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The United States v. Apple

by Paul Creech on Wednesday, August 8, 2012

[dropcap]Apple[/dropcap] has changed the way we do everything.  By forcing change in music industry pricing, purchasing, and packaging, Apple made music more available, likely saved the industry from a more costly and painful transformation later down the road, offered an alternative to music piracy, and improved the way the product was purchased and consumed for the convenience of the customer.  The traditional music retailers were destroyed by this revolution. Do you remember stores filled with aisles and aisles of $15 CDs for albums that had one good song?  When is the last time you ordered a CD to be delivered by mail (Hello, Amazon?)?

Apple decided to change the way we buy e-books.  They created the iPad, not the first e-reader, and not an e-reader, but a device that can consume all media and puke it into your lap in a beautiful aluminum shell. Now, Amazon had the first successful e-reader, they are the biggest e-book retailer on the planet.  They dictate terms to publishers.  They decide how e-books are going to be sold, priced, and who gets to compete with them. They are big enough to under-cut anyone’s price and drive away competition. Amazon can under price the hardback, so you won’t be going into your local Boarders (bankrupt) or any other brick and mortar retailer.  They are so successful that you don’t even know why the e-books that Amazon sells to you at a loss are so expense, and you would never pay full price for a hardback book.  In fact, Amazon wants to send brick and motor e-book retailers where Apple sent music retailers, into a department of your Wal-Mart or into tiny specialty shops preying on skinny jean wearing hipsters who hate their fathers.

Amazon’s World

Amazon uses cheap e-books to sell their Kindle tablets, they sell cheap e-books to fight off competition, and retain market share and sell their Kindle tablets.  Amazon uses these discounts of best-sellers, at a lost to them, to get you used to buying cheap e-books, and the getting the publishers to lower their wholesale prices to match their discounts so Amazon will stop losing money on e-books and the loss turns into a profit as you buy Kindle tablets with big margins and keep buying your e-books through Amazon now at a small margin, and the publishers lose their margins.  Amazon gets bigger and more powerful because they are big and powerful, controlling market share and selling Kindle tablets. So under the e-book world that Amazon built, publishers sell their e-books to Amazon at a wholesale price and then Amazon can sell them at a loss to sell more Kindles and grow market share to push down wholesale prices.

Apple came along and said to some unhappy publishers, why don’t you set  the retail price, set a commission, and let the customers decide if they want to pay it or not. Barnes and Noble also adopted this agency model of pricing.  The reason being, Apple and Barnes and Noble didn’t want to sell e-books at a loss, and publishers wanted to control the price of their product to keep the perceived value of the product high. Amazon finally had competition.

Of course, whatever Amazon was doing in this emerging market was called “normal” and what everyone else did to the owner of so much market share was called unfair competition.  And with so many unhappy retailers happy to adopt this Steve Jobs inspired pricing, Amazon saw a conspiracy to fix prices unfairly at the expense of the consumer.  Now, the United States has laws to protect the consumer from such attempts to fix pricing, though there are no laws prohibiting Apple from selling a different pricing model or publishers from signing those contracts.  There are no laws against e-book publishers from setting their retail price or charging more money for their products. There are anti-trust laws that prevent companies from conspiring with each other to raise and set prices.

Lucky for consumers, and you know, as an aside, lucky for the biggest retailer of e-books on the planet, with the largest market share in the world, who would have been hurt by this unfair competition, which would have hurt consumers because of the lack of competition (if you can make any sense of how completion reduces completion please contact me immediately), the United States, using the coercive power of the government, stepped in to save Amazon from competition save the consumer for illegal price fixing.

The United States Outlaws Apple

The Justice Department cowed a group of publishers into not just rejecting the legal pricing model of Apple, but Apple as e-book retailer, and protecting Amazon and the pricing model that Amazon is using to sell Kindles and dominate market share from competition .  The other publishers named in the suit, and Apple, are defending their right to an agency pricing model.  If the publishers did conspire with each other to raise the price of e-books they’ll lose. If Apple just offered to sell at a higher and fixed commission and pricing model, they shouldn’t.

