Thursday News: Judge Cote finds Apple conspired to raise prices with publisher by implementing Agency pricing

JanePublishing NewsAgency pricing / DOJ / lawsuits19 Comments

A little introduction

I’ve covered the DOJ lawsuit on agency pricing extensively here on Dear Author.  Here’s a rundown of the timeline. You can read an expanded version here.  I had my doubts that agency pricing would survive lawsuits even before DOJ filed its suit.

Even if Agency pricing disappears in 2-3 years because of lawsuits (which I expect that it will), B&N will have been given a window of opportunity to transform itself not only into a technology company, but a profitable technology company.  I submit it couldn’t have been done without Agency pricing.

• April 2012 – DOJ files suit and immediately follows that with an agreement for settlement with Hachette, HarperCollins, and Simon & Schuster.
• July 2012 – DOJ responds to all the objections to the settlement.
• September 2012 – Judge Cote approves settlement with first three publishers.
• Dec 2012 – Penguin settles.
• Feb 2013 – Macmillan settles.
• June 2013 – Apple trial begins
• July 2013 – Judge Cote finds Apple conspired to raise prices and decrease competition.

What the decision says.

Here is the PDF link to the decision. It is 160 pages. I want to reiterate how hard of a battle that Apple had.  The DOJ alleged a Sherman I violation and the only defense to a per se price fixing case is to prove that there was no conspiracy to price fix.  The defendants at the time, Apple, Macmillan and Penguin, filed a motion to dismiss the petition but Judge Cote issued a strongly worded criticism of the parties actions and rejected the motions to dismiss on the grounds that the DOJ had articulated sufficient facts to proceed on a Sherman I antitrust claim. I felt that the defense was lost at that point. That was the biggest win by the DOJ and set the stage for a classic hub and spoke collusion claim.

This ruling should be the centerpiece of any appeal by Apple. Although Judge Cote did write in this initial ruling that even measured under a rule of reason Apple’s alleged actions would be illegal.  Apple could bypass the Second Circuit Court of Appeals and under the Expediting Act take the action directly to the Supreme Court.  This act allows for direct appeals of antitrust cases that are of “general public importance.” The DOJ did this back in 2000 with Microsoft.

Essentially Judge Cote found that in response to Amazon’s growing market dominance, the five publishers and Apple conspired to raise prices and reduce competition to erode Amazon’s willingness to engage in discounting:

The Publishers also feared Amazon’s growing power in the book distribution business. They were concerned that, should Amazon continue to dominate the sale of e-books to consumers, it would start to demand even lower wholesale prices for e-books and might begin to compete directly with publishers by negotiating directly with authors and literary agents for rights -– a process referred to as disintermediation.

As a result, the Publisher Defendants determined that they needed to force Amazon to abandon its discount pricing model. As Hachette’s Young bluntly put it, they had to “defea[t] [Amazon’s] $9.99 pricing policy,” and prevent the “wretched $9.99 price point becoming a de facto standard.”

As Cote would later say, someone else’ monopoly is no excuse for your own anti competitive behavior. Cote peppers her decision with quotes that, if the publishers were on trial could have been enough to generate criminal responsibility:

As a Penguin executive reported to the Penguin Group Board of Directors under the heading “competition and collaboration,” it “will not be possible for any individual publisher to mount an effective response” to Amazon “because of both the resources necessary and the risk of retribution, so the industry needs to develop a common strategy.”

As early as December 2008, Stefan von Holtzbrinck of Macmillan and Hachette’s Nourry agreed “to exchange information and cooperate very tightly on all issues around e-books and the Kindle.” Nourry explained that “at the heart of our strategy” are discussions among “top publishers” in the United States “to create an alternative platform to Amazon for ebooks.”  He observed, however, that the goal of these ventures is “less to compete with Amazon than to force it to accept a price level higher than 9.99.”

In the Fall of 2009, Reidy explained to her superior at Simon & Schuster’s parent company CBS Corporation, Leslie Moonves (“Moonves”), that S&S was considering several different options to “get Amazon to change its pricing.” As Reidy explained,

we’ve always known that unless other publishers follow us, there’s no chance of success in getting Amazon to change its pricing practices. . . . And of course you were right that without a critical mass behind us Amazon won’t ‘negotiate,’ so we need to be more confident of how our fellow publishers will react if we make a move.”

