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.
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Jun 17, 2012 @ 08:09:24
Hey Jane,
Thanks for the great info.
BTW — if the judge doesn’t approve the settlement, and they choose to go w/ injunction, what happens to the 3 pubs that wanted to settle? Do they have to go through the lawsuit, just like Penguin and Macmillan?
Jun 17, 2012 @ 09:13:59
Thanks Jane. These posts are a great analysis of this law suit.
On a somewhat related note, I had two interesting conversations this week with friends who are now reading almost exclusively ebooks. In both cases, they were complaining about the high cost of ebooks. In particular, they both had just started reading J. R. Ward’s BDB series, had purchased all of the previous ebooks at full agency price and wanted the new book which costs in excess of $17.00 in Canada once the HST is taken into account ($15,99 plus 13% – as an aside the tax on print books is only 5%). In both cases, the people that I was speaking to were extremely pissed off at the price, and indeed the prices of all agency books. In both cases, these people are avid readers and had never considered pirating an ebook (or anything else) before. They spend hundreds of dollars in books every year. In talking with others they both learned of sites where they could get the book for free and both of them were seriously considering pirating the book because they felt that the publishers are just gouging and taking advantage of them as customers. In both cases, neither of them felt that there was any justification for the prices that the agency publishers are charging for ebooks. When I pressed further, neither of these people said that they expected every (or any) book to be $0.99 or $2.99, they just wanted the prices to be reasonable in terms of what they were getting.
This is interesting to me because these sentiments were exactly what I heard when music file-sharing became a huge thing about 10 years ago – many of the people I know who used napster and other file-sharing sites for music felt that they were being ripped off by the music industry. FWIW, when iTunes came along with reasonable prices for music downloads, the majority of these people stopped pirating music.
The point to my comment is not to justify pirating, but rather to point out that when people who are otherwise law-abiding, have never considered pirating any form of media and who believe in books and in the importance of supporting authors, start thinking about pirating because of what publishers are doing in terms of pricing and service, publishers need to seriously start rethinking their business models and whether or not they really want to continue with their current RPM model. Further, the fact that there is a good deal of evidence that the agency publishers have done/are doing something illegal in respect of ebook pricing certainly doesn’t help them.
Jun 17, 2012 @ 09:24:32
@Nadia Lee no they can try to redraft a settlement based in why the judge rejected this one.
Industry News-June 17 » RWA-WF
Jun 17, 2012 @ 13:11:20
[...] The Department of Justice’s lawsuit against Apple and publishers has generated a lot of emotion. Dear Author’s Jane Litte regularly turns out thoughtful posts on the topic. Her latest is about why she doubts book discounting will go away. [...]
Jun 18, 2012 @ 05:41:27
@Jane: I think where your argument fails is with the interbrand competition. When we speak of TVs we can discuss interbrand competition because one brand of TV is substitutable for another brand of TV; however, a Dean Koontz novel is not a substitute for a Stephen King novel unless. If you want to buy Stephen King’s newest novel, you don’t go to the bookstore and say “if King’s novel is too pricey, I’ll buy a Koontz novel instead because the books are interchangeable.” On the other hand, if you want to buy a TV and would like that 42-inch Sony but when you get to the store discover that it is out of your budget range but the 42-inch Samsung is in range, you look at, and often buy, the Samsung.
The interbrand argument for books assumes that readers buy a book based on the publisher, not the author. I don’t know of any reader who buys a book because it is published by Random House; the buying decision is based on subject matter and author, not publisher. Consequently, interbrand competition doesn’t really exist in the book marketplace.
The argument against agency pricing also ignores the history of pricing in the book marketplace. The argument that it is not legal (or shouldn’t be) because it establishes a maintained retail price ignores that for decades publishers have similarly priced — both wholesale and retail — books. There is a very narrow range of list prices and of wholesale discounts. For years, nearly every mass market paperback was priced at $7.95 or $8.95, regardless of the publisher. Similarly, hardcovers were nearly universally priced at $25.95 or some other “standard” price level. Wholesale pricing has been between 50% and 60% of list price for decades. (Yes, there are some exceptions, just as there are some exceptions in the agency system.)
The DOJ has not taken a stand opposing anything but the collusion aspects of the agency pricing. Note that Random House, which is the largest of the agency pricing publishers has not been sued. It is incorrect to say that “To allow all types of agency pricing with no discounting merely continues the publishers’ existing contracts and perpetuates the noncompetitive behaviors to which DOJ (and others) oppose.” Each of the publishers is legally permitted to enter into a contract with any retailer that says that if you want to sell my products, you must sell them at list price. There is no legal requirement that Random House permit Amazon to sell the books it publishes or that Amazon be permitted to sell the books at a discount.
One other thing, which Boies and Teicher raise but is too readily glossed over as either wrong or inconsequential: what will be the effect of permitting unfettered discounting on consumer choice and marketplace competition. One justification for RPM/agency pricing is that it enhances competition by requiring a level playing field and not allowing one competitor to continually sell at a loss. Although the settlement agreement attempts to address this issue, it would not be effective because there is no enforcement mechanism, that is, no way to require nonparties to comply.
As for a temporary injunction to stop agency pricing, I do not think that is likely to happen. The argument would have to be that agency pricing is illegal and thus can be enjoined because the DOJ would be likely to prevail on that issue. But that is not currently the case and, more importantly, the DOJ hasn’t sued on that ground.
And a last thought: Suppose agency pricing is eliminated. What would prevent the publishers from raising the list prices and lowering the wholesale discount so as to make it even more costly to discount their books below the minimum pricing they want? Or even more troublesome to retailers like Amazon, also stopping the current returns policy. No court, especially not with the Roberts Supreme Court, is going to dictate pricing.
