The DOJ took Apple and a set of publishers to Court today on price fixing charges in relation to an alleged conspiracy. Now if you read the DOJ’s claim it looks bad but, having read some of these before, let me tell you that they always look bad. We really have to wait until a full response — something that usually only becomes apparent at trial — to really get the picture. But for the purposes of this post let’s suppose it was as bad as the DOJ allege. The one thing that is not well specified in the claim — not that it really has to be — is, what would the world have looked like had this not happened?
Let’s start with what ‘this’ is. When Apple entered the book retailing business it wanted to get publishers on board and so offered them the ability to set their own prices — as per the agency model. As I have written before, that, on its own, is not a bad thing for consumers and there is a first order case that it can be beneficial. It may not be the model Apple used for music and television but it is the model Apple used for the App Store. I can also imagine that Apple did not want to get into the business of setting book prices. After all, books come in many shapes and sizes and Apple may not have wanted to gather the information to ‘get those prices right.’
The problem, of course, was that its primary competitor, Amazon, was selling books at a discount. We don’t know for sure what the case was but there is a chance it was selling them below wholesale. Why? Because Amazon wanted to build demand for its Kindle. So had Apple just launched a bookstore, publishers may have offered books there but the chances were that they would be priced higher than Amazon and not sold. To counter this, Apple would have had to get into the direct pricing game but as the iPad was a device with more than one function (unlike the iPod), its incentives were muted and one can imagine that all this would not have been worth the fuss. This is especially the case as Apple could (and of course does) have its cake and eat it too by allowing Kindle and other apps onto the iPad.
But Apple was a draw for the publishers. Amazon was becoming increasingly dominant and so they were individually and collectively worried about that. By the way, a bottleneck retail distribution channel is something we should all worry about. Apple, no doubt, saw some flaws in the Kindle model and thought that they could improve store design, leverage the iTunes account base and also design an iPad optimised reading experience. That itself might have been attractive to publishers but most of all they probably wanted some retailer to take on Amazon.
Herein lies the point: with Apple just offering an agency model and an iBooks store and app, there wasn’t much hope for it. Perhaps had they not permitted a Kindle app, they could have generated some demand. But with higher book prices and, more critically, consumers needing to make some commitments, there was surely no hope. On that point, note that consumers face a dilemma in this market. Collections aren’t easily portable and this is especially true of Amazon’s. You start buying books from one retailer and it may be costly to switch to others. And the installed base of Kindles meant that consumers could be forgiven for thinking that Amazon was going to be around alot longer than others.
Apple was going to need a few things to generate demand — and that was far from a given. First, they needed to be able to compete on price with Amazon. The agency model gave the publishers the ability to do that but the publishers would have to take a hit. Not surprisingly, at least some and perhaps all were resistant. Second, they needed the publishers to commit to iBooks so that consumers believed that titles would be available there and it was worth investing their collections in. In this world view, Apple didn’t have much interest in what happened but if publishers wanted terms that would allow Apple to compete more effectively with Amazon, it is no surprise that they may have been in a position to push for them.
One way to achieve these things was by signing a most favoured nation style contract with Apple and then using that to push Amazon into a similar contract. The contract Apple offered meant that the publishers would have to drop the Apple retail book price if Amazon, say, had a lower price. So what it did was commit all publishers to something like a ‘poison pill’ if they were unable to convince Amazon to change to an alternative model. So the commitment to something that looks like it may be very competitive at the same time could give publishers a greater incentive to deal toughly with Amazon. In the end, Macmillan lead the charge and through other mechanisms Amazon lost the battle.
But why did they need the Apple contract to do that? Why couldn’t the publishers have gone to Amazon and just said, our wholesale price is now higher — Apple entry or no Apple entry? The DOJ complaint implied they had some collective power. But they may have had individual power too. Why didn’t they just put up wholesale prices making it more expensive for Amazon to offer a lower price point? Now the answer may have been that they were competing with one another. But if you have a highly sought after best seller, surely there was opportunity to earn more. The history of this is murky.
