price for a hardback book is meaningful only in that it determines the wholesale price of the book. The pricing scheme that Apple and the publishers worked out effectively guaranteed not only that no retailer could undercut Apple’s prices in ebooks, but also that the wholesale price of the hardback version of a book would be roughly equal to (for bestsellers) or  greater than (for all other new releases) the retail price of ebook.

Apple, not being a retailer of hardback books, didn’t really care about the actual retail prices of hardback books, but their publisher conspirators did. The deal allowed them to drastically narrow the difference in price between actual retail price of hardback books and the retail price of ebooks, especially for bestsellers. Publishing and distributing hardback versions of the most desirable books is THE reason that the Big Six are the Big Six. Only the Big Six can put that new bestseller everywhere all at once. The more people who switch to ebooks, the less necessary the Big Six become.

This matters a lot more than people realize. I’ll take the latest Grisham book as an example. Amazon’s price for the hardback is $16.47. Let’s assume that price is the same with or without the pricing scheme imposed by Apple and its partners. Yes, I know that Grisham is published by Random House and Random House wasn’t sued because they went to the scheme independently, but they did eventually start using “standard pricing”. Amazon would like to price the ebook at $9.99, but the publisher sets the price at $12.99.  That may not sound like much, but this difference is the difference between the survival of the Big Six or their demise.

The market for books is driven by people who buy lots of books. According to the most recent Pew poll, 78% of Americans over 16 years of age report having read a book in the last year. Of the people who have read at least one book, the median number of books read is 8, but the mean number of books read is 17. The same poll reveals the expected fact that the more books you read, the more likely you are to read ebooks and have bought a dedicated ereader. By raising the price of ebook bestsellers so that the price differential from hardbacks is only half as much means that the number of books you have to buy before you recoup the costs of an ereader is doubled. The hope of the publishers was that this was enough to make the move to ebooks uneconomical for enough people that the necessary critical mass of hardback buyers would be maintained.

The publishers who signed on to the Apple deal weren’t greedy. They were desperate. They could run these numbers with much better data than I can. But I can extrapolate from the public data well enough to know that they were facing a bleak reality. A wide spread between the ebook and hardback versions of a bestseller was a mortal threat. The moment when bestselling authors didn’t need to be in hardback to maximize their earnings was the moment the Big Six would be doomed. That’s what drove them to embark on a course that they had to have known would result in a lawsuit from the DoJ.

 

-William Ockham

Amazon, Apple, Bestsellers, Big Publishing, DOJ, Ebooks, Legal Stuff, Mike Shatzkin, Pricing, Uncategorized

16 Comments to “Auletta’s New Yorker piece is good orientation for thinking about the DoJ case”

  1. As far as I know, no one disputes items 6 or 7.
    7. Since these agreements were signed, price competition among ebooks from major publishers has almost completely disappeared.

    Was there any price competition among ebooks from major publishers in the first place? As in, did major publishers compete with discounting, or did they just march in oligopolic lockstep like gas stations across the street from each other?

    • You have a point. There was retail price competition because Amazon was willing to discount heavily on bestsellers. I will update the post to clarify this.

      • Discounting is an interesting thing, when retailers do it. On the one hand, duh, of course people should be able to buy the stuff and sell it for whatever they want… On the other, you’d think physical books wouldn’t be as prone to discounting, because they have returns. I suppose that distributors/publishers would rather just Not See Those Dadgum Books Back, and the bookstores would rather at least break even than spend the time stripping the books and/or shipping them back.

        And on a third hand, “no discounting allowed” (or a maximum discount) does seem like a logical response if you have one or two Deep Pocketed retailers, and a bunch of shallow-pocketed ones who can’t afford to discount as deeply, and you want all of them to be competing on non-price merits.

        IIRC, the settlement has something in it about what discounting is permitted in the settling-publisher’s contracts, going forward? There’s a limit to how much Amazon (and, in theory, B&N, Sony, etc.) can discount?

  2. In my opinion, the big publishers are shooting themselves in the foot by not settling with DOJ. I come to this conclusion based on an earlier post by Passive Guy that says essentially that the cost of defending against the DOJ lawsuit will be staggering in terms of lawyers costs as well as requiring incredible amounts of time and costly preparation. For Apple, with its huge war chest of money, this will be peanuts. But for the Big Publishers, with their thin profit margins, this could even be tantamount to suicide for their businesses. Time will tell. But I would not put money on the Big Publishers that fight the DOJ.

    • “For Apple, with its huge war chest of money, this will be peanuts.”

      It may be peanuts in terms of money but the hassle of dealing with the DOJ’s anti trust bureaucracy can cripple a company’s innovation, win or lose. Just look at how Microsoft has been leading the industry with cutting edge software.

      B.S.

      • A lawsuit also means the DOJ can look into Apple’s records. That’s not something most major corporations really want.

        I’d be surprised if they don’t settle at some point.

  3. Interesting post and analysis!

    In terms of Shaskin’s original article, it’s full of rheroric and emotional appeals. I found it to be disappointing. I continue to expect more from Shaskin, I don’t know why.

    For options available to publishers other than the criminal act of colluding to price fix, I really liked the interview of Albert Vitale posted here a few days ago. They need some thinkers who are creative and innovative and see the possiblities in e-books, rather than the threat!

  4. If the publishers and Apple didn’t break the law then they will win the case. So why the constant bombardment trying to persuade the DOJ that this isn’t about the law, it is about competing with Amazon because they will ‘destroy’ publishing and book selling.

    I don’t bother to read most of the articles lobbying for the publishers anymore. It’s always the same argument. But like Mira, I do read Mike Shatzkin’s posts, I have a lot of respect for the guy.

    There’s a simple truth here, if you are in the right you only have to state your case once. If, however, you are not in the right, or unsure of your ground, you will state and restate your case repeatedly.

    “When you are in a hole, stop digging” and “Who are you trying to convince?” are sayings that spring to mind.

    If I was writing a character who was either lying, unsure of their ground, or trying to defend the indefensible, then I would have them repeating the same argument to anybody they could find. I would have to be careful not to make the arguments tedious though.

    This constant bombardment of “don’t look at us, look at Amazon” shells lobbed onto the web is becoming a tad tiresome.

    We’ll find out if they broke the law when the case comes to court — or if they settle.

    • Steve, good points! I like this:

      “There’s a simple truth here, if you are in the right you only have to state your case once. If, however, you are not in the right, or unsure of your ground, you will state and restate your case repeatedly.”

      • Yeah, call it deja vu*itis. :)

        The interesting thing is Amazon, as far as I know, have never responded to any of this stuff. They must have PR folks who didn’t sleep through that lesson.

        ETA: then again some people have responded so I may be over-egging the pot there.

        • I think Amazon is wisely playing the “when your opponents are shooting themselves in the foot, just stay out of their way” strategy.

          • yup :)

          • Deep within the secret villainous Lair known as Amazon the Evil Overlord looks upon his most effective PR minions.

            “How can we capitalize on the DOJ’s lawsuit against the Fix Six?” He points at Baron Bothsides, “Should we make statements supporting the government?”

            “No sir. The companies are making so much noise and having their partisans writing letters telling the DOJ to not enforce the law that nothing we can add would help us,” he said as every body sat stunned that the same words came out of both sides of his mouth.

            B.S.

            Just running with the Amazon is evil meme.

    • Heh, good point, Steve. I like that you bring it around to fiction writing, too ;)

  5. Seems like Amazon would have a case on how all these companies got together to destroy their ebook business.

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