DLD Conference 2011The US DOJ’s pursuit of Apple as a “ringleader” in eBook price fixing continues to fascinate me. This week the DOJ released an email exchange between Steve Jobs and James Murdoch (of News Corp) that took place a few days before the launch of the iPad in 2010. Now Apple (and I should add Google) often had reputations out there for giving no ground in negotiations. This exchange demonstrates just how that took place. It is worth going over as others have already noted.

The opening position is an email from Brian Murray of Harper Collins to Eddy Cue of Apple (so it began with the next tier down negotiators).

Eddy,

Thanks for coming in again this morning. We’ve talked over the proposal and I want to make sure that you have a summary of the deal that HarperCollins would be willing to do in your timeframe.

1. Pricing: We need flexibility to price on a title by title basis outside the prescribed tiers in the contract. We will use our best efforts to meet the tiers we discussed.

2. MFN [“most favored nation” status]: In the event that HarperCollins and Apple disagree on a consumer price for a title, HarperCollins needs the ability to make that title available through other agents who support the higher price.

3. Commissions: We need a lower commission on new releases for the economics to work for us and our authors. We believe a 30% commission will lead to more authors asking for ebooks to be delayed a result that will not work for Apple or HarperCollins.

4. The new release window: We need to have flexibility on the agency window. We believe this window should be 6 months rather than 12 months in the event that one or more large retailers do not move to an agency model.

Leslie will be sending Kevin a contract that reflects these points in the event you wish to move forward on these terms.

Thanks
Brian

And in News Corp form it also tells us to consider the environment before printing the email.

Now remember the context here. Amazon were pricing many eBooks at $9.99 and taking a hit on them because publishers were receiving more than that. Apple had proposed a higher price ($12.99 to $14.99) as an industry equilibrium. So point 1 appears to be a desire from Harper Collins to be able to set higher prices than that if they so chose and that is confirmed by point 2. Point 3 is your standard “no, no, no, are you kidding me, I can’t afford that price, your bleeding me” counter and Point 4 is about some marketing flexibility.

It is at this point that James Murdoch of News Corp that owns Harper steps in and goes straight to Steve Jobs.

Steve,

Thanks for your call earlier today, and for the time last week.

I spoke to Brian Murray and Jon Miller [then the head of digital media at News Corp.]—and Brian is sending a note to Eddy today. I thin I have a handle on this now. In short—we we would like to be able to get something done with Apple—but there are legitimate concerns.

The economics are simple enough. [Amazon] Kindle pays us a wholesale price of $13 and sells it for 9.99. An author gets $4.20 on the sale of a hardcover and $3.30 on the sale of the e-book on the Kindle.

[A portion of this email was redacted by the court.]

Basically—the entire hypothetical benefit of a book without raw materials and distribution cost accrues to Apple, not to the publisher or to the creator of the work.

The other big issue is one of holdbacks. If we can’t agree on the fair price for a book, your team’s proposal restricts us from making that book available elsewhere, even at a higher price. This is just a bridge too far for us.

Also, we are worried about setting prices to high—lots of ebooks are $9.99. A new release window with a lower commission (say 10[%]) for the first six months would enable us to proce much more kenly for Apple customers. We’d like to da that.

More on this below in Brian’s note to Eddy. We outline a deal we can do.

Feel free to call or write anytime over the weekend to discuss if you like.

I am in the UK (so eight hours ahead of CA). My home number is [redacted]. I check the email regularly.

Steve, make no mistake that across the board (TV, Studios, Books, and Newspapers) we would much rather be working with apple than not. But we, and our partners who produce, write, edit, and otherwise make all this with us, have views on fair pricing, and care a lot about our future flexibility. I hope we can figure out a way, if not now and in time for this launch of yours, then maybe in the future.

Best,
JRM

The email timings appear weird as the early email is at 6PM on the 22nd January and the later email is at 4PM the same day. I suspect there is a bunch of time zone issues going on. [Oh yeah, and anyone who complains about the typos on this blog, check out the professional letters being exchanged in business negotiations! So much for lessons we teach kids at school, right?]

In this email, Murdoch appears to put themselves in a position of agent for the author but as author deals are surely flexible this seems strange to me. That said, it is the redacted part that outlines Murdoch’s position here and they are pushing for a better deal again at least during the initial period when their books sales might be highest. And the last paragraph is a thinly veiled threat reminder of the breadth of News’ media interests. In other words, Murdoch is worried that if he gives into Apple now, they will lose ground in other areas too.