Reidy assured Moonves, however, that she was “fairly sure that at least two of them would quickly follow us” and would “keep thinking of how to attack the problem (as we perceive it) of current eBook pricing; as you realize, we think it’s too important to ignore.” Reidy acknowledged to Moonves that “we need to ‘gather more troops’ and ammunition first!”

Hachette’s Young told Nourry in late Fall 2009, “[c]ompletely confidentially, Carolyn [Reidy] has told me that they [S&S] are delaying the new Stephen King, with his full support, but will not be announcing this until after Labor Day.” Understanding the impropriety of this exchange of confidential information with a competitor, Young advised Nourry that “it would be prudent for you to double delete this from your email files when you return to your office.”

When HarperCollins soon followed with its own windowing announcement, delaying the digital release of Sarah Palin’s Going Rogue, Hachette’s Nourry congratulated Murray on his decision: “Well done for the Palin book,” Nourry wrote, “and welcome to the Club!”

The three Publisher Defendants who had announced their adoption of a windowing policy hoped that Macmillan, Penguin, and Random House would join their campaign. As Nourry expressed on December 6, in order “[t]o succeed our colleagues must . . . follow us.” Five days later, S&S’s Reidy advised Macmillan that it would “love” for Macmillan “to join” Hachette, HarperCollins, and S&S in windowing, and “fel[t] if one more publisher comes aboard, everyone else will follow suit.” On December 15, Macmillan announced that, starting in January, it would delay release of most of its e-books for 90 days.

When Penguin and Random House chose not to join their competitors and delay the release of e-books, Hachette’s Young found their refusal “deeply divisive and disappointing.”

Interestingly there is an entire discussion on how every publisher basically hated windowing. Sargent believed it increased piracy. Reidy said it punished the ebook reader and a study run by Penguin showed that a delayed release of an ebook never recovered the lost sales. Ultimately Sargent wanted to move past windowing and just raise the price but they felt like they didn’t have the market power to do so. Enter Apple.  But Apple didn’t have an iBookstore and it didn’t have any content contracts. Apple wanted to launch the iBookstore with the iPad and therefore Eddie Cue had TWO MONTHS to close enough deals to make the iBookstore seem viable on launch.

By June, Cue’s team had assembled data that showed that the book market in North America was larger than the music market. The book industry was estimated to be roughly $35 to $42 billion in size, with trade books comprising $12.5 billion of that figure. While trade e-books accounted for just $100 million or so of those numbers, that market was growing at an exponential rate. Apple’s McDonald predicted that the e-book market could reach nearly $1 billion in 2010.

Prior to meeting with the Publishers, Apple assumed that it would purchase e-books from them under the wholesale model and resell them, in line with the arrangement Apple used to obtain movies and TV shows for resale through its iTunes store.  (Jane’s Note: This is kind of important because everyone presumed Apple’s other contracts were agency types as well. Agency was a deviation for them. In fact, it was Hachette and HC that approached Apple with the agency model and that they were considering it with BN.)

Apple learned that current wholesale prices for e-books typically fell in the range of $13 to $15, and some were even sold at prices as high as $17.50. Cue told Publishers that they would need to lower their wholesale prices for Apple if Apple were to enter the business. In order for Apple to compete with Amazon it needed to be able to price e-books as cheaply as Amazon did, and it was not willing to pursue a strategy of loss leaders. As Reidy recorded,

Apple expressed that it “cannot tolerate a market where the product is sold significantly more cheaply elsewhere.”

Several of the Publishers hashed over their meetings with Apple with one another. After Young had met with Apple but before S&S had its meeting, Young could not resist calling Reidy to share the wonderful news that the “Top Man” at Apple opposed $9.99 pricing. He hesitated to say more because S&S would be meeting with Apple the following day, and he did not want to “spoil [the] fun.”

