Not Proven: The DOJ suit Against Apple for eBook Pricing

With the death of Steve Jobs, Apple has lost much of its Teflon insulation from government action.  Nowhere has this been more true than with today’s suit against Apple and five major publishers for price-fixing in the eBook market.  Any charge of collusion always carries with it a certain heft under the antitrust laws, because the fixing of prices among competitors amounts to a per se violation under the antitrust law, at least if those competitors have sufficient market power to alter over prices, which is surely the case when major parties sit down together at the table.

Yet this suit does not fall into the classical model where competitors agree on common prices in cartel like fashion.  What is at stake here is the pricing models that will be used to determine prices.  Right now under the so-called “wholesale” pricing model, the retailers of eBooks set the prices however low they choose.  Clearly they cannot set these prices below the cost of production that has to be paid for the eBooks they peddle.  But the marginal price for the production of an additional eBook is close to zero, so the retailers know that if they pay very little under this model the publishers will have no choice but to go along with the low prices.  This strategy has let Amazon.com to price eBooks at around $9.99, which is a steep discount over the hard cover version.

In dealing with these matters, Apple proposed to all publishers that they shift to an agency model, whereby the publishers set their own prices and that Apple receive a 30 percent commission for the sales over its network.  This same model could be offered to Amazon, which would allow it to compete on even terms with Apple, but would raise its prices, lower its margins and reduce its profits. 

In looking at this situation, DOJ sided with Amazon and held that this form of collusion raised consumer prices and therefore caused an injury under the antitrust laws.  It sounds pat but here are the difficulties.

First, there is no need for any collusion on this issue.  If a single publisher had dreamed up this new scheme, it could have refused unilaterally to sell any books to Amazon or anyone else unless they bought into the model.  Why is it illegal for Apple to come up with a bright idea that helps its competitive position with Amazon? 

Second, it is not clear that lower prices are necessarily in the long term interests of the public at large.  As with all complex transactions, lower prices spell both low costs to consumers and low royalties to authors.  The lower royalties translate into lower level of production of new books, so that we do not have here the usual cartel situation where higher prices reduce output.  It is plausible that the higher royalties increase the number of titles available, and by increasing competition in the new book market, prices are lowered in the long run. 

Third, it is not clear why this arrangement is bad if done by all major publishers simultaneously.  If it has justifications for each acting alone, those justifications remain when they act together.  Under pure competition we would expect gravitation to a single new model if it proves better overall than its rival.  That could be just what is happening here. The cooperative efforts speed the industry toward a more sustainable business platform.

Stated more generally, the usual cartel involves restrictions that have few if any efficiency benefits.  These agency transactions have both pluses and minuses for consumers and for overall social welfare.  It is a good rule of thumb to hold back from public enforcement when the relative balance is unclear.  But note that in the current political climate, that presumption is likely to be reversed by populist forces.  Big is bad.  It will take some time to hear the whole story, but the betting here is that this law suit is a mistake.

  1. Ottoman Umpire

    I’m not sure if I understand the anti-trust definition of cost of production. It was my understanding that Amazon’s $9.99 was a loss leader, in that they were selling books for below their acquisition cost.  They were doing that to push Kindle sales, but, because it was so sustained, it also had the effect of cutting off the oxygen to any would be retailers of e-books.  

    Seems like classic anti-trust behavior to me.  On Amazon’s part, not Apple’s.

  2. Misthiocracy

    If you sell used books through Amazon, you set the price and Amazon takes a commission.

    How is that different from what Apple does with eBooks?

  3. Roberto

    Dubious arguments to say the least Prof. Epstein. Similar justifications have been used to defend every cartel and price fixing arrangement ever entered into where a changing competitive landscape threatened previously secure margins. Social welfare? Efficiency? Truly these are your arguments?

    It strikes me that perhaps antitrust law itself is your target, if so strike it directly.

  4. Ottoman Umpire

    This is interesting from the WSJ:

    The settling publishers did retain one tool for their negotiations with Amazon. Under their agreement with the government, they can make a deal under which Amazon would be prevented from selling a publisher’s entire catalog at a sustained loss. However, if Amazon sold best-sellers at a loss and made that up with profits elsewhere, publishers wouldn’t be able to stop it, so it isn’t clear how valuable that tool would be.

    It’s hard to believe that Hatchette, Simon & Schuster, and HarperCollins would agree to something as toothless as this.

  5. Robert E. Lee

    I prefer to see authors self-publish ebooks.  That’s because an author can offer his works for less than a regular publisher can and still make a greater profit.

    On a separate issue, I won’t buy anymore ebooks until I can get them DRM free.  I refuse to be tied to a particular device to read my books, unable to upgrade, without having to buy the ebook again. 