Now it is Steve Jobs turn to respond:

James,

A few thoughts to consider (I’d appreciate it if we can keep this between you and me):

1. The current business model of companies like Amazon distributing ebooks below cost or without making a reasonable profit isn’t sustainable for long. As ebooks become a larger business, distributors will need to make at least a small profit, and you will want this too so that they invest in the future of the business with infrastructure, marketing, etc.

2. All the major publishers tell us that Amazon’s $9.99 price for new releases is eroding the value perception of their products in customer’s minds, and they do not want this practice to continue for new releases.

3. Apple is proposing to give the cost benefits of a book without raw materials, distribution, remaindering, cost of capital, bad debt, etc., to the customer, not Apple. This is why a new release would be priced at $12.99, say, instead of $16.99 or even higher. Apple doesn’t want to make more than the slim profit margin it makes distributing music, movies, etc.

4. $9 per new release should represent a gross margin neutral business model for the publishers. We are not asking them to make any less money. As for the artists, giving them the same amount of royalty as they make today, leaving the publisher with the same profits, is as easy as sending them all a letter telling them that you are paying them a higher percentage for ebooks. They won’t be sad.

5. Analysts estimate that Amazon has sold more than one million Kindles in 18+ months (Amazon has never said). We will sell more of our new devices than all of the Kindles ever sold during the first few weeks they are on sale. If you stick with just Amazon, Sony, etc., you will likely be sitting on the sidelines of the mainstream ebook revolution.

6. Customers will demand an end-to-end solution, meaning an online bookstore that carries the books, handles the transactions with their credit cards, and delivers the books seamlessly to their device. So far, there are only two companies who have demonstrated online stores with significant transaction volume—Apple and Amazon. Apple’s iTunes Store and App Store have over 120 million customers with credit cards on file and have downloaded over 12 billion products. This is the type of online assets that will be required to scale the ebook business into something that matters to the publishers.

So, yes, getting around $9 per new release is less than the $12.50 or so that Amazon is currently paying. But the current situation is not sustainable and not a strong foundation upon which to build an ebook business.

[A portion of this email was redacted by the court.]

Apple is the only other company currently capable of making a serious impact, and we have 4 of the 6 big publishers signed up already. Once we open things up for the second tier of publishers, we will have plenty of books to offer. We’d love to have HC among them.

Thanks for listening.

Steve

It is actually pretty polite and very clear. He starts by claiming that Amazon’s current pricing is unsustainable. If the earlier figures are right, he has a point here. But then he immediately says that he doesn’t want everyone to go crazy on pricing. Apple have an assessment as to the sustainable price that is basically around the current wholesale price charged by Harper Collins. The claim is then that Apple will earn a slim margin on book sales but that must be because of infrastructure charges that would account for their 30% cut and it is hard to verify from what we know here. But in the back of their mind is that they are trying to preserve margins above distribution costs and give the cost savings from going digital to the customer. Again, that sounds like solid cost-based pricing but Amazon’s pricing behaviour is at odds (for all we know, correctly) with all that. Interestingly, Jobs is accusing publishers of pricing eBooks too high based on neutrality and wants to change that. In effect, if he is successful, Apple will reduce Amazon’s costs which has to be one of the strangest competitive business moves imaginable for a firm that is apparently exercising some sort of market power. That said, Jobs, as apparently is custom in these negotiations, reminds Murdoch of the source of their power. And it is pretty clear that Apple doesn’t need a deal with Harper Collins for the Day One iPad launch.

A day later, Murdoch blinks ever so slightly.

Steve,

I think the crux of this is our flexibility to offer product elsewhere at price-points you don’t like.

If we could offer to you that a certain percentage of releases (>50%) would be available within your pricing structure (< or = 14.99), does that give you enough comfort?

I think we are worried more about the absolute holdback of product elsewhere, and our ceding of pricing to Apple, than we are about the actual haggle over what the price will be.

I haven’t shared this with HC directly—so this is only hypothetical. But if you were willing to accept that a supplier can exploit other avenues (at prices not disadvantageous to you), with a guarantee of substantial volume through Apple—maybe I could work with HC to get to some common ground.

