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Did Apple Conspire with Book Publishers?

While everyone is consumed with deciphering how the bid by Google (GOOG) to acquire Motorola Mobility Motorola Mobility (MMI) will affect the dominance of Apple (AAPL) in the smartphone market, Apple has other fights on its hands. Among them is a class-action lawsuit filed recently that alleges the company conspired with major book publishers to keep e-book prices high by implementing the so-called "agency model," which allowed publishers to set the price instead of Apple. Was this an actual conspiracy, or was it just a way for Apple and the publishers to compete with the dominance by Amazon (AMZN) over the growing market for electronic books?

The seeds for this particular battle were sown early in 2010, after Apple launched the iPad with its built-in iBooks library application. At the time, Amazon was fighting with a number of publishers—particularly Macmillan—over what prices it could charge for e-book versions of their titles. The online-retailing giant, whose Kindle reader gave it profound power over the electronic book market, wanted to keep e-book prices at or below $9.99. Macmillan and other publishers wanted to maintain a pricing structure tied to their traditional print business, with prices starting at around $14.99 and then declining over time as further versions of a book were released.

At one point, Amazon actually yanked all of Macmillan’s electronic titles from its online store as a means of punishing the publisher, which took out a full-page ad accusing Amazon of unfair behavior. Eventually, Amazon relented and restored the books, but the atmosphere in the industry remained tense.

Apple Surrendered to Undermine Amazon

Along came Apple and its iPad. To get publishers on board with the new device, which Apple hoped would allow the iPad to compete with the Kindle as an e-reader, the company agreed to the "agency model" for pricing. This gave Macmillan and other publishers exactly what they wanted—the ability to set whatever prices they chose, instead of having to make do with whatever prices retailers such as Amazon decided they should get.

As the class-action claim (PDF link) describes it: "The Publisher Defendants and Apple implemented this unlawful agreement and combination on or before January 2010, when five of the six major book publishers of fiction and nonfiction works almost simultaneously announced that they were switching from a wholesale pricing model to an Agency model for e-Book sales."

The class-action suit from Hagens Berman in California isn’t the only attempt to challenge the agency model: European antitrust authorities have also investigated if there has been collusion to keep prices high—even conducting raids on publishing houses—and the attorney general in Texas has looked into the issue.

Is there any merit to these charges? The easiest answer is yes and no. There’s no question that when Apple appeared in the market, book publishers were desperate to maintain some pricing control over the new field of e-books because they were afraid the digital format would spell permanently lower prices. The class-action suit (which Patently Apple described in more detail in a recent post) puts it this way: "[P]ublishers quickly realized that if market forces were allowed to prevail too quickly, these efficiency-enhancing characteristics would rapidly lead to lower consumer prices, improved consumer welfare, and threaten the current business model and available surplus (profit margins)."

Not Quite Apple’s Music Strategy

The arrival of Apple and its new iPad provided the perfect rationale for pushing the agency model of pricing: The consumer electronics company needed some way of breaking into the market that Amazon effectively controlled. Recruiting a number of major publishers gave it a substantial push.

Ironically, this put Apple in a position opposed to the one it took with the major record labels when it dominated the electronic music market with the iPod and iTunes: In that case, Apple did exactly what Amazon tried to do with books, dictating the price that labels could charge for their songs. Only after it had become the default online store for the entire music industry did Apple eventually relent and start allowing record labels to charge different prices for songs in their catalogue.

One thing the class-action lawsuit leaves out of the equation is the rationale behind Amazon’s push to keep prices for e-books low, which was similar to Apple’s reasoning in keeping the price of electronic songs low: Inexpensive content spurs sales of hardware. Just as Apple used low song prices to subsidize sales of iPods, Amazon wanted to keep e-book prices low in order to persuade more consumers to buy Kindle e-readers.

Did the publishers achieve what they wanted with the agency model? According to the class-action lawsuit, they did. The suit says: "As a direct result of this anticompetitive conduct as intended by the conspiracy, the price of e-Books has soared. The price of new bestselling e-Books increased to an average of $12-$15—an increase of 33 to 50 percent. The price of an e-Book in many cases now approaches—or even exceeds—the price of the same book in paper, even though there are almost no incremental costs to produce each additional e-Book unit."

Does This Constitute Conspiracy?

So if prices have gone up or stayed high, there must have been a conspiracy or collusion by the publishers, right? Not necessarily—at least, not by the standards required to make a case under the Sherman Antitrust Act. While it’s true that publishers may have tried to implement the agency model collectively, they can easily argue that this was the only means they had to protect their declining businesses from Amazon’s price-cutting attempts. In this scenario, Amazon would be the one that behaved badly by using its dominance in the e-book reader market to force publishers to cut their profits.

In that version of the story, Apple looks like the savior of the poor publishers. Apple itself is more like the underdog in this tale — although it’s a massive hardware and software company, it had virtually no presence in the e-book business before the iPad came along—and no chips to play, apart from its support for the agency model. Like the publishers, Apple could easily argue that it had to take the steps it embraced to compete with Amazon, which dominated the e-book market. Apple might point out that for all its best efforts, Amazon still dominates the market.

In the long run, it seems likely that book publishers will have to relent on their pricing demands, if only because consumers want to pay less for e-books. They have other places to go for low-priced books, including Amazon’s Kindle Singles program and the growing ranks of self-publishers. In that sense, the agency model seems less like some elaborate conspiracy to control the market and more like a desperate move by a fading industry.

Also from GigaOM:

Connected Consumer Q2: Digital Music Meets the Cloud; E-book Growth Explodes (subscription required)

Solar Crunch: Solon to Close U.S. Factory

Fox Urges Viewers to Harass Their Cable Companies

AT&T Outs Pricing for LTE and First Devices

HTC Sues Apple Over Everything

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