Apple DOJ Lawsuit: Why Amazon Wins The E-Book Pricing Battle, But Not The War

The United States Department of Justice filed a civil antitrust lawsuit against Apple and a handful of major book publishers on Wednesday, alleging that the companies colluded to raise the price of e-books back in 2010. Amazon, the maker of the Kindle e-book readers and tablets, couldn't be happier.

The lawsuit says Apple and the five accused publishers -- including HarperCollins, Penguin Group USA, Simon & Schuster, Macmillan and Hachette Book Group -- conspired together to block price competition of e-books, which resulted in customers paying tens of millions of dollars more for e-books than they otherwise would have paid.

Late Apple co-founder and chairman Steve Jobs described the agency model to his biographer, Walter Isaacson.

We told the publishers, 'We'll go to the agency model, where you set the price, and we get our 30%, and yes, the customer pays a little more, but that's what you want anyway,' Jobs said. They went to Amazon and said, 'You're going to sign an agency contract or we're not going to give you the books.'

Attorney General Eric Holder, Jr. will announce the lawsuit at a news conference, scheduled for 12 p.m. ET.

The lawsuit described how for at least a year, beginning no later than September 2008, Apple frequently met with several publishing executives in private dining rooms of upscale Manhattan restaurants to discuss confidential business and competitive matters, including Amazon's e-book retailing practices.

These private meetings, the suit alleges, provided the publisher defendants' C.E.O.'s the opportunity to discuss how they collectively could solve 'the $9.99 problem.'

The '$9.99 problem,' which related to how Amazon charged roughly $10 for e-books that were either bestsellers or newly released, was a big worry for publishers. They didn't believe they could make a profit with Amazon selling their best books for under $10. Compared to this structure, Jobs' pitch of agency pricing with a 30 percent commission sounded like a much better hook.

So, the five book publishers agreed with Apple to sell their e-books in 2010, shortly before Apple released the iPad, which would revolutionize how consumers read and downloaded digital content, particularly news and books.

The news should be no real surprise to Apple. The DOJ had been investigating this possible conspiracy since last year, responding to what government investigators called illegal action with e-book pricing policy. Known as the agency model, Apple's e-book pricing policy allowed publishers to set their own prices on e-books and gave a 30 percent commission to Apple. This model is a stark contrast to the model for print books, where publishers would charge the retailer but ultimately let that retailer set their own price for the book.

Originally, publishers worried the agency model would serve Amazon, mainly because the giant online retailer could afford to sell e-books for less than it paid publishers. That didn't happen. Instead, Amazon lost market share in e-books once the agency model was instituted in 2010, dropping from 90 percent to roughly 60 percent market share.

Therefore, the DOJ has decided to attack Apple's agency model for its pricing arrangement with the major book publishers.

Sharis Pozen, the DOJ's acting director of its antitrust decision, told a House subcommittee in December that the department was looking into competitive pricing in the e-book industry. The Justice Department sent publishers potential proposals with hopes of a settlement, but with Pozen ready to leave the department by May, it looks like the DOJ wants a lawsuit while she's still with the department. The case looks to attack how the agency model was created and which publishers adopted it first, which makes later agency model publishers like Random House safe, for now.

Amazon loves the DOJ's decision to go after Apple.

This is a big win for Kindle owners, said Andrew Herdener, a spokesman for Amazon. We look forward to being allowed to lower prices on more Kindle books.

Some of the book publishers are choosing to settle with the Justice Department, including HarperCollins and Hachette.

Hachette was not involved in a conspiracy to illegally fix the price of e-books, and we have made no admission of liability, the publisher said in a statement. Hachette's unilateral adoption of agency was designed to facilitate entry by a new retail competitor and to increase the diversity and health of retail booksellers,and we took these actions knowing that Hachette itself would make less money than before the adoption of agency.

MacMillan, on the other hand, will not settle with the government, citing demands that were too onerous, according to John Sargent, the company's CEO.

After careful consideration, we came to the conclusion that the terms could have allowed Amazon to recover the monopoly position it had been building before our switch to the agency model, Sargent said. We also felt the settlement the D.O.J. wanted to impose would have a very negative and long term impact on those who sell books for a living, from the largest chain stores to the smallest independents.

Even though the DOJ is finally dropping the gauntlet on Apple, the government doesn't realize how futile this lawsuit is. Whatever competition was created by Apple's agency model will be gone, and all companies will be able to sell e-books at a fair price. But frankly, other companies should learn how to create creative ways to be competitive.

[The Justice Department is] on the verge of killing real competition in order to save the apperance of competition, said Scott Turow, president of the Authors Guild. This would be tragic for all of us who value books, and the culture they support.

The government cares about making a safe and even playing field for all, but it is missing out on the key component's of Apple's agency model. Apple only needed ingenuity and time to persuade these publishers that a new model would serve both interests. This isn't a model that the DOJ needs to fight, because it works. Apple's e-book sales are going up while Amazon's are going down, but Apple has something others don't: The entire ecosystem.

Apple can control every part of its digital experience, from the hardware to the software to the downloadable content, and even the store in which the digital content is downloaded from. Apple thought of everything, and now the DOJ is acting like Apple has an unfair advantage. Maybe it does, or maybe it's price structure was the first one to actually make sense for book publishers. Prices don't need to always be lower; prices need to make sense with the value of what's being sold. If book publishers want to sell books for $14.99 instead of Amazon's $9.99 or lower, they should be able to.

For now, Amazon is the clear winner from this major lawsuit, but it won't be for long. Amazon has not evolved beyond an online retailer, while Apple can retail, manufacture, produce, design, and more importantly, innovate. Amazon has no ecosystem beyond its online store and Kindle e-readers and tablets. Apple will fight this case, and even though it may lose, there's no denying Apple's direction. The company's stock recently hit 600, just one month after it hit 500, and a lawsuit won't stop that number from climbing even higher.