Jun 18, 2012 @ 05:43:50
I see I dropped a sentence. It should read: “however, a Dean Koontz novel is not a substitute for a Stephen King novel unless you believe that books are essentially widgets — there are no differences that make King unique and Koontz unique or that separate a P.D. James from a Tony Morrison.”
Jun 18, 2012 @ 08:49:13
@Richard Adin: I’m not qualified to address your arguments on legal grounds, but I would like to point out one thing.
Most readers do not approach the purchase of A Book the way they approach the purchase of a television, and this is even more true, imho, when it comes to romance readers. While we may on occasion set out to buy The Newest from Our Favorite Author, we also buy in sufficient quantity of otehr titles and other authors that if there is nothing new from our favorite author(s), yes, we will buy something else, because we have lots of “favorites.” So yes, books are a little more like widgets than they are like TVs. Not exactly like widgets, but more like widgets than like something that’s only purchased once every two or three or (in my case) 12 years.
Jun 18, 2012 @ 09:22:51
@ R. Adin
If Agency is eliminated. what would prevent the publishers from raising the list prices and lowering the wholesale discount? At best it’s a stupid question, at worse, it’s a threat (vote for agency or you’ll be sorry).
Sales, of course. Readers of can borrow from friends or the library, buy from a used book store, or read cheaper self-pubbed books. And of course, everyone can read less and play Angry Birds more.
Jun 18, 2012 @ 10:31:10
@Richard Aden – If books aren’t subject to interbrand competition, they wouldn’t be price sensitive. There are some books that are less sensitive to price fluctuations such as the big name author books, but I’d argue that the majority of books are. Further, if books aren’t subject to interbrand competition then the purpose of RPM wouldn’t apply to books. It is a rule of reason meaning not every RPM is going to be valid.
I disagree that the history of retailing is based on agency pricing. Agency pricing is when a firm sets a price and only the firm sets the price. A wholesale situation is the exact opposite of agency pricing. The entire history of retailing for books is the opposite of agency pricing. I actually wrote an article for DA here about how discounting is a deep part of book retailing. (Indoctrinated into discounts is the post). The big box stores started discounting at a deep rate in the 70s, I believe.
Finally, as to the issue of TI, no the argument is that the contracts were illegally obtained through collusive agreement. That’s why they should be voided now. It’s not an argument premised on agency, but on the illegality of how the contracts were obtained and the ongoing consumer harm.
Jun 18, 2012 @ 11:09:59
@Richard Adin — Actually, I did exactly what you say people don’t do with books. I went to the bookstore (specifically, the Amazon site) when Stephen King’s 11/22/63 came out, intending to purchase the book, but decided not to buy because the price was too high for me at that point. I bought other books instead. So I would say books are substitutable, at least to some significant degree.
Jun 18, 2012 @ 11:18:39
@SAO: Well said. Of course, in relation to my earlier comment, some folks may just decide to investigate those “free” books more often.
@ Richard Adin: As Jane noted, DTB retailers have been determining the price for years – Chapters and Amazon both have deep discounts off of their hardcovers and trade paperbacks if you buy online. Chapters has loyalty points and discounts for “club” members (as do B & N and Amazon). They also have coupons and “buy 3 get the 4th free” promotions. The agency model prevents all of this retailer-driven promotion with e-books. I also agree with Jane’s and Linda Hilton’s comments regarding whether books are interchangeable. I can certainly find many examples (in the past year alone) when I have passed over an ebook that I was interested in because the price was ridiculous and purchased another book (or books) instead.
Jun 18, 2012 @ 15:37:48
I’m going to join the voices here in saying I’ve definitely chosen different books in the past two years due to agency pricing. No, one book isn’t the exact equivalent of another in terms of content, but they can be equivalent in terms of use. If I deem one book too pricey, I can still settle in with a different book and enjoy my reading time just as much.
I haven’t bought agency-priced ebooks for two years. If I can find a coup[on for a paper copy I might buy it, but I usually wait for the book from the library now, or look for it at used book stores. For ebooks I’ve found many replacements for the pricey “agency” books and haven’t missed them.
Jun 18, 2012 @ 15:39:32
@Richard Adin: “Suppose agency pricing is eliminated. What would prevent the publishers from raising the list prices and lowering the wholesale discount so as to make it even more costly to discount their books below the minimum pricing they want? ”
IN short, and even greater explosion of self-publishing and small ebook presses. When the “big” publishers start leaking not only customers but well-liked authors, maybe it will give them pause.
Jun 19, 2012 @ 06:05:09
@Richard Adin. I think the point is that the market should dictate price, not the courts but not the publishers by illegal* collusion either.
And no, books are not widgets but they’re not TVs either. There are plenty of books I think about buying but then don’t because they’re too expensive. I buy few agency books these days and I buy books all the time. I think I’ve bought 10 in the past week alone. There are plenty of books and I hear plenty of recs from trusted reviewers. With rare exception, I can and do find something else to buy/read if the price is prohibitive. A lot of my ebook buying is on impulse. Believe me, that impulse fades fast of the book is too dear. Plus, as SAO said upthread, there’s always Angry Birds – or Fruit Ninja or even free to air TV. Books compete against various forms of entertainment, not just each other.
*alleged
WRITING ON THE ETHER: Clear Surface | Jane Friedman
Jun 21, 2012 @ 07:01:41
[...] headlines it Agency pricing and MFNs are like peas and carrots or why the DOJ settlement won’t disallow discou…. “Agency” is the term, by the way, because a retailer acts as a publisher’s [...]