May 20 2012

What is this price fixing lawsuit about anyway? A Q&A

By Jane • Ebooks, Publishing News • • Tags:

Introduction

I’ve talked to several readers about the price fixing lawsuit and people have a lot of questions.  I thought I could provide a few answers here to help clarify matters.  If you have a question, drop a line in the comments.

1.  What are the lawsuits and who do they involve?

There are three lawsuits in the United States alleging that five of the big six publishers (Hachette, HarperCollins, Macmillan, Simon&Schuster and Penguin) colluded with Apple to raise ebook prices.  Those three lawsuits are as follows:

  • Department of Justice (a federal lawsuit)
  • 31 States’ Attorney Generals
  • Private class action suit

There are also investigations taking place in Canada, Australia, and the EU.

2.  What are the suits about?

All three of the U.S. lawsuits are essentially the same.  The suits allege (or accuse) that Hachette, HarperCollins, Macmillan, Simon&Schuster and Penguin conspired or colluded with Apple to raise the ebook prices from the price level that ebooks were at leading up to January 2010 which was primarily $9.99 for Bestsellers and under.

What we know from the documentary evidence (or evidence that is supported by emails, notes, memos or telephone records) is that executives of the five publishers communicated with each other about two things:

  • windowing ebooks (windowing means holding back the sale of an ebook for a period of time after the paper book is released)
  • moving to a retail price maintenance model (or “Agency” as it is commonly known) that guaranteed the price would be the same at Apple as it would be anywhere else and that Apple would get a 30% commission from all digital books sold through Apple’s store.
Judge Cote, the judge who is presiding over all three suits, said that the documentary evidence creates a “plausible” case for “per se” violations of the antitrust law.

3.  You’ve made a big deal about “per se”.  What does that mean?

Shorter answer: It is much harder for a defendant to win a per se case and much easier for the plaintiffs.  Accusations that Amazon made them do it won’t be permitted in a per se case.

Long answer: Per se is a legal standard.  Accusations of antitrust violations are measured against one of two standards: either “per se” or “rule of reason”.

Per Se:  A per se violation is “conclusively presumed illegal.” Under this standard, business justifications or social benefits are not considered and the Defendant Publishers would not be allowed to offer proof to justify their actions such as arguing that Amazon was going to destroy publishing. Under a “per se” standard, Amazon and their actions are completely unimportant.  The Supreme Court in United States v. Socony- Vacuum Oil Co., 310 U.S. 150, 221, 222 (1940). said the following:

The elimination of so-called competitive evils is no legal justification for such buying programs. The elimination of such conditions was sought primarily for its effect on the price structures. Fairer competitive prices, it is claimed, resulted when distress gasoline was removed from the market. But such defense is typical of the protestations usually made in price-fixing cases. Ruinous competition, financial disaster, evils of price-cutting, and the like appear throughout our history as ostensible justifications for price-fixing. If the so-called competitive abuses were to be appraised here, the reasonableness of prices would necessarily become an issue in every price-fixing case. In that event, the Sherman Act would soon be emasculated; its philosophy would be supplanted by one which is wholly alien to a system of free competition; it would not be the charter of freedom which its framers intended.

The reasonableness of prices has no constancy due to the dynamic quality of the business facts underlying price structures. Those who fixed reasonable prices today would perpetuate unreasonable prices tomorrow, since those prices would not be subject to continuous administrative supervision and readjustment in light of changed conditions. Those who controlled the prices would control or effectively dominate the market. And those who were in that strategic position would have it in their power to destroy or drastically impair the competitive system. But the thrust of the rule is deeper, and reaches more than monopoly power. Any combination which tampers with price structures is engaged in an unlawful activity. Even though the members of the price-fixing group were in no position to control the market, to the extent that they raised, lowered, or stabilized prices, they would be directly interfering with the free play of market forces. The Act places all such schemes beyond the pale, and protects that vital part of our economy against any degree of interference. Congress has not left with us the determination of whether or not particular price-fixing schemes are wise or unwise, healthy or destructive. It has not permitted the age-old cry of ruinous competition and competitive evils to be a defense to price-fixing conspiracies. It has no more allowed genuine or fancied competitive abuses as a legal justification for such schemes than it has the good intentions of the members of the combination

Rule of Reason:  Under the rule of reason, the accusing parties (the states, DOJ, class action plaintiffs) would have to prove that the price movements made by the Defendant Publishers were not reasonable and the Defendant Publishers and Apple could offer proof that would justify their actions.  In  Clorox Co. v. Sterling Winthrop, Inc. (2nd Cir. 1997), the 2nd Circuit defined the rule of reason standard in this fashion:

