JURIST Guest Columnist Daniel Crane of the University of Michigan Law School says that unless the government can prove that the publishers actually agreed on e-book prices or a formula for price setting, the lawsuit will be more difficult because of a recent Supreme Court ruling…

The lionization of the recently departed Steve Jobs had barely faded from the headlines when the US Department of Justice (DOJ) decided to sue Apple for antitrust violations, effectively naming the sadly defenseless Jobs Conspirator Number One. On April 11, 2012, the DOJ Antitrust Division filed a civil complaint against Apple and seven book publishers including HarperCollins, Hachette Book Group, Macmillan, Penguin and Simon & Schuster, alleging a conspiracy to raise the prices of e-books. According to the complaint, the publishers and Apple colluded to force Amazon to switch from the wholesale model, where Amazon sets the price of e-books, typically at $9.99, to an agency model, where the publisher sets the price of the books, typically at $14.99, and the distributor retains a 30 percent commission.

Accompanying the case filing came the news that three publishers, Hachette, HarperCollins and Simon & Schuster, were settling on terms that would require the companies to grant retailers — such as Amazon and Barnes & Noble — the freedom to set their own e-book prices. The remaining publishers and Apple appear to be willing to fight the government’s case.

The opening narrative of the case is relatively straightforward. Between the introduction of Amazon’s Kindle in 2007 and the introduction of Barnes & Noble’s Nook in 2009 and Apple’s iPad in 2010, Amazon was the juggernaut in the e-book and e-reader market. Amazon strategically priced e-books at an attractive $9.99 in part to stimulate demand for the Kindle and, arguably, to entrench its market position in advance of the availability of competitive technologies.

The book publishers felt that Amazon was devaluing the e-book market in order to promote its proprietary systems and technology. They feared that Amazon’s low e-book pricing would condition consumers to expect low e-book prices forever — that it would poison the well. Because Amazon was initially the only game in town for e-book distribution, the publishers had little power to resist Amazon’s demands. The advent of the iPad (and to a lesser extent the Nook) emboldened the publishers to demand different terms of dealing with Amazon.

Here is where the narrative becomes contested. The DOJ says that in late 2008 the publishers began to conspire with one another and eventually with Apple to force Amazon’s hand. The conspiracy allegedly began as a deal between Apple and the publishers. Under the terms of the deal, the publishers would set the ultimate retail price, which would be capped in several tiers based on the hard copy list price. Thus, for example, a bestseller with a list price below $30 could be sold for up to $12.99; one with a list price between $30 and $35 for up to $14.99. Amazon would collect a 30 percent royalty for distributing the book. Further, the publishers would agree to an unusual most favored nation (MFN) contract with Apple, providing that the publisher would guarantee to lower the retail price of each e-book in Apple’s iBookstore to match the lowest price offered by any other retailers, even if the publisher did not control the other retailer’s ultimate price to consumers.

Having agreed to these terms with Apple, the publishers were allegedly able to force Amazon into the same type of arrangement. Because allowing Amazon to continue to undercut prices in iBookstore would quickly erode the whole deal, the publishers collectively forced Amazon to adhere to the new e-book pricing plan and agency model.

The DOJ complaint pursues a theory of per se illegality under Section 1 of the Sherman Act. If one believes every part of the story, the government may ultimately prevail in this theory. Reading the narrative more critically, however, some potential weaknesses in the government’s case appear.

First, for purposes of modern antitrust analysis, it is critically important to distinguish between vertical and horizontal agreements. The complaint, of course, alleges a horizontal agreement, but most of the direct evidence alleged of the complaint seems to be of a series of vertical deals between Apple and the publishers. Assume that the government ultimately proves that the book publishers were all interested in moving to an agency model, that they had a number of discussions with each other about how to do that, and that Apple agreed to help by entering into a series of vertical contracts that would serve as the benchmark for other industry contracts. Under the US Supreme Court’s decision in Leegin Creative Leather Products, Inc. v. PSKS, Inc., a set of vertical resale price maintenance agreements with MFN clauses would be judged under the rule of reason, not the per se rule. The government would need to prove a relevant market and show that the vertical agreements had anticompetitive effects in that relevant market. Apple and the publishers would be allowed to show, in rebuttal, that the vertical agreements were supported by efficiency considerations. Rule of reason challenges have been notoriously difficult to win. A recent empirical study [PDF] by Michael Carrier found that defendants won 99.6 percent of rule of reason cases to reach final judgment over the last decade.

The DOJ will argue that there is ample evidence of horizontal agreement among the publishers since they clearly had many contacts on the subject of e-book pricing and coordinated their strategies with respect to Apple and Amazon. It is important here to distinguish between different subject matters of agreement however. An agreement to share information and pursue a common strategy to switch the industry from a wholesale model to an agency model — though a horizontal agreement — would likely be subject to the rule of reason as well. Unless the government can prove that the publishers actually agreed on e-book prices or a formula for setting e-book prices, the per se rule is unlikely to apply. If the rule of reason analysis applies, it’s off to the races.

The DOJ complaint has superficial appeal because of the price effects story — prices suddenly jumping 50 percent — and consumer unhappiness with those increases. But e-book prices are just one facet of the story. If Amazon was using e-books as loss leaders to lock in customers to Kindle technology, then the overall effects on consumer welfare from the switch to the agency model might actually be positive even if e-book prices increased in the short run. Indeed, given the interdependence between readers and e-books, it would be surprising if the introduction of attractive new reader technologies like the iPad and Nook didn’t have implications for e-book pricing. Peering into the lawsuit from the outside, one doubts that things are nearly as simple as the complaint alleges.

Being sued under the antitrust laws is a rite of passage for hugely successful and innovative US tech companies — just ask IBM, AT&T, Microsoft and Intel. Google may be breathing a sigh of relief that Apple’s number came up before the conclusion of the Federal Trade Commission and EU investigations into Internet search, but it surely will not be long before Google feels the heat as well. Facebook’s day is probably a few years away. In the meantime, Apple’s travails with e-books will make for interesting summer reading. If we can all afford it.

Daniel Crane is a Professor of Law at the University of Michigan Law School. He is also Counsel with Paul, Weiss, Rifkind, Wharton & Garrison LLP. His recent scholarship has focused primarily on antitrust and economic regulation, particularly the institutional structure of antitrust enforcement, predatory pricing, bundling and the antitrust implications of various patent practices. He is the author of The Institutional Structure of Antitrust Enforcement and the forthcoming Intellectual History of Competition Policy: Selected Readings.

Suggested citation: Daniel Crane, DOJ e-Book Price Fixing Lawsuit is Superficial, JURIST – Forum, Apr. 23, 2012, http://jurist.org/forum/2012/04/daniel-crane-ebook-pricing.php.