Ebooks and Antitrust

The Justice Department sues Apple and five book publishers for fighting Amazon

Back in 2010, a giant retailer had 90 percent of a market—a near total monopoly (monopsony, if you want to be precise).

This company tried to dictate pricing in the industry via its dominant position (aided significantly, to be sure, by its early innovation in the market) and by the fact that it can use its profits elsewhere to subsidize heavy discounts, selling them at a loss so other retailers can’t match its prices. That threatened to further cement this company’s grip on the market, as did the fact that it sold a device that locked consumers into its proprietary software. This company used its monopoly power to demand lower prices from manufacturers, removing their products from its store (and thus cutting off almost all sales) when they didn’t comply.

Manufacturers in this market—the folks who actually make the stuff people buy—were gravely concerned about the power this retailer had assumed over their business.

Another giant company came along and told manufacturers it had a better model. It would let them set their own prices for their own goods in exchange for a fixed cut and for barring other retailers from selling for less. The manufacturers agreed and individually set their own prices for their products.

While this would have been vertical price fixing and considered illegal five years ago under the Sherman Antitrust Act, a 2007 Supreme Court ruling has changed that, saying that retailers can set minimum prices for their products to “give consumers more options so that they can choose among low-price, low-service brands; high-price, high-service brands; and brands that fall in between.”

Two years later, the model has made an impact. The monopoly retailer’s position in the market has been reduced to 60 percent. Prices have risen about 25 percent, which allows for the emergence of two new major retailers who wouldn’t have been in the market since they would have been competing to lose money on every book sale. Sales have continued to boom.

The Justice Department sues for antitrust violations. But whom does it sue? The companies fighting the monopoly, naturally.

The dominant retailer I’m talking about above, of course, is Amazon. The competitor is Apple (and, later, Barnes & Noble), and the manufacturers are the major book publishers.

But the Obama administration is missing the forest for the trees in suing them for colluding to raise prices in the ebook market.

While this may look like price-fixing, and the DOJ has some damning-looking meetings and timelines (that Penguin’s CEO says contain “material misstatements and omissions”), it’s ultimately about companies being forced to do what the government wouldn’t do: Take on a monopolistic competitor that abused its market power to dictate how they do business.

How do we know this? Because the publishers sued here made less money under Apple’s agency sales model than they did under Amazon’s loss leader policy. As Macmillan CEO John Sargent, who is fighting the DOJ suit, says:

When Macmillan changed to the agency model we did so knowing we would make less money on our e book business. We made the change to support an open and competitive market for the future, and it worked.

What kind of sense does it make for companies to fix prices to make less money? The publishers were gravely worried about the monopoly power Amazon was accumulating over their market and they acted to break it. If anybody was anticompetitive here it’s Apple, which leveraged its heft and the publishers’ weak position vis a vis Amazon to ensure itself a 30 percent profit margin on ebook sales.

This kind of market distortion is unsurprising when companies like Amazon, which doesn’t play nice, are allowed to accumulate dominant positions and to use their power to dictate terms.

GigaOm’s Mathew Ingram writes that “A case against Amazon wouldn’t make any sense unless it could be shown that Amazon’s behavior was causing higher prices.” It’s true antitrust laws are there primarily to protect consumers, but they do that in part by protecting competitors and suppliers from chokeholds in markets. Doing so ultimately protects consumers in the long run—on prices and on selection.

Taking a loss on something to establish or maintain a dominant market position is predatory pricing. In the short run, that may benefit consumers, but it won’t in the long run.

(UPDATE: I’ve made several copy edits to fix tenses in the opening few paragraphs)

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Ryan Chittum is a former Wall Street Journal reporter, and deputy editor of The Audit, CJR's business section. If you see notable business journalism, give him a heads-up at rc2538@columbia.edu. Follow him on Twitter at @ryanchittum. Tags: , , , ,