First, the “`[p]laintiff bears the initial burden of showing that the challenged action has had an actual adverse effect on competition as a whole in the relevant market….’” Id. (quoting Capital Imaging, 996 F.2d at 543). Then, “[i]f the plaintiff succeeds, the burden shifts to the defendant to establish the `pro-competitive “redeeming virtues”‘ of the action. Should the defendant carry this burden, the plaintiff must then show that the same pro-competitive effect could be achieved through an alternative means that is less restrictive of competition.” Id. (internal citations omitted) (quoting Capital Imaging, 996 F.2d at 543; Bhan v. NME Hosps., Inc., 929 F.2d 1404, 1413 (9th Cir.1991)). Ultimately, the goal is to determine whether restrictions in an agreement among competitors potentially harm consumers. See SCFC ILC, Inc. v. Visa USA, Inc., 36 F.3d 958, 965 (10th Cir. 1994). The focus of the inquiry on consumers “cannot be overemphasized and is especially essential when a successful competitor,” as here, “alleges antitrust injury at the hands of a rival.” Id.

(Note there is also an inherently suspect standard that can be applied as well but I’m going to skip that for purposes of brevity and coherence)

4.  Why can’t the publishers set their own prices like other manufacturers of goods like shoes or perfume or computers?

Publishers can set their own prices. In this circumstance, however, the publishers didn’t just set and maintain certain prices.  They got together and made sure all their publisher friends were going to do it as well because they knew (according to the allegations) that they couldn’t afford to engage in Retail Price Maintenance if only one of them was going to do it.

It used to be that Retail Price Maintenance (RPM) which is a manufacturer setting the price at which a good could be sold was not permissible except under certain circumstances such as when the seller was an agent or pass through of the owner.  The best example of this is a real estate broker and a home owner.  The home owner sets the price and the real estate agent helps to broker the deal but the real estate agent acts as the agent of the home owner.  The agent can’t change the price of the house without the permission of the owner.

Under those scenarios, an owner or manufacturer of a good could set the price of a good.  In 2007, the U.S. Supreme Court loosened the rules on RPM and basically said that if there is a good business justification, then a manufacturer or producer of a good could set their own price.  In the decision of Judge Cote to deny the Defendant Publishers and Apple’s move to get rid of the lawsuit, she references that RPM can be used.  In the settlement proposal for the DOJ, RPM is allowed under certain circumstances.

Those circumstances include allowing retailers to pass on their commission (whatever is negotiated between the publisher and the retailer like Amazon) to the consumers in the form of a discount.

5.  Isn’t Amazon a monopoly? Why is that okay?

Not all monopolies are illegal. (See the Primer) It isn’t even illegal to acquire a monopoly.  There were ebooks before Amazon, but it wasn’t until Amazon introduced the Kindle and its one click buy feature from the device itself that ebooks began taking off.  Amazon released the Kindle First Generation on November 19, 2007.  From 2008 to 2010, ebook sales grew from .6 % to 6.4% of the overall book market. (Source: AAP) Amazon had 80-90% of the ebook market at the beginning of 2010. Nook entered the market on November 22, 2009, Apple with iBooks announced on January 2010, and Kobo in July 2010.  Currently the ebook market for trade fiction sales varies from publisher to publisher but is around mid 20% to 30%.

6.  Didn’t Amazon acquire its monopoly through predatory pricing?

In 2010, when the publishers and Apple allegedly colluded to fix price, Amazon controlled 80-90% of 6.4% of the overall book market according to the statistics of the American Association of Publishers.  While Amazon did sell some of its ebooks at a loss leader price of $9.99, the Kindle was one of two dedicated devices marketed to the US readers and widely available in the US. (Sony’s reader actually predated Amazon).  In other words, no one was competing against Amazon from 2007 to 2010 except for Sony.

There were other ebook retailers, but none that sold a dedicated reading device and none that allowed on device purchasing and delivery of ebooks over a cellular connection.  Amazon would have evidence that it provided a product and service in the ebook market that was technologically advanced at the time.

Nonetheless, let’s talk about predatory pricing for a minute. Predatory pricing (a Section 2 violation of the Sherman Act)  is considered anticompetitive and a violation of antitrust.  However, it is very difficult to prove.  Predatory pricing requires proof that the seller deliberately undercut its competitors to drive those competitors out of business.

In Brooke Group v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993), the Supreme court established the following test:

Accordingly, whether the claim alleges predatory pricing under § 2 of the Sherman Act or primary-line price discrimination under the Robinson-Patman Act, two prerequisites to recovery remain the same. First, a plaintiff seeking to establish competitive injury resulting from a rival’s low prices must prove that the prices complained of are below an appropriate measure of its rival’s costs.