At a breakfast meeting, Penguin’s Makinson discussed the Apple meetings with Hachette’s Nourry. On December 17, Rupert Murdoch, Chairman and CEO of HarperCollins’ parent company News Corp, relayed to Random House that Apple would soon be launching an e-reader and would be “selling books at 15 dollars.” Charlie Redmayne, a HarperCollins’ digital officer, bluntly suggested to Murray immediately after their meeting with Apple on December 16 that they coordinate a response to Apple with the other Publishers. As Redmayne wrote, in light of their “[g]reat meeting . . . I wou[]ld talk to the other CEO’s early and look to present in early Jan.”

Cue succeeded in speaking with key executives from each of these three Publishers early the following week. He explained that he had met with all of the Big Six the preceding week, and had come to the conclusion that the way forward would involve four components. First, the e-book “industry” needed to move to the agency model, which would allow the Publishers to set the prices and introduce what Cue euphemistically termed “some level of reasonable pricing.”

Apple reiterated that it would not tolerate windowing, it did not want to lose money, and it did not want any price competition. It advocated for an industry-wide adoption of the agency model as “the only way” to “move the whole market off 9.99.”

Enter the MFN.  The Most Favored Nation clause required Apple iBookstore to reflect the lowest prices anywhere on the market.  It was noted in the decision and argued vociferously by me that Agency Pricing actually reduced the revenue authors and publishers saw from the sale of an ebook (unless you were a mass market published author).

The problem with the $12.99 pricing for publishers is that it is still getting far less money for each sale than it had in the past. Under the 70/30 share, publishers are getting $9.09 on each hardcover sale thus rendering the royalty share loss for an author at $.88 cent per sale.

For mass market paperback sales, publishers are going to come out ahead under the agency model. Assuming a $7.99 price point, under wholesale model, publishers were receiving around $4.00 per book. Under Apple model, the publishers could price the digital book at $5.99 and still be slightly ahead of the game. Macmillan stated that its low point for the digital editions of paperbacks would be $6.99.

So the above quoted stuff was my best guess. Here was the chart in the decision:

Anyway, the MFN, Judge Cote said “eliminated any risk that Apple would ever have to compete on price when selling e-books, while as a practical matter forcing the Publishers to adopt the agency model across the board.”  Every publisher (but Random House) agreed that in order for this to work, every etailer would also need to be moved to the agency model, thus ensuring the “industry” shift.

To change the price of e-books across the industry, however, the Publishers would have to raise Amazon’s prices. This is where the MFN became such a critical term in Apple’s contracts with the Publisher Defendants. It literally stiffened the spines of the Publisher Defendants to ensure that they would demand new terms from Amazon. Thus, the MFN protected Apple from retail price competition as it punished a Publisher if it failed to impose agency terms on other e-tailers.

There was stuff about price tiering which I found less interesting (pages 59-65) but essentially the price tiers created uniformity across the industry.  Publishers don’t compete on price; they compete on authors and books.  And remember that bit about John Sargent on his treadmill making his decision to move to Agency a lonely one?

At a lunch between Macmillan’s Sargent and Amazon’s Grandinetti, Sargent announced that Macmillan was planning to offer Amazon the option to choose either an agency and reseller model. But, Sargent was mistaken. Neither Apple nor his fellow Publisher Defendants would allow Amazon the option of remaining on a wholesale model.

At a dinner that night, Cue explained to Sargent that Macmillan had no choice but to move Amazon to an agency model if it wanted to sign an agency agreement with Apple. The next morning, on January 21, Sargent wrote to Cue and in a carefully crafted message admitted that he had “misread” Cue in their previous discussions, and warned that “[t]he stumbling block is the single large issue we clearly had a misunderstanding about.” That stumbling block was “significant enough for us that we may in fact give you a no later today.” Referring to the commitment to move all resellers of e-books to an agency model, Cue responded that afternoon that he “d[id]n’t believe we are asking you to do anything, you haven’t told us you are doing. We are just trying to get a commitment.” He requested that they all “sit down . . . and talk through it.”

