Apr 22 2012

Antitrust Primer for the Publishing Price Fixing Lawsuit

By Jane • Ebooks • • Tags: ,

Purpose of the Antitrust Law

This article is to lay out, in simplest terms, antitrust law as it pertains to the publishing price fixing lawsuit. It is not designed to address the shortcomings of the law or the need for reform but the status of the law. Additionally, my knowledge of the antitrust law is very shallow.

The purpose of the antitrust law is to promote competition with the underlying maxim that competition creates the best product at the lowest price for the benefit of the consumer.  Some economists argue that the focus on consumer welfare in antitrust laws harms competition and business.  For instance, increased prices redistributes wealth from the consumer to amongst the producers and that is economic neutral outcome but because antitrust laws have focused on what is best for the consumer, an economic neutral outcome that pushes more money from the consumers’ pockets to that of a producer is a disfavored result.

What is a monopoly?

A monopoly is defined by the U.S. Supreme Court as follows:

In United States v. du Pont & Co., 351 U. S. 377, 391, we defined monopoly power as “the power to control prices or exclude competition.” The existence of such power ordinarily may be inferred from the predominant share of the market. In American Tobacco Co. v. United States, 328 U. S. 781, 797, we said that “over two-thirds of the entire domestic field of cigarettes, and . . . over 80% of the field of comparable cigarettes” constituted “a substantial monopoly.” In United States v. Aluminum Co. of America, 148 F. 2d 416, 429, 90% of the market constituted monopoly power.

United States v. Grinnell Corp., 384 U.S. 563 (1966)

There are two basic types of monopolies: single firm and multi firm monopolies. Multi firm monoplies are generally frowned upon because they are viewed as actions of collusions. The Apple + Publisher lawsuit is an alleged multi firm monopoly. Some believe Amazon is a single firm monopoly.

When is the monopoly okay?

Section 2 of the Sherman Antitrust act says that a company shall not monopolize or attempt to monopolize. However, the acquisition of a monopoly through “a superior product, business acumen, or historic accident” is not an antitrust violation.

The mere possession of monopoly power, and the concomitant charging of monopoly prices, is not only not unlawful; it is an important element of the free-market system. The opportunity to charge monopoly prices—at least for a short period— is what attracts “business acumen” in the first place; it induces risk taking that produces innovation and economic growth. To safeguard the incentive to innovate, the possession of monopoly power will not be found unlawful unless it is accompanied by an element of anticompetitive conduct.

Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, LLP, 540 US 398, 407 (2004)

When is the monopoly bad?

From the above definition, we know that it is monopolies exercising power in an anti competitive behavior that violates the antitrust law.

The first antitrust law was the Sherman Antitrust Act of 1890 followed by the Clayton Antitrust Act and the Federal Trade Commission Act of 1914, the Robinson-Patman Act of 1936,  and  Hart-Scott-Rodino Antitrust Improvements Act of 1976.

Antitrust violations are broadly known as Section 1 or Section 2.

Under Section 1 of the Sherman Antitrust act, the following are considered “per se” violations:

  • price fixing
  • dividing markets
  • bid rigging

If a firm or a group of firms are proven to be engaged in one of the above, then there is no real defense. The battle accused firms must face is whether they are considered to have engaged in a per se violation.  The parties cannot argue (as many of the press have in response to the DOJ filing) that the prices were reasonable or that the collusion was necessary to prevent or eliminate price cutting or competition that would ruin them.  I.e., the parties cannot argue that the price fixing was necessary to prevent Amazon from gaining a larger slice of the digital market through low pricing.

Under the Clayton Antitrust Act, certain business activities like price discrimination and tying were impermissible if it harmed competition. A famous tying case was the Eastman Kodak Company v. Image Technical Services, Inc.  The other antitrust laws were designed to address monopolies formed through mergers and acquisitions.  A Clayton Antitrust violation is often viewed under the rule of reason.  Under the rule of reason, anticompetitive behavior can be defended by a competitive outcome.   In other words, a defense that Amazon’s big pockets and tendency to price low to keep or acquire a monopoly and hurt publishers would be an appropriate in rule of reason case.  However, the government hasn’t brought a rule of reason case. It has alleged a per se violation.

The Federal Trade Commission Act bans “unfair methods of competition” and “unfair or deceptive acts or practices.

What is considered an antitrust violation?