  6. Duane Oyen

    Nonsense.  Amazon’s “loss” on Kindle books is due to the magic of accounting- the publishers’ decision regarding fixed costs allocation.  At $9.99 there is substantial contribution margin over variable costs.  A publisher who insists that the electronic version price match the hard copy price, is actually allocating significantly higher fixed costs to the electronic version- contrary to every burden allocation scheme known to cost accounting.

    In the Apple case, multiple parties colluded on price floors, to limit price effects of competition.  Should that be illegal?  That is a different- policy- question.

    But there is no way that in free markets we should worry for five minutes that “As with all complex transactions, lower prices spell both low costs to consumers and low royalties to authors.  The lower royalties translate into lower level of production of new books…… “  Prof. Epstein’s view here sound like that of an established author, with a publisher who wants to protect his current market.

     I don’t care how much authors make, or that Mark Helprin thinks he should get the government to enforce a perpetual copyright for him.  The writer/publisher case is pure protection of current business models at consumer expense.

  7. Misthiocracy

    So… This is all very confusing. A few questions:

    • Writers and/or publishers should be legally-prohibited from pricing their own work? If Amazon wins, does that mean that a writer or publisher that sells eBooks directly on their own website would be legally required to charge the same price that Amazon would?  
    • How do Barnes & Noble, Sony, Google, and eBooks.com price eBooks?   Are they parties to this lawsuit?  
    • Is Apple telling writers/publishers that if they sell their eBooks through Apple they cannot also sell the same book through the other retailers?
  8. Palaeologus
    Richard Epstein: 

    Apple proposed… an agency model, whereby the publishers set their own prices and that Apple receive a 30 percent commission…  This same model could be offered to Amazon… but would raise its prices, lower its margins and reduce its profits. 

    Well, this makes no sense. Of course, a retailer can have higher prices with lower margins. But that obviously isn’t the case here. If Amazon was making better than 30 points on e-books and the publishers didn’t like the retail price, pubs would simply raise the wholesale cost (i.e. the amount they charge Amazon and other book retailers).  Amazon has a history of retailing traditional books near-to-below cost and it has pushed the envelope with e-books to build traffic.

    What Amazon fears is that it’s future, potential margins will be compromised. There is a reason that Amazon is buying up publishers and offering in-house publishing. If they can reach the cat-bird’s seat of controlling content and delivery… it’s monocle guy time.

    What we have here are two corporations aiming for market dominance: Amazon is a bit more heavy-handed, Apple a touch more crony friendly.

  9. Fricosis Guy

    Whew…I saw “Not Proved” in the subject and thought Ricochet had gone mad and given Arlen Specter a guest posting gig.

  10. BlueAnt
    Richard Epstein: 

    Second, it is not clear that lower prices are necessarily in the long term interests of the public at large.  As with all complex transactions, lower prices spell both low costs to consumers and low royalties to authors.

    With all due respect, this point is factually untrue.

    Joe Konrath, an author who switched to self-publishing on Amazon and saw massive increases in his royalties, covers this point extensively on his blog.  His analysis of the agency model’s harm to both authors and consumers seems prescient today.

    One of his major points is that Big 6 publishing houses all insist on offering authors only 17.5% of eBook price as royalties.  Neither the Author’s Guild nor the larger author community can get them to budge on these contractual clauses.  Yet Amazon offers 70% author royalties (35% for books under $2.99), cutting checks more often than  the traditional publisher’s twice-a-year payout cycle.  All while selling eBooks cheaper than what publishers set on iTunes.

    Lower prices leads to lower profits for publishers in the long run.  But why should we worry more about them, than any other set of middlemen technology has made obsolete?

  11. Michael Pate

    Being a Librarian, I have been following all this for a while.

    While it may not have been proven, the fact is that 3 of the Publishers have already settled so it means they chose not to contest the case.

    It is unclear as to how any of this affects author royalties – which are usually pretty low to start with.

    What I think is really going on is that as the publishing industry transforms into e-publishing, the traditional strengths that publishers have in terms of creating hard cover books and getting them distributed go away. There have been numerous examples of self-published or small independent publishers books hitting the top of the ebook charts without any of the traditional support promotions.  This strikes terror in the hearts of the publishing company executives.

    Agency pricing is popular with publishing executives because it pays for them.

  12. Southern Pessimist

     It is a good rule of thumb to hold back from public enforcement when the relative balance is unclear.  But note that in the current political climate, that presumption is likely to be reversed by populist forces.  Big is bad.  It will take some time to hear the whole story, but the betting here is that this law suit is a mistake.

    As one who spends almost as much on e-books as I do on groceries, my heart lept a little when I read about this suit. It is easy to assume that any collusion on pricing is evil, but you are right, it will take time to hear the whole story.

  13. Misthiocracy

    One simple reason Apple has a good case against antitrust is that it is a tiny player in the e-book business. It has very little share of the market. Amazon owns 90% of the e-book market.

    Source: http://business.financialpost.com/2012/04/12/why-apple-will-probably-win-its-e-book-legal-battle/