However, it seems to me that there is a line of argument that suggests that had Apple not existed, the publishers would have eventually toughened up on the wholesale price and it isn’t clear that Amazon could have pushed back so easily. If Apple had entered but with higher prices, Amazon’s power to push back would have been diminished further. This is just a long way of saying that the copyright over books gives publishers a degree of market power and it is not at all clear that they would have been unable to find a way of exercising it. And interestingly, we have to surely acknowledge that as book prices rose and with them Amazon’s profits from the eBook selling part of their business, surely Amazon’s incentives to discount the Kindle further increased. And as more Kindles went out there, so too did Amazon’s potential dominance. In the end, is Amazon’s market share lower as a result of all this?
All this is not to justify meetings in smoke filled rooms to try and get prices higher. If that occurred, it’s bad and should be punished. What I point out here is that it is not clear that the counterfactual was the world where Amazon offered discounted prices well into the future. Perhaps as this develops we will learn more about negotiations in this industry and be able to understand what might have been.
Digitopoly 
Obviously this is just the beginning, but if the DOJ’s claims are proven true then despite what you say, the publishers themselves clearly thought they couldn’t get what they wanted through means other than collusion, or they wouldn’t have broken the law to get it.
I think the answer to the question about publishers acting individually is that the publishers are afraid of retribution from Amazon in forms of burying authors and distorting searches and the “customers who viewed this” type of features. Certainly, any individual publisher needs Amazon a lot more than Amazon needs any individual publisher.
I really appreciate pretty much everything you write about the book publishing industry. Thanks.
This is the third pro-Apple blog that you’ve posted on this issue, I start to wonder…
Anyway, as far as your assertion that agency model is beneficial, this is merely based on the avoidance of ‘double marginalisation’ under linear pricing. Now you tell me why you believe the publisher and Amazon couldn’t prevent this inefficiency through non-linear pricing arrangements instead. This is particularly so given Amazon’s willingness to set efficient retail prices by eventually incurring a loss because of high linear wholesale prices. That is to say, the cause of double marginalisation, if any, is to be found in the publisher’s unwillingness to set efficient prices, not the downstream distributor’s fault. Incidentally, you admit this by arguing that absent the collusive agreement publishers could have set higher wholesale prices thus worsening double marginalisation! This is all a bit confusing, don’t you think?
Why Apple’s contracts were needed at all? Ever heard about facilitating practice? To the extent that the contracts provided a commitment device, this helped publishers to reach an agreement and unite against Amazon.
On what did Apple stand to gain from all this? Well this is where your analysis is lacking the most, almost naïve I’d say. With the Kindle Fire, Amazon’s strategy changed from an e-book platform to a multi-media audio-visual platform, which, if successful, could grow to a challenger for Apple’s platforms. So by mismanaging e-book’s pricing (and thus renouncing to internalise complementarity and network effects across content categories) Apple took a defensive move in the knowledge that high e-book prices were more damaging for the upcoming and ambitious Amazon’s platform.
Not having followed the details, to me the economics here seems rather more straightforward: what the use of agency model by both Apple and Amazon with mutual MFN clauses stops is price competition between different retailers of the same book. Different books (publishers) are still competing against each other on price. But then you’ve intentionally prevented the competition between two editions/sources/retailers of the same book when you granted intellectual property over it. Now it may be desirable to roll back this intellectual property, but logically it needs to be done through IP reform, not antitrust litigation?
We actually went through this once before with printed books and publisher’s “suggested” retail prices which were strictly enforced by denial of product until the 1960s when the government allowed book discounting and firms like Barnes & Noble and a host of department stores, among others, started selling books at lower prices. If you look at the numbers, it led to much higher book sales and was very good for the industry as a whole.
France strictly regulates the prices of books and allows only the most limited forms of discounting. Amazon ran into trouble when they offered free shipping on orders over roughly E25. France is subsidizing its publishing industry at the expense of French consumers, but France has a real problem. Writers, even French writers, might seriously consider writing in English for access to the much larger market. If I were a French consumer, I might find it worth the trade off and be happy to pay higher prices in exchange for books in my native language.
English speakers don’t have this problem, and a lot of them would rather get lower prices.