Why Apple's E-Book Pricing Model Might Not Be Unfair

Photograph by Scott Eells/Bloomberg

The U.S. antitrust lawsuit against Apple and five major book publishers alleges that they conspired to fix prices for e-books ahead of the 2010 launch of the iPad and iBookstore, forcing Amazon to raise e-book prices for its Kindle. The heart of the argument raised by the Department of Justice is that Apple’s “agency” model of selling e-books, in which the retailer retains a fixed percentage of the book’s sale price, is fundamentally less fair and leads to higher retail prices than the traditional “wholesale” model, in which the retailer buys a book from the publisher at a discount and resells it at a profit.

A key difference between the agency and the wholesale models, underscored in the lawsuit, is the process of setting the retail price. In Apple’s agency model, the publisher sets the final price and the retailer (Apple) receives a fixed commission based on that price. (Apple has the right to match the lower price of another online retailer.) In the wholesale model, the publisher sets a suggested retail price (often imprinted on the book cover) and sells the book at a discount to the retailer (Amazon), which is then free to set a price of its choosing. The argument against the agency model is that because it removes retailers’ control over the final price to consumers, it leads to higher prices and is therefore unfair to consumers.

Is Apple’s agency model unfair?

One argument raised in support of the “unfairness” of the agency model is the increase in the prices of e-books following Apple’s market entry and, specifically, the elimination of the $9.99-or-less prices as the default for e-book versions of new releases and New York Times bestsellers. Yet it is unclear why $9.99-or-less should be considered a fair and optimal price of e-books, given that it was imposed on publishers by a retailer who at that time controlled nearly 90 percent of the e-book market—in addition to playing a major role in distributing the publishers’ physical books.

Switching from a monopoly to a duopoly following Apple’s market entry helped minimize the asymmetric balance of power between publishers and retailers, making the resulting pricing reflect the more competitive nature of the current market structure. Thus, while the introduction of the $9.99 price point for new e-books was a brilliant marketing move by Amazon that helped promote and build the e-book market, it is not a foregone conclusion that it represents a fair price and that the wholesale model is an optimal pricing strategy.

There is also no reason to think that the agency model will lead to higher consumer prices once the e-book market matures. Indeed, unlike the physical book market—which entails significant variable costs associated with printing, inventorying, and distributing books—these costs are rather negligible for e-books. Moreover, the demand for e-books is relatively elastic, meaning that as the price of e-books declines, consumers are likely to buy more books. This combination of low variable costs and elastic demand suggests that lowering consumer prices to the point that makes e-books financially viable for both publishers and distributors might be in their long-run best interests. So far, there is no reason to think that this cannot occur under the agency pricing model as long as the distribution market for e-books remains competitive.