A case of mistaken monopolist?

Judges question Apple ebook verdict and Amazon’s role

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In a new twist in the long running antitrust case against Apple, an appeals court on Monday cast doubt on the Justice Department’s theory that the company brokered an illegal conspiracy among book publishers, and asked instead why the government’s focus has not been on Amazon.

The 90-minute hearing, which took place at the Second Circuit Court in Manhattan, represented a major shift in momentum in a case that has until now gone completely against Apple. On Monday, the three appeals court judges suggested that District Judge Denise Cote might have been too quick to conclude that Apple’s pricing arrangements with five publishers violated antitrust laws.

“Would it not matter that all those people got together to defeat a monopolist? It’s like the mice that got together to put a bell on a cat,” U.S. Circuit Judge Dennis Jacobs told the Justice Department’s lawyer, Malcolm Stewart.

The cat in question here is [company]Amazon[/company], which controlled over 90 percent of the ebook market in early 2010 when Apple and the publishers introduced “agency pricing,” which lets publishers set an ebook’s retail price and pay the publisher a commission. Amazon had previously used the wholesale model for all ebooks.

On Monday, Apple’s lawyer Theodore Boutros urged the appeals court to regard the pricing tactic as a legitimate business arrangement used to “come into a market dominated by a monopolist.”

The judges appeared to give weight to this suggestion, and to accept Boutros’ contention that a brief price spike, which damned Apple and the publishers before Judge Cote, should not result in an automatic finding of illegal price-fixing. Instead, Boutros said the price spike was limited only to the five publishers, and that the overall effect of Apple’s entry to the ebook market dramatically benefited consumers since many more players were willing to enter the market.

The appeals court judges also expressed skepticism over Stewart’s repeated attempts to liken the agency pricing arrangements to a criminal drug conspiracy in which [company]Apple[/company] was the driver.

“When you’re dealing with the illegal drug industry, you’re looking at one of the few areas where the law doesn’t look favorably on new entrants,” said Circuit Judge Debra Livingston.

$450 million settlement at risk

If the appeals court decides to disturb Judge Cote’s verdict, their ruling would have an immediate ripple effect on a related legal proceeding, involving class action lawyers and state governments, in which Apple has agreed to pay out $400 million to consumers and another $50 million in legal fees.

But in an unusual arrangement, the $450 payout is contingent on the Second Circuit upholding the verdict. If the appeals court judges remand the verdict, the payout could drop to a total of $70 million and, if they reverse it entirely, the payout will be nothing.

At the hearing, Boutros suggested that the appeals should overturn Court’s ruling as a matter of law, or at least remand it to a different judge.

The major legal issue at stake turns turns on competing antitrust doctrines known as “per se” versus “rule of reason” — which specify how courts should assess situations in which companies are found to have colluded on a given business issue.

The appeals court, however, may be hard-pressed to reverse Judge Cote, who found in a 160-page decision that Apple was liable under either standard.

In the event the appeals court does remand or reverse, its finding is likely to turn on whether Apple and the publishers’ behavior was justified in the context of what Judge Jacobs called a “new entrant breaking the hold of a monopolist” using “arguably predatory” tactics.

For the publishers, the outcome will not effect their liability since they have already agreed to pay out millions as a result of voluntary settlements.

A five-year cooling off period

A portion of Monday’s arguments were taken up by lawyers from Simon & Schuster and Macmillan, which are two of the five publishers that were caught up in the antitrust investigations (the others are Hachette, HarperCollins and Penguin, which has since merged with Random House).

Macmillan and Simon & Schuster were there to object to a part of Judge Cote’s order in which Apple must engage in a five-year “cooling off period” with the publishers, and engage in only arms-length negotiations. For practical purposes, this means that the publishers will not be able to limit Apple’s ability to engage in discounting, which could in turn complicate their negotiations with other retailers.

The publishers claim this five-year provision is unfair since they are this month coming to the end of their own two-year settlements with the government. They claim that the Justice Department is, in essence, reneging on its earlier agreement with them since the five-year arrangement with Apple will have knock-on effects in their negotiations with other ebook retailers.

The publishers asked the judges to excise a part of Judge Cote’s order that applies the five-year cooling-off period and, if necessary, to make a special preliminary decision on this matter so their pricing strategies are not compromised.

