Together, Apple, Amazon, and Barnes & Noble dominate the e-book business. And it is a business that is unusually hostile to its suppliers. E-book sellers require a very strange form of best-price guarantee from publishers. E-book publishers are responsible for the retail price of their products wherever they are sold. The retail price essentially has to be exactly the same everywhere. It is an arrangement that appears to violate antitrust laws on the face of it. The Department of Justice pointed this out to Apple and a handful of book publishers last week, but while one or two of the book publishers were willing to settle, Apple was not. And it is a case that Apple simply cannot afford to settle.
Apple is much better off winning or losing in court. Nor could Amazon or Barnes & Noble settle, if they were the ones being targeted by the Department of Justice. Book publishers too are better off losing in court than agreeing to a settlement. Any party that settles this kind of price-fixing case before the rest of the industry does puts itself at a competitive disadvantage.
That’s because settlements do not create legal precedents. The only precedents that matter in U.S. antitrust law are federal appeals court decisions. If the e-book industry is ever to stop price-fixing, it has to be decided in court and affirmed on appeal. That will create a precedent that anyone in the industry can use as a model to follow, or as a template to settle any similar misconduct.
Imagine the fate of a book publisher who agreed to stop its price-fixing practices while the rest of the e-book industry carried on. Imagine, for a moment, that you are this book publisher. Agreeing with the Department of Justice to stop price-fixing puts you almost immediately in violation of your contracts with Amazon, which, just like Apple’s, makes you responsible for price-fixing. Something similar to this happened once, and Amazon, overnight, set about withdrawing all of the publisher’s products from its store — and not just the e-books, but the printed books and everything. The terms of Amazon’s supplier contracts permit it to do this, and if it did it once, it could do it again. The publisher wouldn’t have its book in Amazon’s store again until the Department of Justice had a similar talk with Amazon — and who knows when that might happen? The public life of a newly released book is often less than a year. The wheels of justice routinely take ten years or longer to reach a resolution. No book publisher knows whether it will even be around ten years hence.
To see what is at stake, you have to imagine the e-book business without price-fixing. If there is no more price-fixing, e-book sellers will have to start competing on price.
Of course, the biggest costs in selling digital downloads are the money-handling costs, the transaction fees charged by the banks for credit card payments and the like, and these are roughly the same for everyone. But look at just the operating costs, and these strongly favor Apple, especially when compared to Amazon. Operating costs are important to look at, because when businesses have to compete on price, often what happens is that less efficient businesses are forced out. That’s the nature and the putative advantage of free-market competition. In consumer electronics recently, this was the story of Circuit City. Circuit City spent more money on its operations and charged higher prices to cover its costs. Customers went looking for lower prices, and Circuit City shut down. Another possible result is that the more efficient company earns a fortune while its competitors struggle to break even. Does this sound familiar within the history of Apple?
Apple has the advantages of economies of scale. It sells lots of digital downloads of all kinds, while its e-book competitors sell few downloads other than e-books. It has the advantages of vertical integration. Apple designs and builds computer servers and networking equipment of the sort that are used in a data center for delivering digital downloads. It can set up its data center without having to pay retail price for much of anything. Apple also has the advantages of operating efficiency. ITunes Store, from which the technology for its iBookstore is borrowed, has been a model of low-cost operation for years. Amazon will eventually figure out how to duplicate this, but it could take ten years to catch up with where Apple is now.
There is one more point that works against Amazon if there is a free market for e-books. Amazon has been using the profits from e-books to subsidize its e-book hardware. How much money Amazon loses when it sells an e-book device is a closely guarded secret, but estimates have run as high as $200. Meanwhile, Apple sells its devices at a handsome profit. If the price-fixing stops, Amazon will no longer be able to rob authors to pay engineers. Its business model will be broken.
Apple may be the defendant, but it is its biggest e-books competitor, Amazon, that has the most to lose if Apple loses its case in court. This could be the reason why the Department of Justice picked Apple instead of Amazon as its first defendant. Amazon as a defendant would be fighting for its life. Amazon would fight so hard it might even win its case in court, overturning a century of price-fixing laws. That’s a risk the Department of Justice decided not to take. Apple, by contrast, has obvious conflicts of interest as a defendant. Apple loses only if the case sets a strangely narrow legal precedent. Essentially, it loses only if it settles out of court.
Price-fixing cases are usually defended by denying that any price-fixing took place. That is an avenue of defense that would seem not to be available when the duty to fix prices is written directly in a contract that may be presented for the judge to see. I have a hard time imagining the legal theories Apple may employ to defend the e-book industry’s practices, but whatever the theories are, Apple’s legal team can be counted on to argue them vigorously, forcing the courts to make a clear determination.