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E-books, innovation and antitrust

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There are plenty of oddities in the antitrust case brought by the Department of Justice Wednesday against Apple and five leading publishers over e-book pricing, starting with the fact that Apple is far from the dominant player in the e-book business, Amazon is, which would seem to make Amazon a more logical target of scrutiny. There’s also the fact that the “agency pricing” model the publishers are alleged to have conspired with Apple to impose on the market, in many cases, reduces a publisher’s gross revenue per copy compared to the “wholesale model” it was meant to replace, which would seem to make it a rather odd conspiracy for the publishers to engage in.

Those are just some of the reasons, in fact, that many commentators have cited for being skeptical of the government’s case and why some legal experts have predicted the case will fail in court, if it ever gets that far. Some have even suggested it’s practically un-American for the Justice Department to be targeting an icon of American innovation and business success such as Apple.

Perhaps so. Not being a lawyer I can’t judge the legal merits of the government’s case (you can read the full complaint here). But there are plenty of other reasons to oppose the agency pricing model for e-books, whether or not what Apple and the publishers did was illegal.

The government’s case rests on an alleged conspiracy among the publishers to raise the retail price of e-books by wresting pricing power away from Amazon.com. Amazon sold most new e-books for $9.99, a price the publishers felt was too low and feared would become cemented in consumers’ minds as the basic value of an e-book. According to the complaint, the publishers conspired, with the connivance of Apple, to impose a new pricing model on Amazon in which publishers would set retail prices and the retailer would get a commission on each sale. — the so-called agency model. As part of the alleged conspiracy, the publishers all agreed to stop selling e-books to Amazon under the traditional wholesale model that allowed Amazon to set its own retail prices.

The publishers real fear, however, as noted in the government’s complaint,was not the impact of Amazon’s pricing on e-books but its potential to cannibalize sales of expensive hardcover books. As the Consumer Federation of America’s research director Mark Cooper pointed out in a letter to Congress on e-book pricing last week, however, roughly 60 percent of the average retail price of hardcover books goes to cover the costs of  manufacturing, physical distribution and brick-and-mortar retailing of books. Publishers take another 20 percent. In content industries generally, in fact, costs associated with the making, distributing and retailing of physical goods account for nearly 80 cents of every dollar consumers spend.

Digital technology is disruptive to producers precisely because it eliminates most of those costs. In publishing, as in movies, music, newspapers and video games, the high costs of production and distribution have long acted as barriers to entry to other market entrants. That’s why those industries tend to be highly concentrated under a small number of dominant publisher-distributors. When you take those costs out of the system, as Amazon did with e-books, you eliminate the levers of market control for publishers.

What’s happening in the e-book market, in fact, is not fundamentally different from what happened in the music industry (ironically largely at the hands of Apple). The retail price of recorded music has plunged thanks to digital technology and the record labels lost market power. At the same time, innovation has flourished at the retail level, as new market entrants have pioneered new models and methods for delivering music to consumers. Ultimately, those new channels will make it easier for artists to reach their fans directly, reducing their dependence on the labels for their livelihood.

The record labels, of course, responded to those changes much as publishers are now, engaging in multiple price-fixing conspiracies to try to preserve the high price of CDs.

As Matthew Ingram pointed out in a very smart post on GigaOM, the publishers’ efforts to defend the agency pricing model for e-books seems very much like an effort to stave off the same disruptive forces that restructured the music industry. Disruption is not always pretty, especially for the incumbent interests, But another word for that disruption is “innovation,” and it generally benefits consumers.

Question of the week

Can Apple still compete with Amazon in e-books without agency pricing?