Apple Bilked Consumers Out of Millions of Dollars and Said It Was For Our Own Good

On Wednesday the Department of Justice filed an antitrust lawsuit (PDF) against Apple and several major publishers for the alleged collusion of the price of e-books.

Three of the publishers, Simon & Schuster, Hachette, and HarperCollins quickly settled, either unwilling to risk costly legal proceedings or, also likely, tacitly admitting guilt. It’s hard to tell these days. The others, Macmillan, and Penguin Group, all led by Apple, denied any wrongdoing, ready to do battle against charges of “conspiring to limit pricing competition.”

CEOs bemoaned the “wretched $9.99 price point” for ebooks, the DoJ alleged during a press conference in Manhattan Wednesday afternoon, noting that the point of the collusion was “less to compete with Amazon as to force it to accept a higher price than $9.99.” The DoJ claimed that “to effectuate their conspiracy, the publisher defendants teamed up with defendant Apple, which shared the same goal of restraining retail price competition in the sale of e-books.”

But the story really begins two years ago with the launch of the first iPad, when the late Steve Jobs met with various publishing honchos looking to strike a deal that could make iBooks more economically competitive versus Amazon’s dominant Kindle platform.

Steve, being Steve, wanted 30 percent of all sales. Those incredible terms may have, in normal circumstances, killed any potential deal, but with Amazon pushing digital book pricing down to $9.99 (a number publishers found excruciatingly low) a solution was found.

That solution meant transitioning from the wholesale model, where retailers get to make final pricing decisions, to an agency model, a system in which vendors get to make the calls. The entire situation is aptly summed up by a Jobs quote found in the lawsuit.

“We’ll go to [an] agency model, where you set the price, and we get our 30 percent, and yes, the customer pays a little more, but that’s what you want anyway,” Jobs is quoted as saying, highlighting the win-win nature of the deal. Of course, the unaccounted-for loser then becomes the end consumer, at least according to the U.S. government.

Other things that pissed off the DoJ included “most-favored nation” provisions (in the sense of Apple, not actual countries) that Apple leveraged, such as one clause that requires book sellers to match their lowest prices for their friends in Cupertino. Apple’s argument is that these steps were required to increase competition, which is ultimately good for the consumer, even if they’re getting charged $2, $3 or even $5 more for the books they want thanks to Apple’s huge cut.

But the competition premise does have wheels. At the time, Amazon commanded 90 percent of the market. That number has since fallen to 60 percent at the hands of Barnes & Noble and less so Apple, according to a report from the AP. And even if consumers are paying more, this could be a good thing, notes NYU legal professor Richard Epstein, who believes the DoJ will probably lose this one.

First, there is no need for any collusion on this issue. If a single publisher had dreamed up this new scheme, it could have refused unilaterally to sell any books to Amazon or anyone else unless they bought into the model. Why is it illegal for Apple to come up with a bright idea that helps its competitive position with Amazon?

Second, it is not clear that lower prices are necessarily in the long term interests of the public at large. As with all complex transactions, lower prices spell both low costs to consumers and low royalties to authors. The lower royalties translate into lower level of production of new books, so that we do not have here the usual cartel situation where higher prices reduce output. It is plausible that the higher royalties increase the number of titles available, and by increasing competition in the new book market, prices are lowered in the long run.

Third, it is not clear why this arrangement is bad if done by all major publishers simultaneously. If it has justifications for each acting alone, those justifications remain when they act together. Under pure competition we would expect gravitation to a single new model if it proves better overall than its rival. That could be just what is happening here. The cooperative efforts speed the industry toward a more sustainable business platform.

Stated more generally, the usual cartel involves restrictions that have few if any efficiency benefits. These agency transactions have both pluses and minuses for consumers and for overall social welfare. It is a good rule of thumb to hold back from public enforcement when the relative balance is unclear. But note that in the current political climate, that presumption is likely to be reversed by populist forces. Big is bad. It will take some time to hear the whole story, but the betting here is that this law suit is a mistake.

So books are not oil, I guess. For Apple’s sake, they better hope so. Forbes reports that a $9.99 price point could cost the company a quarter of a billion dollars in just a couple of years. Or put it another way: That’s about $252 million back in the pockets of you and me.