The US Department of Justice (DoJ) has accused Apple and five of the country's six largest publishers of colluding to fix prices for electronic books (e-books). Three of them, Hachette, HarperCollins and Simon & Schuster, decided to settle with the DoJ to avoid what Hachette called "lengthy and costly litigation with government plaintiffs with virtually unlimited resources". The other two publishers, Penguin and Macmillan, have decided to fight the case, as has Apple.
How did this all start?
The elephant in the room is online retailer Amazon. The firm's position as the world's biggest online shop gave it a head start in e-books. It capitalised by releasing the highly successful Kindle e-reader in 2007. By 2010 Amazon controlled 90% of the e-book market.
In theory the publishers should have been delighted. Of all the content industries music, news, films, etc books had made the most successful transition from analogue to digital. Amazon was still paying publishers what they wanted.
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Customers also should have been happy as, in a bid to win new custom, Amazon was retailing best-selling authors at knockdown prices. Indeed, on the face of it, the only people losing out were Amazon shareholders, as its commitment to a maximum price of $9.99 cost them money on many titles.
Nonetheless, the publishers worried that once Amazon's monopoly was secure, it would negotiate lower prices or even replace traditional publishers completely. In a 2009 strategy memo, Penguin Group CEO John Makinson noted that: "Competition for the attention of readers will be most intense from digital companies whose objective may be to disintermediate traditional publishers altogether. This is not a new threat, but we do appear to be on a collision course with Amazon, and possibly Google as well."
What did the publishers do?
The publishers decided to team up with the only other company that could break Amazon's stranglehold on the market Apple. The plan was that Apple could use its iPad, set to launch in 2010, to compete with the Kindle. But, unlike Amazon, Apple was unwilling to sell e-books at a loss.
It wanted the same 30% margin it would make selling magazines, newspapers and games on the iPad. So the publishers and Apple came up with a new agency model (how they came up with it is the focus of the DoJ's case see below).
Publishers would be free to set the end price of the e-book, while Apple, in its role as agent, would charge them 30% for selling it on. With Apple on board, the publishers felt confident enough to play hardball with Amazon. In 2010, Macmillan told Amazon to switch to the agency deal or face delays getting the rights to sell new titles.
At first Amazon refused, but when it realised all the other publishers were on board, it acquiesced. Bizarrely, the publishers were in effect forcing Amazon to take a bigger share of e-book profits at their expense.
Why did they do that?
As Apple founder, the late Steve Jobs, recounted in his biography, Amazon's $9.99 policy was "eroding the value perception of their [publishers'] products in customers' minds". Under the new agency model, they could push bestsellers back into the $12-$14 range.
Raising the price of e-books meant that they could protect sales of far more lucrative hardcover books in traditional bricks and mortar' stores. As James McQuivey of Forrester Research told the FT: "The agency model pricing was intended to delay fundamental changes in the business, such as the erosion of hardback sales, and it bought them a couple of years."
So what have the publishers done wrong?
The DoJ is particularly bothered that all five publishers signed identical contracts at around the same time. The DoJ's case centres on a series of meetings between the heads of all five publishers in exclusive New York restaurants. It claims that these clandestine meetings were used to hammer out the price fix deal. As a DoJ official told The Wall Street Journal: "We don't pick business models that's not our job. But when you see collusive behaviour at the highest levels of companies, you know something's wrong."
Does the DoJ have a case?
Opinion is split. Strong evidence of collusion will be bad news for the publishers. But on the flipside, the agency model actually broke an existing monopoly Amazon's share of the e-book market fell to 60% under the agency deal. The case against Apple looks even more uncertain. The DoJ claims Apple acted as a go-between and brokered the agency deal. Yet since it admits Apple didn't attend the exclusive dinners, this could be hard to prove.
How will the case affect online retail?
A win for the DoJ would reestablish lower prices for e-books. Amazon, for one, is delighted, with a spokesman hailing the decision as "a big win for Kindle owners". It is also likely to accelerate the demise of the traditional bookstore as it will exacerbate the cost difference between cheap e-books and their physical counterparts.
The case may also spill over into other industries. The agency model underpins the App stores' pioneered by Apple that sell virtual goods such as music and software online. If the DoJ is successful in this case, it might start looking for collusion' elsewhere. It's little wonder all eyes are on the outcome of the case the whole future of online media retail could be shaped by it.
James graduated from Keele University with a BA (Hons) in English literature and history, and has a NCTJ certificate in journalism.
After working as a freelance journalist in various Latin American countries, and a spell at ITV, James wrote for Television Business International and covered the European equity markets for the Forbes.com London bureau.
James has travelled extensively in emerging markets, reporting for international energy magazines such as Oil and Gas Investor, and institutional publications such as the Commonwealth Business Environment Report.
He is currently the managing editor of LatAm INVESTOR, the UK's only Latin American finance magazine.
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