The Justice Department and the Price of Books

The Wall Street Journal reports that the Justice Department is going after Apple and book publishers for colluding to fix prices in the e-book market, a big development in that fast-growing industry.

Back when Apple launched its iBooks store, Steve Jobs got publishers to switch how they sold e-books to retailers. Publishers had been selling them for half the list price and letting retailers charge whatever they wanted. The problem was Amazon, which tried to commandeer the book industry with ultra-low prices, losing money on books in order to build a dominant position for its Kindle, which it was also selling (and still sells) at a loss.

This is taken straight from Apple’s playbook with the music industry a decade ago. Apple all but controls music-industry pricing now and book publishers wanted to avoid giving up pricing power on their own products.

Recognizing this, and needing a toehold in a nascent market already dominated by a competitor, Jobs told book publishers they could set their own prices in his store and Apple would take a 30 percent cut. The kicker was that they couldn’t let anyone else sell ebooks cheaper than the price Apple got. That’s what happened, and Amazon had to follow suit, which didn’t make Kindle readers very happy.

Basically, Justice is saying that Apple and Co. used anticompetitive practices to fight anticompetitive practices.

But the big question I have is what exactly is illegal about the Apple deal? In 2007, a big Supreme Court decision, Leegin Creative Leather Products, Inc. v. PSKS, Inc., overturned a century-old antitrust law banning minimum-pricing restraints outright. The Journal doesn’t mention that, much less how it affects Justice’s case.

So let’s turn to The Wall Street Journal itself, circa 2010 on what the Leegin ruling means:

The 2007 ruling, known as Leegin for the manufacturer’s former name, overturned a 1911 antitrust precedent that had held that vertical price-fixing is always illegal. Instead of automatically voiding such agreements, courts should evaluate them individually to determine the impact on competition, the justices held.

In the majority opinion, Justice Anthony Kennedy wrote that discounts can harm consumers by driving prices down, depriving retailers of the profits they need to provide good service. In some cases, price-fixing can “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.”

Here’s a 2007 Billboard story describing the potential effect of the Leegin ruling on music-industry pricing (Best Buy and Walmart took out tons of record stores in the 1990s by selling CDs as loss leaders):

Even with that ruling, retailers should be aware that horizontal price strategies—ones where competitors like all majors labels agree on a set price—are still illegal under Chapter 1 of the Sherman Act. But what the ruling does is allow for the “rule of reason” to be applied on whether setting a vertical price restraint—an agreement between a major and retail—could now be ruled legal if it promotes interbrand competition.

In other words, Simon & Schuster and Harper Collins can’t get together and decide how much to force retailers to charge for new releases, but they can separately decide the minimum price their products can go for, as long as it promotes competition. Does it promote competition if retailers can’t sell books for a loss? I reckon that depends on whether you see loss leaders as predatory pricing—the powerful and capital-flush gaining market share at the expense of smaller competitors.

It’s worth noting what Sarah Lacey reported an unnamed publishing industry insider told her about Amazon back in January:

So Amazon, pretty much since they started selling books, has been selling them for razor thin or zero margin. We sell them books at 50% of the retail price. You’ll notice that popular books are usually selling for more than 50% off. So they’re actually losing money on them. For years Borders and Barnes and Noble maintained that this was unsustainable, but the tactic succeeded in putting Borders out of business, putting BN on the ropes, and destroying hundreds of indie stores. It also lowered customers’ perception of what a book *should* cost.

It seems like Justice has a weak case. The dominant force in a market (Amazon) is selling products at a big loss in part to prevent or weaken competition. A competitor (Apple) comes in with a new business model that the suppliers of the product (publishers) like better and which lets them set minimum prices individually and vertically with retailers—something that is legal as of five years ago, if it doesn’t harm competition. The book industry argues this allows “more electronic booksellers to thrive,” which has the benefit of being obviously true, and Amazon and others get the same terms Apple does.

Unless the Justice Department has evidence that publishers got together to set minimum prices, and there’s no reason to believe that, then what’s the legal problem here?

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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 Follow him on Twitter at @ryanchittum. Tags: , , , ,