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Apple, E-Books and the Amazon Juggernaut

Today, as Apple faces its latest day in court, an antitrust expert ponders the company's odds.

Asa Mathat

Being sued by the government under the antitrust laws has historically been a rite of passage for great American companies like Standard Oil, U.S. Steel, DuPont, IBM, AT&T, Microsoft, Intel and Google. Apple is the latest to be inducted into this rarified company. In a 2012 lawsuit, the Justice Department alleged that the Cupertino company conspired with seven book publishers to fix e-book prices. After being found liable by the federal district court in Manhattan in July of 2013, Apple is preparing to argue its case in the court of appeals today, Dec. 15.

Apple should be feeling good about its chances. Although the government’s case has superficial appeal, the record suggests that Apple’s actions may have benefited rather than harmed the welfare of e-book customers.

A quick recap of what happened: Between the introduction of Amazon’s Kindle in 2007 and the introduction of Barnes & Noble’s Nook in 2009 and Apple’s iPad in 2010, Amazon was the juggernaut in the e-book and e-reader market. Amazon strategically priced premium e-books at $9.99 to stimulate demand for the Kindle and, arguably, to entrench its market position in advance of competitive technologies reaching the market.

The book publishers felt that Amazon was devaluing the e-book market in order to promote its proprietary systems and technology. They feared that Amazon’s low e-book pricing would condition consumers to expect low e-book prices forever for premium books. Because Amazon was initially the only game in town for e-book distribution, the publishers had little power to resist Amazon’s demands. The advent of the iPad and the Nook emboldened the publishers to demand different terms of dealing.

According to the Justice Department, in late 2008 the publishers began to conspire with one another, and eventually with Apple, to force Amazon’s hand. The conspiracy allegedly began as a deal between Apple and the publishers. Under the terms of the deal, the publishers would set the ultimate retail price, which would be capped in several tiers based on the hard-copy list price. Further, the publishers would agree to a most-favored nation (MFN) contract with Apple, providing that the publisher would guarantee to lower the retail price of each e-book in Apple’s iBookstore to match the lowest price offered by any other retailer.

Having agreed to these terms with Apple, the publishers were allegedly able to force Amazon into the same type of arrangement. Because allowing Amazon to continue to undercut prices in iBookstore would quickly erode the whole deal, the publishers collectively forced Amazon to adhere to the new e-book pricing plan and agency model.

The book publishers quickly settled with the government, leaving Apple to defend itself alone at trial. The district court found that Apple had joined the conspiracy among the book publishers and hence that it had committed a per se violation of Section 1 of the Sherman Act.

The district court’s decision was questionable. There are important distinctions in antitrust law between vertical and horizontal agreements and collective and unilateral decisions. Horizontal price-fixing agreements among competitors are considered illegal per se — they are condemned without any inquiry into the actual effects of the agreement. On the other hand, vertical agreements — as between a publisher and a distributor — are adjudged under a flexible “rule of reason” that considers all of the relevant facts about whether the restraint harmed or helped competition and the welfare of consumers. Here, there was ample evidence that Apple entered into a series of vertical agreements with the book publishers that were in its individual self-interest, regardless of any alleged conspiracy among the publishers.

Because the district court mistakenly condemned Apple’s conduct as per se illegal, it failed to pay serious attention to two issues suggesting that a different result should obtain under a fuller rule of reason inquiry.

First, although the point of a price-fixing conspiracy is generally to increase prices, there is compelling evidence that the shift from a wholesale to an agency model resulted in a decrease in the average prices of e-books. While the prices of premium books that Amazon had previously been selling below cost increased, Apple and B&N’s entry facilitated the vast expansion of the e-book market, including the availability of many new low-cost books. The net effect for consumers was an expansion of choice and variety at lower average prices.

Second, it would be misguided to judge the competitive effects of Apple’s behavior solely based on e-book prices. Amazon was strategically using low, and arguably anticompetitive, e-book prices to entrench the entire Kindle ecosystem. Market entry by new competitive ecosystems like the iPad/iBookstore required disruption of Amazon’s prevailing business model. Consumers undoubtedly benefited immensely from the introduction of the Nook and iPad and their associated online bookstores.

In analyzing the Justice Department’s case against Microsoft a little over a decade ago, the U.S. Court of Appeals for the D.C. Circuit cautioned against using rigid per se rules to assess the legality of new arrangements in dynamic technology markets. Such rules, the court wrote, pose a serious risk of retarding innovation and harming the interests of consumers. There is considerable wisdom in that observation for the e-books case.

Daniel A. Crane is associate dean for Faculty & Research and professor of law at the University of Michigan Law School, where he teaches antitrust and related regulatory courses. Crane has authored several treatises on antitrust law, including “Antitrust” (Aspen, 2014), “The Making of Competition Policy: Legal and Economic Sources” (Oxford University Press, 2013) and “The Institutional Structure of Antitrust Enforcement” (Oxford University Press, 2011). An editor of the Antitrust Law Journal and member of the American Antitrust Institute’s Advisory Board, he also serves as counsel in the litigation department of Paul, Weiss, Rifkind, Wharton & Garrison of New York.

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