FN38:  Neither Sargent nor Cue was credible during the trial when they denied that Cue had explained at dinner that Macmillan was required to put Amazon on the agency model. Sargent protested that he could not remember the conversation, even though his email on the following day referred to “the single large issue” that might lead Macmillan to abandon its negotiations with Apple. Cue explained in his deposition that the biggest issues during his negotiations with Macmillan were the MFN and price tiers, and that he thought the discussion at dinner had been about pricing tiers; then at trial explained that he now remembered that they had discussed one-off promotions. Cue’s contemporaneous notes, however, indicate that the core issue in dispute with Macmillan was, in fact, the MFN and its implications. In an email to Jobs on the evening of January 21, just hours after sending his email to Sargent, Cue reported that “[a]fter a long afternoon with their general counsel, we are in agreement on the terms” with Macmillan, “but the CEO and GC have legal concerns over the price matching.”

Judge Cote details the confirmation of the contracts. It took some wrangling. Even Steve Jobs had to jump in to convince Rupert Murdoch of the rightness of Apple’s proposal. Jobs sent a couple of lengthy emails to Murdoch and one of them basically said, get with us or your customers are going to steal your books.

By Friday evening, January 22, Cue was able to report progress. He informed Jobs that he had commitments from Hachette, S&S, Macmillan, and Penguin that they would sign. At this point, Penguin required assurance that three other Publishers were also signing Agreements. As Cue admits, in these final days the Publishers needed reassurance that they would not be alone in signing an agency agreement with Apple because they feared Amazon’s reaction, reassurance that Cue readily provided.

After the agreements are reached and Apple launches the iPad, prices go up but the ebooks sold decreased by 12.9 to 14.5 percent.  Amazon testified that Random House’s sales increased 41% while Hachette, Penguin, and Harper all suffered declines in Kindle book sales after Agency prices were instituted.

In the five months that followed, the Publisher Defendants collectively priced 85.7% of their New Release titles sold through Amazon and 92.1% of their New Release titles sold through Apple within 1% of the price caps. This was also true for 99.4% of the NYT Bestseller titles on Apple’s iBookstore, and 96.8% of NYT Bestsellers sold through Amazon.

While conceding that the prices for the Publisher Defendants’ e-books went up after Apple opened the iBookstore, Apple argued at trial that the opening of the iBookstore actually led to an overall decline in trade e-book prices during the two-year period that followed that event. Its evidence was not persuasive. Apple’s experts did not present any analysis that attempted to control for the many changes that the e-book market was experiencing during these early years of its growth, including the phenomenon of disintermediation and the extent to which other publishers decided to remain on the wholesale model. The analysis presented by the Plaintiffs’ experts as well as common sense lead invariably to a finding that the actions taken by Apple and the Publisher Defendants led to an increase in the price of e-books.

The remainder of the decision is the application of the aforementioned facts (among many others that I didn’t include) to the well established law.

Some additional notes.

The review by the higher court (the appellate court) is a de novo review which essentially means the higher court reviews all the evidence to see if they agree with the trial court’s findings. Most appeals are for corrections of errors at law meaning only legal errors like the right standard to apply to the case can be reviewed.  But Judge Cote, obviously cognizant of the review standard, made an important ruling on credibility.  She did not find Cue, Sargent, Reidy, and other publisher representatives credible.  Instead she relied on emails and other documentation made contemporaneously (more closer in time to the events).  The credibility rulings are almost always found binding on the higher court because the trial judge is considered to be in the best position to judge a witness.

Among other things, Apple also has to argue that there was not substantial evidence supporting Cote’s decision which, given the decision, is probably unlikely.

What happens next:

• There will be a damages phase. I believe (although I didn’t check this) that DOJ can ask for treble damages (the actual damages x 3)
• Settlements of Macmillan and Penguin need to be ruled on.
• New restitution forms will have to be sent to account for the Penguin and Macmillan settlements.

Jane

Jane Litte is the founder of Dear Author, a lawyer, and a lover of pencil skirts. She self publishes NA and contemporaries (and publishes with Berkley and Montlake) and spends her downtime reading romances and writing about them. Her TBR pile is much larger than the one shown in the picture and not as pretty. You can reach Jane by email at jane @ dearauthor dot com

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