On August 3, 2012, the United States filed a number of telling documents in support of their agreed final judgment against HarperCollins, Hachette, and Simon & Schuster. (Macmillan and Penguin are publisher defendants in this case but are not a party to this settlement).  The proposed final judgment, if accepted by the court, would make no admissions of any fact relating to the accusations of the United States, nor admit any wrong-doing.

These companies are sure to face derivative suits by plaintiffs’ attorneys seeking compensation for wrong-doing by officers and directors relating to this action.  These suits are by shareholders, are in the name of the company, and against individuals for bad decisions that affect stock price, revenue or cause other harm to the company.  Not admitting wrong-doing gives their defense attorney’s a stronger case to rebuff those inevitable lawsuits.  Usually, the Business Judgment Rule, which states that the Court will not seek to post hoc supplant it’s uniformed judgment for that of business executives acting in the moment, without something else (gross negligence or willful misconduct), will shield individual directors and officers from individual liability associated with bad business decisions.

The proposed final judgment requires the settling defendants to end all their contracts with Apple, terminate all similar agency pricing agreements with other e-book retailers (like Barnes and Noble), give notice and any desired information to the Department of Justice before entering into business agreements with other e-book publishers, and give the Department of Justice copies of all its contracts with e-book retailers.

For two years after the final judgment the settling defendants can’t restrict by contract any retailer from offering a discount on their products, must terminate any agreement that restricts discounts, agrees not to enforce the provision of contracts in effect (and not subject to termination) which limits the e-book retailers from discounting products, and prohibits the entering into of any agency pricing contract for the sale of e-books.  Further, the settling defendants agree not to retaliate against e-book retailers who offer discounts on their products during the period that the e-book publishers are prevented from enforcing or entering into contracts against doing so. So for two years they don’t control how they price and sell their products, can’t disrupt Amazon’s business plans and pricing models, you know, for competition sake. And after the two years are up, the publishers can’t “retaliate” against them.  I’m shooting in the dark here, but I’d guess that refusing to allow Amazon to discount their product against their best interest would be retaliation. This is an entire section that seems as though Amazon was asked what they wanted for Christmas, and Eric Holder got it for them.

The settling publishers can’t conspire amongst themselves and other publishers to raise, set or fix the price of e-books (okay, that’s illegal).  They can’t tell each other, even indirectly through a retailer (or tell a retailer if that retailer is likely to tell another publisher) competitively sensitive information such as business plans and strategies; past, present, or future wholesale prices; any terms of any agreement with any retailer or author.   These companies don’t get decide what information, which they own, is available for disclosure to their competition, because it might help the competition compete with them, and that would be bad for competition.  They can’t share this information in forming business relationships because those people might tell their competition and that would hurt competition.  This all only makes sense if the competition that the Holder Justice Department is concerned about is not among publishers but retailers like Apple and Amazon….but whatever.

The settling publishers must also set up compliance programs to ensure the final judgment is carried out, certify their understanding, conduct annual audits, and turnover to the Department of Justice all copies of their non-privileged correspondence of any one alleging non-compliance, or concerning compliance between employees and anyone. Then certify annually that they are in compliance with the final judgment.

Thank the heavens for Attorney General Eric Holder preventing these publishers from selling their books using a different pricing model that then one Amazon uses, and forcing them to allow Amazon to degrade the value of their product to sell their own high margin products, thereby increasing competition and protecting the consumer from this evil conspiracy.  Had this competition of pricing models played out in the market who knows the evil it would have wrought upon our shores?  Our world is a safer and more just place, and I for one, will sleep better tonight.


These materials have been prepared for general informational and entertainment purposes only and are not intended as legal advice.

Paul Creech
Paul Creech is an attorney living in Houston, Texas. Paul has baccalaureate degrees in philosophy and political science from Utah State University, and a juris doctorate degree from Houston College of Law. He is a former U.S. Marine. Besides the law, Paul's interests include sports, art, and food.

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