Finally, the appeals court judges also mulled what to do with the special monitor that Justice Cote appointed to oversee Apple’s compliance. The appointment has drawn criticism because the monitor selected by Cote was a friend of the judge who lacked antitrust experience and hired a special advisor at extra cost.

The appeals court said it will reserve its decision, meaning a ruling is likely to come sometime in 2015.

7 Responses to “Judges question Apple ebook verdict and Amazon’s role”

  1. So …. it’s completely legal to steal something from my neighbor then, if it’s the only way I can get it and he has a few of them? I mean it seems like he’s monopolizing the thing and I want to be in on that party so somehow that seems to impact my own relationship with the law. At least according to this thinking.
    And if I do get arrested I should just try to convince the judge that the cops shouldn’t have been wasting time looking at my lawfullness anyway since there are other people breaking the law.
    This is ludicrous. Try that “but some other car was going even faster, why didn’t you pull him over instead?” bit the next time you are stopped for speeding. See if the cop agrees with your legal reasoning.
    The lower courst had it right. What Amazon was or was not doing has no bearing on what Apple did. If Amazon is doing something wrong. Great. Go after them for that. But the two things are two different things.

  2. Michael W. Perry

    Sounds good, especially those hints from the appeals court that perhaps the DOJ should have gone after Amazon instead. Keep in mind that, at the time of Apple’s alleged price-fixing the iPad was not yet out and it had a 0% market share. Apple, eager to sell iPads, wasn’t going to hurt those sales by conspiring to make ebooks more expensive on its devices.

    If it had wanted to lower prices and improve competition, the DOJ could have taken on Amazon’s convoluted royalty scheme, which is price fixing and raises the price of many books. It pays 70% only for ebooks priced between $2.99 and $9.99. That has two perverse effects on ebook pricing:

    1. Publishers who might have priced their ebooks at $0.99 or $1.99 are forced to raise their prices to $2.99 to avoid to avoid Amazon’s miserly 35% royalties on low-priced ebooks.

    2. Publishers of ebooks whose limited sales mean they must be priced for more than $9.99 are forced to double their prices to make up, yet again, for Amazon’s miserly 35% royalty rate.

    Compare that to Apple, which pays 70% of retail at all price levels and thus doesn’t force publishers to raise prices.

    • Thanks for the thoughtful comments, Michael. I hadn’t considered the consequences of royalty splits and Amazon’s $2.99/$9.99 pricing points, but your theory makes sense.

      More broadly, I can’t say for sure if Apple made ebook prices higher or lower, but to this day I’m flummoxed as to why Justice figured they were an anti-trust threat — to this day, Apple’s never had more than 10 percent of the market.

      Ultimately, it felt like it devolved into a grudge match between DOJ and Apple lawyers. I can understand the annoyance at Apple’s arrogance, but that doesn’t excuse going to the wall on this — it’s going to be quite a comeuppance if Second Circuit reverses.

    • Len Sherman

      As a clarification, while somewhat convoluted, Amazon’s royalty rate policy is better compared with the mainstream publishers who only offer authors a 25% royalty on ebooks, regardless of price (and on top of that only pay authors every 6-12 months vs. quarterly for Amazon). I have not heard many authors complaining about Amazon’s royalty rate policies compared with traditional industry practices.

      I wonder whether authors really would make more money selling their books at $1.99 vs. $2.99, even if they received the same royalty at both price points. Amazon undoubtedly has done the math, and I suspect they believe demand is not elastic enough to encourage $1.99 pricing to maximize revenue. After all, Amazon is not in business to limit their revenue, and in this regard, what’s good for Amazon is good for authors. As for self-published books priced above $9.99, good luck with that! I doubt many authors could sell many books at such elevated prices. In any event, this aspect of Amazon’s royalty policy only affects a very small part of the ebook market.

      Finally, the price of ebooks clearly increased considerably (and ebook sales volume commensurately declined) immediately after the Apple/publisher deal was inked. This collusively arranged price increase was a central proof point in the government’s case against Apple and 5 publishers. One can argue that some of Amazon’s business tactics were legally questionable, and if so, that’s a separate case to be made. But the case that was decided had strong factual backing. It will be interesting to see if the appeals court rules otherwise, not on the merits of facts per se, but on the broader business context involving a third party — the Amazon elephant in the room!