July 10, 2013 7:17am PT by Eriq Gardner
Apple Loses Government's Antitrust Lawsuit Over E-Books
A New York federal judge has found that Apple colluded with major book publishers to inflate the price of e-books.
The Department of Justice brought the lawsuit in April 2012 and alleged that Apple had acted as the "hub" in a hub-and-spoke conspiracy to move the book industry from a "wholesale" model dominated by Amazon.com to an "agency" model where Apple and other e-retailers would take commissions. The result of the actions resulted in e-books being sold past the $9.99 price point that was regularly used by Amazon.
The big publishers settled the government's claims, leaving Apple to defend its own actions in a three-week trial last month.
In a ruling on Wednesday, U.S. District Judge Denise Cote said the government has proven its case.
"The plaintiffs have shown that the publisher defendants conspired with each other to eliminate retail price competition in order to raise e-book prices, and that Apple played a central role in facilitating and executing that conspiracy," wrote Judge Cote said in a 160-page ruling. "Without Apple's orchestration of this conspiracy, it would not have succeeded as it did in the Spring of 2010."
The trial that ended on June 20 brought out top executives from CBS Corp's Simon & Schuster Inc., News Corp.'s HarperCollins Publishers Inc, Penguin, Lagardere SCA's Hachette Book Group, and Macmillan -- the companies that came to an agreement with the government to settle antitrust claims.
At a bench trial, Judge Cote also heard from Eddy Cue, Apple's senior vp of internet software and services, Keith Moerer, director of iTunes and Kevin Saul, Apple's associate general counsel. Also called to testify were executives at Amazon and Google and several economists.
"At their very first meetings in mid-December 2009, the Publishers conveyed to Apple their abhorrence of Amazon’s pricing, and Apple assured the Publishers it was willing to work with them to raise those prices, suggesting prices such as $12.99 and $14.99," says Judge Cote in summarizing the findings.
She adds, "For their part, if the Publisher Defendants were going to take control of e-book pricing and move the price point above $9.99, they needed to act collectively; any other course would leave an individual Publisher vulnerable to retaliation from Amazon."
That was the impetus behind a move from the wholesale model to an agency one that would be enforced through so-called Most Favored Nation contractual clauses. Apple did so as it sought to introduce its iBookstore around the time of its iPad launch.
"Apple seized the moment and brilliantly played its hand," writes the judge, adding the iBookstore "provided the Publisher Defendants with the vision, the format, the timetable, and the coordination that they needed to raise e-book prices."
Although the case centered on the price collusion, and meetings in 2009 and later deal-work that is said to have prompted excited publishers to make a flurry of calls how Apple's entry into the business could be used for advantage, the judge notes how the publishers worked in concert in other ways.
The judge says, "Another strategy that Publisher Defendants adopted in 2009 to combat Amazon’s $9.99 pricing was the delayed release or 'withholding' of the e-book versions of New Releases, a practice that was also called 'windowing.'"
Apple didn't want this. It believed that windowing led to the alienation of customers and piracy.
Saying that Cue was a "master negotiator," Apple's team is said to have arrived at meetings with publishers with certain goals in mind, including an all-or-nothing approach. It was Hachette and later HarperCollins who were the first to suggest an agency model, which Cue originally rejected but later rethought.
As Cue negotiated with publishers, he reported to Apple's late CEO Steve Jobs, telling his boss, “[c]learly, the biggest issue is new release pricing and they want a proposal from us.”
Eventually, the parties agreed on a model where Apple would sell books and take a 30 percent commission. The judge notes, "Agency would give the Publishers the control over e-book pricing that they desired, and ensured that Apple would make a profit from every e-book sale in its iBookstore without having to compete on price."
The only problem was competing with Amazon's $9.99 price point. In the ruling, Judge Cote goes into detail about Apple's team enacted higher prices for e-books, a 30% commission for Apple and no retail price competition. Essential to this structure was raising price caps and moving other e-tailers to the agency model. The MNFs helped on this front.
The judge says, "the MFN effectively forced the Publisher Defendants to change their entire e-book distribution business to an agency model if they wanted to take control of retail pricing. Any other course would be a race to the bottom in e-book prices and would give the Publisher Defendants a fixed share of a far too small revenue stream."
The entire ruling is likely to be closely read by many executives and attorneys in the industry. Not just the book business either as movies, music and other entertainment content is increasingly sold through digital channels. Those with a stake in new media will look for guidance on how to establish business relationships without running afoul of antitrust monitors.
In this case, Apple's lawyer attempted to argue in closing arguments that "Apple should be applauded and not condemned for its beneficial impact on the e-book market."
But the judge rejects this, saying not only that the government has proven a per se violation of the Sherman Act "through compelling direct and circumstantial evidence that Apple participated in and facilitated a horizontal price-fixing conspiracy," but also that Apple has failed to show the agreements had pro-competitive effects. The judge says that the launch of the iBookstore, the technical novelties of the iPad, and the evolution of digital publishing were "independent" of the agreements.
"In any event, the Plaintiffs have shown that the Agreements did not promote competition, but destroyed it," the judge concludes.
The case against Apple now moves to a new phase where a judge will have to determine what the corporate giant's penalties should be for participating in an antitrust conspiracy. Apple is being pursued by various state attorney generals looking for damages on behalf of customers who paid inflated e-book prices.