Bobbing for Antitrust Apples: E-book Price Fixing Challenge

With the advent of new digital items and applications that did not exist even five years ago, it is not surprising that the FTC and DOJ are eyeing the handful of large companies that dominate the marketplace for them with a watchful eye (anybody else picturing Sauron right now?)  It is even less surprising that Apple, Inc. has been pinched by the Justice Department with claims that it violated the Sherman Act with its anticompetitive behavior.  This is not to say that Apple actually did anything illegal – but something about having more cash than your government makes such a suit inevitable.  (Ask Google how its $500 million settlement for online advertising felt.)  This leads us to today’s topic: the DOJ’s antitrust suit against Apple and six other book publishers alleging e-book price-fixing

As mentioned in previous Antitrust articles, American Antitrust law is a sprawling and complex body of law.  Naturally, then, any article addressing an antitrust issue must stick to a very narrowly defined set of issues.  For this article’s purposes, it will suffice to simply define price fixing and examine why the government frowns on it.  To begin with a bit of background, American antitrust law (more appropriately called “competition law”) starts with the Sherman Act of 1890, which prohibits agreements or practices that restrict free trading and competition between businesses.

The basis for this protection, and the foundation of the government’s suit, is found in 15 U.S.C. § 1:

Every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several States, or with foreign nations, is declared to be illegal. Every person who shall make any contract or engage in any combination or conspiracy hereby declared to be illegal shall be deemed guilty of a felony

In English, that means if your company gets together with other companies in an attempt to stifle the free market and competition, the government will step in and put you all on time out. The Supreme Court, however, explained the purpose of 15 U.S.C. § 1 in Spectrum Sports, Inc. v. McQuillan:

The purpose of the [Sherman] Act is not to protect businesses from the working of the market; it is to protect the public from the failure of the market. The law directs itself not against conduct which is competitive, even severely so, but against conduct which unfairly tends to destroy competition itself.

So what did Apple and the other publishers do that put them on Uncle Sam’s Radar?  Allegedly, they agreed among themselves to sell their e-books at the same price.  This is also known as “Price Fixing” and it’s a big no-no.  When companies who sell the same product agree among themselves to set the same price for that product, they could (not necessarily will) set that price as high as they wish, because there will be no place cheaper to get it.  The type of price fixing alleged here – ‘horizontal’ price fixing – is considered violative of the Sherman Act regardless of the effect on the market.  This means that even if the agreement didn’t actually harm the market whatsoever, it would still be considered anti-competitive.

However, recent case law suggests that if Apple and its alleged co-conspirators had not made a concerted effort to set the price as high as it would go, there would be no antitrust claim.  This is because it is not a violation of the Sherman Act to look at your competitor’s price and set yours close to it (because hey, obviously someone’s paying it).   So long is there no agreement, shared effort, conspiracy or collusion to do so, you’ll be fine.  This is known as conscious parallelism, and it is not a violation of the Sherman Act.  But, when there are additional circumstances present, ranging from evidence that the defendants acted in concert against their own economic interests or were invited to common action by others, a conspiracy – and § 1 violation – are back in play.

Back to why Apple is in hot water.  Before the iPad launched, Amazon’s Kindle was the e-reader of choice (arguably, it still is.)  In providing e-books to its customers (and stimulating demand for the Kindle), Amazon forced publishers selling e-books for the Kindle to sell them for less than the book’s price in print.  When Apple jumped into the e-reader market, though, it needed to compete with the very popular – and much cheaper – e-books available through Amazon.  According to the Complaint, Apple agreed to let publishers set their own prices for e-books, while Apple would receive a 30% commission on each sale. In order to keep their profit margins up, the publishers set a price that was higher than Amazon’s paltry $9.99 e-book price.   Theoretically, with the release of the iPad, users would prefer to read (and be seen in trendy coffee shops) using Apple’s device, rather than the Kindle.  In contrast, Amazon’s wholesale model allowed it to negotiate with the publishers for the rights to books, and sell them at whatever price they wish – so long as it was below the price of the printed book.   

Apple has remained pretty quiet about the suit thus far.  Granted, this all happened within the last couple of days, but Apple’s only comment is to deny any wrongdoing.  It argues that its contingency model of pricing (allowing the publisher, not the retailer, to set prices) was designed to lead to more diversity in a marketplace dominated by Amazon.  Incidentally, this is very similar to how Apple makes money on the apps it sells- are e-books all that different? The government apparently thinks so.  Apple further contends that it was an oligopolistic savior in a nearly monopolistic market, as Amazon was dangerously close to owning the entire market.  Because Amazon’s prices were so low, a condition found only because of Amazon’s sheer market power, other publishers (read: smaller independent publishers) would get squeezed out of even competing – leaving Amazon the uncontested ruler of the e-book market.    I’m not sure Apple is as altruistic and benevolent as it says, but it’s a good argument that I’m sure will get a lot more attention as the case progresses.  And it looks as though it will progress; where most of the publishers have settled, Apple has flat out refused to do so.

But never forget this: Antitrust law is a notoriously difficult body of law and one that changes daily.  And antitrust suits are about as difficult to prove as they are costly to defend, so this may turn into a chicken race where the winner will be the one who can afford to stick with it longer. Still, given that the maximum damage award against each corporate defendant is $100,000,000, Apple (and the other defendants) may just write the check and avoid the bad publicity.  The Magic 8-Ball predicts the outcome of this suit will be a payday for the DOJ and US Treasury.  If the anti-competitive effects of this conspiracy are as alleged, the defendants’ settlements will more than offset the lost tax revenue from reduced economic activity – with a little extra as a black flag of deterrence for those who may attempt a similar scheme.  The benefit to the actual consumers of e-books, though, remains unknown.  Magic 8 Ball says it doesn’t look good.


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2 comments so far.

  • [Avatar for Mike Cane]
    Mike Cane
    April 17, 2012 01:59 pm

    >>>Incidentally, this is very similar to how Apple makes money on the apps it sells- are e-books all that different?

    What about music? Do you know that Apple buys music from the labels under a wholesale model that pre-Apple Amazon bought eBooks from the Big Six?

  • [Avatar for ceej@y]
    [email protected]
    April 15, 2012 06:40 pm

    I’m not sure what the DOJ is claiming, but they should be framing the claim against Apple as a hybrid antitrust claim (hub-and-spoke conspiracy, probably). The publishers are really in hot-water for horizontal price-fixing, which is probably why most of the publishers settled already. But Apple’s wrong doing is less obvious; they are not horizontal-competitors with the publishers, but rather are vertical-actors (downstream from the publishers). That helps Apple defense, which is why they are holding out. Since retailers often can choose from different suppliers, there usually isn’t a huge potential for consumer abuse due to vertical price-fixing. Apple however is financially huge retailer and may have agreed to conspire with the current monopolists of the publishing industry. The courts really jump on price-fixing because they believe it hurts consumers.

    I could also see a tying claim: Apple trying to use the publishers monopoly of ebooks to coerce consumers to buy an iPad. That’s maybe weak though because consumers seem to lust after iPads.