The U.S. Threat To Sue Apple And Publishers: What It Means

The Justice Department is about to sue Apple (NSDQ: AAPL) and five publishers for conspiring to raise the price of e-books. The warning is a game-changer in the government’s long-running anti-trust investigation — here’s an explanation of the case and what could happen next.

What is the meaning of the Justice Department’s threat?

Sources close to the anti-trust investigation told the Wall Street Journal that the government is ready to sue Apple and the publishers for price-fixing. What this means is that the Justice Department, which has been investigating e-book pricing since last year, has decided the parties violated the Sherman Act.

Will Apple and the publishers go to court?

When the U.S. concludes that an anti-trust violation has occurred, the companies and the government typically sign a “consent decree” that keeps the matter out of court. For practical purposes, this means that the parties agree to a set of conditions that often include codes of conduct and a fine. The fact that the government is talking about suing suggests that the parties were unable to come to such an agreement. If the government sues, it will ask a federal judge to rule that Apple and the publishers violated the Sherman Act and to impose a penalty. Apple and the publishers could theoretically beat the case in court but the matter is unlikely to get this far. These cases rarely go to trial because the stakes become higher and companies don’t want to incur more publicity.

So there will be a settlement?

The Wall Street Journal (NSDQ: NWS) reports that some, but not all, publishers are in settlement talks with the government. A Justice Department agreement with one publisher may lead to a domino effect in which the other publishers and Apple settle soon after. The government also has an incentive to settle because these deals can amount to a political victory in which the Administration can claim to be standing up for consumers.

What does this mean for e-book prices?

Recall that the anti-trust investigation is about the publishers’ decision to switch to “agency pricing” in which they set the price and allow retailers like Apple, Amazon and Barnes & Nobel to take a commission. Prior to this system, the industry was using a wholesale model in which the publishers sold to the retailers which in turn sold the e-books at whatever price they liked. In practice, this meant that Amazon was often selling books at a loss to build market share (and, in the publishers’ eyes, teaching consumers to get accustomed to unrealistically low prices). A settlement between the government and the publishers — which is the most probable outcome — will likely include provisions that restrict agency pricing and permit retailers to engage in more discounting.

Who wins and who loses?

Amazon is the obvious winner here. A return to wholesale pricing could mean lower prices and consumers buying more e-books — which will in turn make them more dependent on devices like the Kindle Fire which Amazon has turned into a virtual shopping mall.

For publishers, the Justice Department’s rumored lawsuit is a major setback that threatens the pricing system that has provided them with higher e-book margins in the last year.

For Apple, the price of e-books means little to a company that has enough cash to buy a good part of Western Europe. But the government’s antitrust finding is a strategic setback in its battle with Amazon (NSDQ: AMZN). In the long term, the development could also pose a threat to the 30 percent pricing system Apple uses in other areas like apps and music.