The second prerequisite … is a demonstration that the competitor had a reasonable prospect, or, under § 2 of the Sherman Act, a dangerous probability, of recouping its investment in below-cost prices. …  Recoupment is the ultimate object of an unlawful predatory pricing scheme; it is the means by which a predator profits from predation. Without it, predatory pricing produces lower aggregate prices in the market, and consumer welfare is enhanced. Although unsuccessful predatory pricing may encourage some inefficient substitution toward the product being sold at less than its cost, unsuccessful predation is in general a boon to consumers.

The court goes on to say:

That below-cost pricing may impose painful losses on its target is of no moment to the antitrust laws if competition is not injured: It is axiomatic that the antitrust laws were passed for “the protection of competition, not competitors.”

and

If circumstances indicate that below-cost pricing could likely produce its intended effect on the target, there is still the further question whether it would likely injure competition in the relevant market. The plaintiff must demonstrate that there is a likelihood that the predatory scheme alleged would cause a rise in prices above a competitive level that would be sufficient to compensate for the amounts expended on the predation, including the time value of the money invested in it. As we have observed on a prior occasion, “[i]n order to recoup their losses, [predators] must obtain enough market power to set higher than competitive prices, and then must sustain those prices long enough to earn in excess profits what they earlier gave up in below-cost prices.”

Evidence of below-cost pricing is not alone sufficient to permit an inference of probable recoupment and injury to competition. Determining whether recoupment of predatory losses is likely requires an estimate of the cost of the alleged predation and a close analysis of both the scheme alleged by the plaintiff and the structure and conditions of the relevant market.

It should be noted that when Amazon began its $9.99 pricing scheme, there were only a few competitors in the marketplace: Sony, Fictionwise, Diesel.

6.  Is there any action that can be taken against Barnes & Noble for their alleged actions against Random House?

In the amended complaint of the States’ Attorneys General, there were allegations that Barnes & Noble engaged in two different acts to create and enforce the collusion:

  • BN assisted Macmillan in its move to Agency Pricing by moving Macmillan’s products to the top of its merchandising pods and to the front of the Nook recommendation section.
  • BN punished Random House for not colluding by not including RH books in any of its advertising.
People have asked whether BN would be in trouble for this.  First, this information was known to the government  plaintiffs at the time their lawsuits and given that BN was not included in the lawsuits, it is unlikely any charges would be brought.  Second, there don’t appear to be any allegations of collusion with BN, only that BN helped enforce the collusion.  This is likely not enough to be a violation of the Section 1 price fixing allegations.

7.  Will the prices come down? Or what will happen next?

Simon & Schuster, Hachette, and HarperCollins have agreed to settle with the DOJ.  The terms of the settlement would allow retailers to gain control over pricing and include those publishers ebooks in loyalty programs, discount clubs, and straight up discounting.  Amazon has signaled that it will begin discounting once the settlement is approved.  The settlement could be approved as early as August.  The parties have 30 days to comply with the agreement once the settlement is approved.  The earliest prices will likely be reduced is September or October of 2012.

Simon & Schuster has reportedly settled with the States’ Attorneys’ General.  The terms of this settlement is unknown at this time but will be made public.  Based on past reports, it is likely to include cessation of the current control by S&S over pricing along with some kind of rebate to consumers who purchased S&S books from 2010 until the date of the settlement.  Hachette and HarperCollins were reportedly in settlement talks with the states.

If Simon & Schuster, Hachette, and HarperCollins would settle with DOJ and the States’ Attorneys’ General and those settlements would result in some payment to consumers, then it is likely the Class Action suits would be dismissed.

You can read more about what might happen next here.

8.  Will “Agency” pricing still exist?

The DOJ settlement terms allowed for a 2 year cessation of agency agreements except one kind.   The  settlement agreement allows a retailer, like Amazon, to discount books but limits the discount in one year for one publisher to not exceed the retailers aggregate commission.  Assume Amazon signs an agreement with Hachette and Amazon agrees to accept a 30% commission on every book sold.  For one year, the total amount of discounts cannot exceed the total commission Amazon received for that year.  Some of the books could be half off, buy one get one free, or not be discounted at all.  But the total discount cannot exceed total commission.  Assume Amazon sold 100 books for Hachette that were retail priced at $9.99.  The total commission for Amazon would be $299.70.  Thus, the overall discounts Amazon gave to us readers could not exceed $299.70.

I hope this helps to clarify some issues. Please feel free to drop a question in the comments.

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