A § 1 violation of the Sherman Act (restraints of trade by agreement, contract, or conspiracy), requires proof of the following:

  • The charged conspiracy was knowingly formed and was in existence at or about the time alleged;
  • The defendant knowingly joined the charged conspiracy; and
  • The charged conspiracy either substantially affected interstate or foreign commerce or occurred within the flow of interstate or foreign commerce.

A § 2 of the Sherman Act (acquisition of a monopoly), requires proof of the following:

  • possession of monopoly power in the relevant market
  • the willful acquisition maintenance of that power as distinguished from growth or development as a consequence of a superior product, business acumen, or historic accident.

Apple and the publishers have been accused of a § 1 violation of price fixing.  The publishers will argue that their prices and agreements with Apple were made independently and that the similarity of pricing was conscious parallelism.

How does this affect the DOJ lawsuit on price fixing?

This is not an easy case. First, many believe that post Broadcast Music, Inc. v. CBS, 441 U.S. 1 (1979), price fixing isn’t always measured under per se but rather rule of reason.

“This is not a question simply of determining whether two or more potential competitors have literally ‘fixed’ a ‘price.’ As generally used in the antitrust field, ‘price fixing’ is a shorthand way of describing certain categories of business behavior to which the per se rule has been held applicable.”

BMI, 441 U.S. at 9-10.  Instead, some price fixing may have a business justification and should be measured under the rule of reason.  Apple and the publishers (sounds like Gladys and the Pips) will attack the suit on a two pronged basis.  First, that there was no price fixing and second, if there was, it isn’t a per se violation.

The biggest hurdle for the government in moving forward with a per se violation will be proving an agreement.  In Business Electronic Corp. v. Sharp Electronics Corp., 480 F.2d 1212, (5th Cir. 1986) aff’d 485 U.S. 717 (1988), the Fifth Circuit found that a distributor’s termination of a retailer’s contract for failing to observe a price floor was not inappropriate without some agreement by the parties to set a price.  The U.S. Supreme Court approved of this.  In other words, price fixing required proof of an agreement.

There is no written agreement of the defendants to fix prices.  Instead, the government is arguing that the conduct of the publishers is indirect evidence of the agreement hence the allegations of meetings,  phone calls and double delete email warnings.  The government must show that independent action was not likely.  John Sargeant’s statement that he made his decision alone in his basement on the treadmill is an argument that Macmillan’s pricing decisions were independent of any other publishers.

Price fixing monopolies are considered unstable because the incentive to cheat on a partner in the cartel is too great.  Overtime, at least one or more of the firms in the cartel will reduce prices to gain market share thus shattering any agreement.  It is much easier to maintain a cartel if the market players involved are oligopolistic.  While there are a number of small publishers, the Big 6, as they are called, control some 80% or more of the trade book business.

The jury instructions tell a jury that they cannot find price fixing solely on the fact that Apple and the publishers talked about prices in person or wrote about different prices, or that there was a suggested price that everyone followed or that the publishers refused to deal with anyone who didn’t adopt their retail price maintenance model.   The instructions focus on the existence of an agreement and the compliance with the agreement.

The courts have settled on a conscious parallelism plus test here. See e.g., Monsanto v. Spray-Rite Service Corp., 465 U.S. 752 (1984).   In other words, the government has to prove something other than the publishers looking at each others’ actions in the marketplace and matching them.  In the civil class action suit, the Plaintiffs identified the following “pluses”:

  •  private and public statements made by Defendants suggesting a common view of an “industry problem” that required a coordinated response (¶¶ 99-109);
  • opportunities to conspire and signal intentions to one another through trade associations, the media and third-party intermediaries (¶¶ 5, 79-82, 101, 153);
  • the date and place of meetings where the price-fixing was coordinated, including the identities of the individuals involved (¶ 152);
  • a simultaneous and unprecedented price increase of thirty to forty percent unrelated to an increase in costs (¶¶ 199-203);
  • a recent history of engaging in related simultaneous conduct (¶99-109);
  • a common motive to price-fix (the elimination of price competition in the retail market for eBooks) (¶ 119);
  • action that would have been against each Defendant’s self-interest without collective involvement (¶¶ 139-143);
  • coercion in the form of simultaneous boycotts and refusals to deal (¶¶ 145-166);
  • a highly concentrated market (¶¶ 57, 143, 146); and
  • government investigations into Defendants’ apparent collusion (¶¶ 191-198). (this shouldn’t be a plus)

There are two elements that stood out for me in reading the DOJ’s complaint. First, Apple set the pricing floor and ceiling for ebooks and every publisher accepted those terms.  Did the publishers individually attempt to negotiate for differing floor and ceilings?  Why was it the same for every publisher?  No other app in the app store has a pricing floor or ceiling like the books in the iBooks store. Why were books treated differently?

