Thursday, August 27, 2015

Apple loses appeal in e-books antitrust case - Part 2

This is the second in a series of comments on the Second Circuit’s June 30 decision in the Apple e-books antitrust case.

The Second Circuit has upheld a federal trial court finding that Apple, together with five of the so-called "Big Six" publishing companies, fixed prices for e-book editions of new issues and New York Times best sellers. The e-book reader market had been (and continues to be) dominated by Amazon's Kindle platform, first introduced in 2007; Kindle is an e-bookstore, an e-book format (including a digital rights management system), a cloud-based storage system, and a suite of e-readers. When Apple introduced its more general purpose iPad in 2010, it commenced competing with Amazon's Kindle across all these dimensions. Importantly, Apple sought to distribute e-books and so required access to the major publishers' catalog.

Amazon had been selling most new release and New York Times bestseller e-books below cost, attracting legions of readers to the Kindle ecosystem with its $9.99 pricing. Apple cleverly upset Amazon's $9.99 pricing policy by positioning itself as a sales agent (and not a retailer) of e-books, taking a 30% commission on sales. Apple thus generally restored retail pricing authority to the publishers. Apple's agency contracts, however. required e-book retail prices on iPad to match those offered on Amazon. This 'most favored nation' obligation drove the publishers to renegotiate their distribution deals with Amazon. Collectively (and with Apple playing an active coordinating role), the book publishers placed Amazon on an agency basis as well. The publishers then immediately raised e-book retail prices across both platforms - a surprising result in a market that appeared to be growing more competitive through the introduction of the iPad.
Federal and state antitrust authorities brought a civil antitrust suit against Apple in 2012. The publishing companies entered a series of consent decrees; Apple chose to fight the government in court. On July 10, 2013, the trial court held that the price fixing of e-books was a per se antitrust violation, and, in the alternative, an illegal restraint of trade that not saved through application of the antitrust "Rule of Reason." On June 30, 2015, Apple's appeal to the Second Circuit was firmly rejected, with two of the three members of the panel upholding the trial court's finding that Apple had committed a per se price fixing offense.

Apple had argued before the Second Circuit that it could not be held liable for price fixing as it was not in a 'horizontal' relationship with the book publishers; rather it was (as a distributor) in a vertical relationship and so foreign to any price fixing among the publishers. But Apple's argument failed to take into account the form and substance of Apple's agency relationships with the book publishers. In a traditional distributorship (such as those used Amazon prior to the introduction of the iPad), producers set wholesale prices and the distributor sets retail prices. Facing a producers cartel, the distributor would resist high wholesale prices. Apple, however, was a sales agent, not a distributor; as such, Apple was not in a pure "vertical" relationship with the publishers. Apple did not directly set the retail prices; the publishers did. But as a sales agent (receiving a 30% commission), Apple had the same incentives to limit output and seek higher e-book retail prices as did any other member of the cartel.

And further, Apple was hardly hands off as to iPad e-book retail prices. It set (within the agency agreements with the respective publishers) maximum prices the publishers could charge for their e-books on the iPad platform. And it is hardly surprising that the publishers generally raised their retail prices to levels approaching the maximums permitted by their respective agency agreements. While each agency agreement with Apple was formally independent, they shared substantially the same terms. Thus, Apple's agency agreements, operating collectively, functioned to set higher prices across the industry. The practical effect of Apple's systematic (and consistent) approach to these large publishers was to fix prices.

It is true, as Apple argued, that it had distinct commercial interests from the interests shared by the publishers. It had an interest in promoting the iPad, including use as an e-book platform (in competition with the Kindle). But the presence of distinct interests did not prevent the courts from finding that Apple was complicitous in fixing e-book prices.

Generally speaking, price fixing (a species of cartelization) is considered one of the most serious antitrust offenses. It is usually condemned per se; that is, without requiring the plaintiff to demonstrate an adverse effect on competition. Apple argued that even were it to be found to be a party to price fixing, liability should not automatically follow. Rather, given the novel technology involved and the asymmetric role of Apple is distributing e-books, the courts should apply the antitrust "Rule of Reason" in assessing liability. This would involve a balancing exercise, weighing the asserted procompetitive benefits of the Apple's network of agency agreements against any harm to competition. The majority of the Second Circuit panel found Apple's conduct to fall squarely within the per se condemnation of price fixing, and so further Rule of Reason analysis was not necessary.

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