Wednesday, April 11, 2012

News: Department of Justice Sues Apple and Five Publishers

This morning, the Department of Justice filed an antitrust lawsuit against Apple and five of the “big six” U.S. book publishers—Hachette, Simon & Schuster, Penguin, HarperCollins and Macmillan (the lone exception was Random House)—charging them with collusion in the move to the agency pricing model for e-books. The alleged goal of such “collusion,” and the move to agency pricing in general, was to raise the price of e-books. Shortly after the filing of the suit, settlements with Hachette, Simon & Schuster, and HarperCollins were announced, but it appears that Apple, Macmillan and Penguin plan to fight. 

Agency Pricing

Under agency pricing, the publisher sets the price that a retailer must charge and the retailer keeps a commission as the “agent” of the transaction. For this reason, since agency pricing agreements have been in effect, the price of an e-book from any of the “big six” publishers has been the same whether purchased through Amazon, Barnes and Noble, Apple, Google Books or any other retailer.

An interesting thing to note: it does not seem that the DOJ is challenging agency pricing itself, but merely the manner in which it was instituted.  In fact, as I wrote when “anticipating” this news last month, a 2007 Supreme Court decision rejected a “blanket ban” on mandated prices, thus changing a long-established interpretation of antitrust law. (Especially if you're interested in the law, check it out. It's interesting.)

Additionally, the settlements which were announced do not seem to bar agency agreements entirely. Rather, the agreements change in one important way: e-book retailers regain some pricing power. Whereas prior to the settlement, e-book retailers could not discount an e-book sold under agency pricing at all (even if they wanted to), now they may forgo their commissions on such sales and apply them as a discount. Still, it seems that e-book retailers will not be able to sell e-books at a loss because the aggregate discounts cannot exceed the total commissions paid by the publisher during a period of “at least one year.” This portion of the settlement is the most confusing. More information can be found here, although the link may expire.  If you want to read the entire settlement agreement, you can do so here

How is Apple Involved? 

When the iPad launched, Apple wanted to get into the e-book business. At the time, e-books where still sold on the wholesale model; publishers sold e-books to Amazon (and other retailers) at a discount to a “list price,” and (like physical books) the retailer could choose the retail price. When Amazon made a point of offering best-sellers for $9.99, it was likely doing so at a loss, as a way of attracting more customers. Publishers hated the $9.99 price point. They feared that consumers would become accustomed to such a price and, since Amazon could not lose money on every book it sold, their wholesale prices on all e-books would have to drop to reflect this.

When Apple first approached the publishers at setting up the iBookstore, it knew that the publishers were upset. (It is also possible that it didn’t want to have to lose money on e-books like Amazon, although that is unclear.) Still, the allegation is that Apple first floated the concept of agency pricing, and demanded that no other retailer receive a different agreement. 

Results of Agency Pricing 

Whether or not there was “collusion,” there is no doubt that agency pricing raised the price of e-books; there are no e-books from the “big six” currently selling for $9.99. And yet, as counterintuitive as it sounds, there is an argument that higher prices actually led to more options for consumers. (I first talked about this in my post from March.) This point assumes that other retailers could never have kept pace with Amazon’s price points. But with prices universal, Barnes and Noble’s Nook was able to soar, and even Apple was able to claim a portion of the market. Since agency pricing was instituted, it is estimated that Amazon's share of the e-book market dropped from about 90 percent to around 60 percent, with Barnes and Noble and Apple at 25 percent and 15 percent, respectively.

Unanswered Questions and Going Forward

Random House was the only “big six” publisher not sued because it was not part of the negotiations when Apple and the other publishers were working to establish agency pricing. In fact, Random House only started using agency pricing last year, more than a year after the other companies had begun. Since it seems that agency pricing itself is not in question, it’s possible that the Random House agreements will not have to be altered, as the agreements with settling defendants will have to be.

Still, given the way Amazon has been behaving recently, it seems unlikely that it will negotiate materially different agreements with publishers of similar size. It was clear back in February that Amazon is willing to go to extraordinary lengths if publishers do not give it the agreements it demands. They removed hundreds of titles from publishers associated with the Independent Publishing Group after the group refused to give a deeper discount to the list price of their e-books. (Those books were sold under the wholesale model. See my heavily biased post on this issue.) Amazon is also trying to get publishers to spend significantly more money for so called “co-op advertising,” where specific titles are spotlighted on the website. One article claimed that Amazon raised fees by 30 times their 2011 costs.

In the wake of this suit and settlement, it remains to be seen what kinds of agreements Amazon (and Barnes and Noble) will demand. Will they stick with a revised agency pricing that gives them some pricing power? Or might they demand a return to a wholesale model? If the goal is lowering the price of e-books for consumers, wholesale pricing might make a small, but not huge difference. Publishers are likely demand a whole sale price that keeps their revenue consistent. For instance, on an $11.00 e-book, right now the publishers keep 70% or $7.70. Suppose they demand the same $7.70 as the wholesale price. Amazon could then set the price at their desired $9.95 target and still make a good profit. But the gain for consumers in their pocketbook will be a loss in the end. Amazon will regain a bigger chunk of the e-book market and thus be able to dictate better terms from publishers. Through better terms, publishers will make less revenue. If publishers make less revenue they will have less to risk on paying for new talented authors or even old established authors. What looks good on the surface, is anything but good. The quality and quantity of content produced by major publishers is in danger with lower e-book prices.

There was a separate law suit filed by the State Attorneys General of 15 states, claiming that the agency pricing model led to the overcharging of consumers. I was surprised to see that Hachette and Harper Collins agreed to pay $52 million in “consumer restitution.” I would have thought they would have fought this particular accusation. Still, although I have not seen the agreement, I would bet that they agreed to pay without any admission of wrong doing. Consumers feel as through e-books should automatically be cheaper than physical books. They think that e-books must be *much* cheaper to produce. The fact of the matter is that “most of the costs of publishing a book are fixed (acquisition, cover design, editing, marketing, etc), and don’t go away in a digital world.” (From my March post.) At some point, publishers will need to persuasively make this point to consumers. The cost of paper and binding is small in the bigger picture. Through book prices, consumers are paying the author, a talented editor to make sure the writing is well put together, a marketing team to make sure that they even hear about a book (and to make sure that the publisher can turn a profit that can be spent elsewhere). A low price is bad for everyone.

No comments:

Post a Comment