Second, the David Shanks email to Barnes and Noble. In the email, Shanks urges Barnes & Noble to punish Random House for not hopping aboard the pricing agreements that the other publishers had agreed to with Apple.  This type of email is evidence that the DOJ will point to as attempting to police or enforce a collusive agreement.  In other words, if there is only conscious parallelism why would Shanks need Random House to engage in the same type of pricing.  That is one piece of evidence that seems to rule out independent action.

The Interstate Circuit Case (or the Hub and Spoke conspiracy)

A similar factual pattern was presented in the 1939 case of  Interstate Circuit, Inc. v. United States, 306 US 208.  This is the hub and spoke conspiracy.   Apple, as the hub, enters into similar agreements with all of the publishers, the spokes.

The Interstate Circuit case, a two firms contributed 74% of the licensing fees to movie distributors for first run and second run films, constituting a monopoly in the cities in which the firms operated. There were eight distributors delivering about 75% of the all the first class feature films shown in the U.S.  The theatre firms wanted the eight distributors to agree to a pricing structure which raised the price of a seat in the theatre house from slightly below 25 cents to above 25 cents and in some cases 40 cents.  Interstate sent out a letter with all the distributors on the letterhead demanding a floor (no lower than 25 cents) and a restriction on double billings (two movies for one admission) for the better seats.  This was designed, it was alleged, to prevent competition from subsequent run and often independently owned theatres.

The admission price customarily charged for preferred seats at night in independently operated subsequent-run theatres in Texas at the time of these letters was less than 25 cents. In seventeen of the eighteen independent theatres of this kind whose operations were described by witnesses the admission price was less than 25 cents. In one only was it 25 cents. In most of them the admission was 15 cents or less. It was also the general practice in those theatres to provide double bills either on certain days of the week or with any feature picture which was weak in drawing power. The distributor appellants had generally provided in their license contracts for a minimum admission price of 10 or 15 cents, and three of them had included provisions restricting double-billing.

Interstate Circuit Inc, 306 U.S. at 218. The trial court inferred from the agreement signed by the distributors and other actions such as the distributors failing to call the officers of the firms to testify and only put the local managers and failing to renegotiate differing contract terms.

The problem here is that Apple was not (and is not) a dominant player in the digital publishing market.  I don’t know if iBooks has even a 1% market share.  The hub in a hub and spoke conspiracy ordinarily has a dominant market share such as the two theatre houses that controlled the majority of the market in which they had first run theatres.  The DOJ identified the relevant market in its petition as trade ebook market. I find that definition too narrow and wonder if it won’t spike the DOJ’s suit.

Conclusion

As I stated earlier, this is no easy case for the government.  There are three parties left in the suit: Apple, Macmillan, and Penguin.  The three will have differing arguments.  In the beginning, it will behoove all three to stick together, all arguing the same points of law.  The first step is to file a motion to dismiss but I think the DOJ petition pleads enough facts to overcome a motion to dismiss.  After the motion to dismiss, the parties will engage in what is called “discovery.”  Depositions will be taken.  Those are oral questionings recorded by a court reporter.  Written questions called interrogatories will be sent back and forth as will requests for documents and admissions.  After discovery is complete, the defendants will ask for a summary judgment meaning that the DOJ doesn’t have enough evidence to move forward to a jury trial. It is my belief that if the defendants cannot win at the summary judgment stage, their likelihood of prevailing drops dramatically.

At some point, the DOJ may ask for a directed verdict.  This is a request to the judge that reasonable minds could not disagree that the undisputed facts support a finding that the defendants engaged in per se violations of the antitrust act. My guess it that if the DOJ did file this, it would likely lose the motion, primarily on the argument that there are too many facts in dispute.

As an aside, the parties involved are facing lawsuits from the states, a civil class action, and now a class action lawsuit in Canada.

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