Jun 17 2012
Agency pricing and MFNs are like peas and carrots or why the DOJ settlement won’t disallow discounting
Retail price maintenance v. Agency pricing
The retail price maintenance (“RPM”) instituted by five of the big 6 publishers is commonly known as Agency Pricing. It is a pricing model wherein the producer of a widget, like the publisher of a book, gets to control the price. For nearly 100 years, RPM was considered per se illegal which meant if you engaged in it, you received a visit from the DOJ. In 2007, the Supreme Court in a case known as “Leegin” said that the illegality of RPM would be analyzed under the “rule of reason” thereby making most instances of RPM permissible.
Agency pricing is actually something a bit different. True Agency pricing requires an actual agent and principal relationship such that the agent is merely facilitating the sale between the principal and the end user. Given that the product goes from the publisher and is housed by the purported agents (the retailers) and distribution is controlled by the retailers along with the enveloping DRM, the pricing arrangement by the publishers most accurately reflected an RPM. However, it has become known as Agency Pricing.
Industry parties argue for preservation of Agency.
In recent days, we’ve seen the statements of Barnes & Noble, paid industry consultant Mike Shatzkin, and the American Booksellers Association make an argument that Agency Pricing must be preserved. As David Boies for B&N and Oren Teicher for the ABA notes, the Justice Department is not taking issue with Agency Pricing aka RPM and thus the settlement agreement which permits only one kind of Agency Pricing should be redrafted to permit any publisher to engage in any sort of Agency Pricing. Neither Boies or Teicher addresses the issues of the Most Favored Nations clause (“MFN”).
What is the Most Favored Nations clause.
A MFN is a clause that requires a book to be sold at the same price no matter the retailer. Under the wholesale model, retailers would be guaranteed that it received the best wholesale price. Retailers could still compete against each other on price. Under Agency, however, the publisher sets the price. If the publisher makes a deal with Barnes & Noble to sell at a price, then every retailer with an MFN in their contract gets to lower the price as well even if the publisher hasn’t adjusted the price with the other retailers. In other words, the MFN is the trump card in the pricing scheme that works to set the price the same at every retailer. It eliminates pricing as a form of competition between retailers.
Why not let the publishers agency price?
So what if the publishers are permitted to agency price? What no one explicitly states is that publishers must get the retailers to accept this deal: Agency with no MFN. Why would Amazon agree to this? Publishers would be able to price a book lower at Barnes & Noble yet higher at Amazon. It would be able to provide deals at Apple, Kobo, Barnes & Noble, and every other retailer except for Amazon and Amazon would be hamstrung by the Agency pricing deal. The converse is also true. Amazon has a Kindle Daily Deal wherein it prices a book for $1.99. Yesterday it was a Random House book. A few days ago it was a Penguin book. Both houses are Agency houses but because of the MFN, that price was matched at Barnes & Noble. Barnes & Noble also has a daily special and Amazon price matches it every time.
Feldman argues here that what Boies, Teicher, et al are arguing for is Agency pricing with an industry wide, unspoken MFN. That essentially these entities are arguing for no price competition.
Here are two problems with this argument and why I believe the DOJ would not enter into a settlement that would eliminate discounting.
Agency pricing by publishers decreases inter brand competition.
First, lack of price competitiveness would discourage interband competition. In Leegin, the Supreme Court noted that “the promotion of interbrand competition is important because ‘the primary purpose of the antitrust laws is to protect [this type of] competition.’” Leegin Creative Leather Products v. PSKS, Inc., 127 S. Ct. 2705, 2715 (2007) Interbrand is “the competition among manufacturers selling different brands of the same type of product.” Book A from Random House competing against Book B by Penguin, for example. Or in non book terms, Coke v. Pepsi. Interbrand competition is driven by elements such as brand recognition, quality of product and diversity of product. Intrabrand is competition amongst retailers selling the same brand. Intrabrand competition is fostered by either price or amenities.
As can be seen by the past two years, publishers are generally lockstep in their pricing which is a result, in part by Apple’s price floor, but also a long history of industry parallelism. There is no evidence of the price of print books decreasing, for example, but instead increasing. In Leegin, the Supreme Court noted that interbrand competition will eventually either reduce prices or increase services and amenities to consumers. The Court contemplated that
As a general matter, therefore, a single manufacturer will desire to set minimum resale prices only if the “increase in demand resulting from enhanced service … will more than offset a negative impact on demand of a higher retail price.” Mathewson & Winter 67.
Essentially the Supreme Court is saying that a rational publisher would only set an minimum retail price if the increased amenities would increase demand sufficient to offset the loss of sales at a higher retail price. However, when 60% of the market of book publishers set a minimum retail price, this doesn’t encourage an increase in amenities or services or enhanced service.
Additionally, the alleged collusion is exactly one of the dangers warned about by the Court in Leegin.
Resale price maintenance may, for example, facilitate a manufacturer cartel. See Business Electronics, 485 U.S., at 725, 108 S.Ct. 1515. An unlawful cartel will seek to discover if some manufacturers are undercutting the cartel’s fixed prices. Resale price maintenance could assist the cartel in identifying price-cutting manufacturers who benefit from the lower prices they offer.
This is one of the reasons why Penguin’s president’s behavior toward Random House, along with B&N’s enforcement, is so key (in my opinion). Retail price maintenance is supposed to keep cartels from forming because the incentive to break from the price fixing cartel is so high. If the rest of the members adhere to a higher price point, the other member can gain market share with the lower price point which is what Random House did from 2010 through Feb. 2011. But when there is punishment if a cartel member steps out, this is considered anti competitive behavior.
Agency pricing with no discounting maintains the status quo.
Second, allowing the publishing parties to engage in Agency with industry wide MFNs and no discounting essentially maintains the status quo. There would be no need for the lawsuit if that were an outcome agreeable to the DOJ. In order for the DOJ to justify bringing the suit, some sort of punitive action has to take place. The first of which is to eliminate the existing contracts that were allegedly made through improper collusion. The second is to alter the landscape such that the alleged collusive behavior can’t occur again.
To allow all types of agency pricing with no discounting merely continues the publishers’ existing contracts and perpetuates the non competitive behaviors to which DOJ (and others) oppose.
What if Judge Cotes does not approve the settlement.
I’m not entirely convinced that Cotes will approve the settlement; however, the parties involved want the settlement and it does have a pro consumer outcome which would, within 30 days of the settlement approval, result in severing the existing contracts that were allegedly improperly obtained. However, if Cotes did not approve the settlement, she could entertain a request for a temporary injunction. A temporary injunction can be put in place to stay any Agency pricing until a permanent injunction hearing takes place. Generally a temporary injunction is granted if the success of the permanent injunction is likely and the harm if no action takes place is high. I think the government can make a good case for agency pricing by the publishers to be enjoined.
One final note. The DOJ suit is not the only one that the publishers are facing. The States’ Attorneys General suit is supposedly on the verge of settlement and the AGs hate the Leegin decision. 41 states wrote to Congress requesting a repeal of the Leegin decision and Kansas actually found the very same Leegin company had violated Kansas state law against retail price maintenance. In other words, the same “agency is great” arguments aren’t going to fly with the state AGs.