This is the first of a series of comments on the Second Circuit’s June 30, 2015 decision in the Apple e-books antitrust case.
Through a series of spectacular commercial moves, Apple succeeded in disrupting the e-book space upon its 2009 release of the iPad, sweeping away Amazon Kindle’s popular $9.99 pricing for new releases and for New York Times best-sellers. The iPad brought meaningful competition to Amazon’s wildly successful Kindle as an e-book platform; the emergence of this new distribution channel raised e-book prices, whether purchased on iPads or Kindles, seemingly defying an economic law of gravity. It was a coup that only a Steve Jobs could pull off. The e-book price shift attracted the attention of federal and state antitrust authorities. In 2012, the government brought a civil antitrust action against Apple and five major publishers. The book publishers settled, and the government proceeded in a price fixing claim against Apple. On June 30, a panel of the Second Circuit Court of Appeals upheld a federal trial court’s finding that Apple violated Section 1 of the Sherman Act.
Apple’s play in resetting the commercial terms of e-book distribution was brilliant, even if (as the courts have now determined) illegal. The Apple e-book case addresses some major issues in contemporary antitrust law. May a party, in a vertical relationship with a producers cartel, be found liable for price fixing? Does such a situation constitute a per se antitrust offense? Antitrust analysis will follow; this comment describes, with no small amount of admiration for Apple’s cunning, the ‘scheme’ that reformed the e-book market.
Amazon's Kindle, introduced in 2007, was the first commercially successful e-book device. Of course 'commercial success' takes a peculiar form when speaking of Amazon: here the term reflects achievement of Amazon's market share ambitions, and not profits. It remains a mystery whether the entire Kindle project has ever been profitable. Amazon's behavior as a distributional monopolist is certainly odd. While Amazon's Kindle quickly grabbed an enormous market share, Amazon sold the most desired e-books - new releases and New York Times bestsellers - at a magical $9.99 price point. Amazon lost money on nearly every popular e-book it sold (it paid more than $9.99 to the publishers), and consumers were delighted. Amazon was, in effect, subsidizing Kindle readers. One expects a monopolist to charge high prices and to constrict sales volume. Instead, the Kindle brought readers low prices and increased the number of books sold.
Which is not to suggest that this state of affairs pleased the major book publishers. New releases and bestsellers are the heart of publishing's profits; the traditional hardback book is the means by which publishers extract the highest rents from the most ardent readers (less passionate readers will await the cheaper paperback editions that follow hardback release). The publishers had not anticipated Amazon's retail pricing policy when setting wholesale rates, and they universally hated the $9.99 price point (even though they profited from each sale). The $9.99 price for e-books on Kindle ate away at higher-priced hardback sales. Moreover, the publishers feared that the $9.99 price would work to adjust consumers' price expectations downward, inevitably driving down the prices of hardcover books as well.
But the book publishers feared approaching Amazon. No single publisher was forceful enough to recast Amazon's Kindle retail pricing policy. And collective action among the publishers - which generally did not compete with each other on price - would constitute easily detected price fixing.
Apple's executives, when planning the launch of the iPad, recognized that it could serve as an e-book reader (among many other functions) in competition with Amazon's Kindle. Apple had no interest, however, in emulating Amazon by selling e-books at a loss. Apple thus faced two challenges: reaching terms with the book publishers that would be profitable to Apple and halting the downward price pressure Amazon's Kindle was placing on the retail e-book market.
Apple could not directly collude with Amazon to raise e-book prices (here Apple would have faced swift and certain antitrust liability). It could - and did - act with respect to the major book publishers. It proposed an agency relationship between each publisher and Apple. Apple would not resell books on the iPad and would not set ebook prices. Rather, Apple would execute sales on the publisher's behalf, retaining 30% of revenues as a commission.
But Apple inserted a Most Favored Nation clause into its iPad contracts with the publishers. The publishers, who would generally set their respective prices on iPad, were obliged to match the prices sold on Kindle. So long as their books were sold by Amazon at $9.99, their iPad prices would have to follow. The iPad sales would be even less profitable, given than Apple would retain its 30% commission on each sale.
Given the presence of the Most Favored Nation clause, selling e-books on iPad would only be attractive if the prevailing e-book prices (that is, the Amazon Kindle prices) would increase significantly. In separate but coordinated negotiations between each publisher and Amazon, the publishers pushed Amazon on to an agency model. Apple’s encouragement stiffened the spines of the book publishers; Apple’s active supervision of the renegotiation of the Amazon agreements assured each publisher it was not facing Amazon alone. Having wrested retail pricing authority from Amazon, the publishers followed with rapid and sizable price increases. Apple's iPad entered the market, grabbed e-book reader market share away from Amazon’s Kindle. Apple distributed e-books profitably and took away Kindle’s commercial advantage as a source for below-cost e-books.