Please let me know.

A different question: we have four areas of discussion (related to our product) between our teams right now: Books, US Video, Int’l Video, and newspapers. All at different stages of maturity, these discussions are all centered, for us, around the desire to make our product widely available, and to make yours and our products more attractive for our customers. It seems though that we in each one we largely encounter a “take it or leave it” set of terms, and predictably we’ve so far failed to really strike the kind of partnerships that could move things forward.

Is it worth considering in the round, over the next few months or weeks, whether or not some of these loose ends can be tidied up? It’s clear that Apple is already becoming an attractive platform for so many of our customers—all over the world. As a creative company at our core, NWS [News Corp.] should be more engaged with Apple, and I think Apple could be more engaged with NWS, globally, than either of us are today.

Best,
JRM

Murdoch gets complicated here. He is nervous about Apple doing something and doesn’t want to give them some control rights. Again he pushes for higher prices on some books. It isn’t surprising that he is worried about an Apple price cap if we think about what happened in music. But the attempt to raise prices is precisely the sort of risk that I outlined in my paper on mobile app pricing and applies equally here. So it isn’t a surprise that Apple doesn’t want that. Amazon have used other ways of capping prices but Apple doesn’t want to subsidise things the way Amazon does.

The last two paragraphs are somewhat amusing. Murdoch would like a nicer playground. None of all this ultimatum stuff. He argues that that doesn’t produce nice partners. But again he shows the peacock feathers but also provides an interesting window as to what conglomerates think they are getting when they have multiple product lines.

In response, Steve Jobs lays out Murdoch’s options clearly — a perfect end to an extensive form game.

James,

Our proposal does set the upper limit for ebook retail pricing based on the hardcover price of each book. The reason we are doing this is that, with our experience selling a lot of content online, we simply don’t think the ebook market can be successful with pricing higher than $12.99 or $14.99. Heck, Amazon is selling these books at $9.99, and who knows, maybe they are right and we will fail even at $12.99. But we’re willing to try at the prices we’ve proposed. We are not willing to try at higher prices because we are pretty sure we’ll all fail.

As I see it, HC has the following choices:

1. Throw in with Apple and see if we can all make a go of this to create a real mainstream ebooks market at $12.99 and $14.99.

2. Keep going with Amazon at $9.99. You will make a bit more money in the short term, but in the medium term Amazon will tell you they will be paying you 70% of $9.99. They have shareholders too.

3. Hold back your books from Amazon. Without a way for customers to buy your ebooks, they will steal them. This will be the start of piracy and once started there will be no stopping it. Trust me, I’ve seen this happen with my own eyes.

Maybe I’m missing something, but I don’t see any other alternatives. Do you?

Regards,
Steve

Interestingly, Jobs lays out the possibility that the demand curve for books is more elastic than they all think and that $12.99 may be too high a price. But he wants to keep prices for rising too much. He then says either (a) you are with Apple; (b) you are with Amazon or (c) try fighting with Amazon without Apple as a partner and see how that works.

Murdoch didn’t see any alternatives and chose door (a) a few days later before the iPad launch.

What is interesting about this exchange is that Murdoch did not resist the MFN agreement at least as it pertained to not discounting Harper Collins products elsewhere. The real sticking points in the negotiation are price (which Apple never appears to cave on) and retail price (which Apple actually resisted, successfully, a price increase). In my mind, this appears to be Jobs wanting to keep things clean. Everyone gets the same price and consumers don’t get confused. I suspect that he may have wanted to get book prices to $9.99 but new from Amazon’s failure to get publishers to agree to it, that that would be futile. He was picking a long-run equilibrium.

How this all pays in the antitrust proceeding is anyone’s guess. Remember, according to these email, Jobs got publishers to accept a lower amount that they received for books not a higher amount. But Apple was not going to subsidise the retail price the way Amazon had apparently done. But if Amazon persisted with lower prices, the publishers and Apple would share in the costs of that. This is something that Apple appeared to leave in the hands of publishers. Apple looks here like they capped publisher retail prices but did not set a floor. That has to be one of the strangest proposed alleged collusive arrangements ever. If it did work to increase prices that surely did require Amazon’s agreement. I remain perplexed by the story here.

2 Responses to The Anatomy of a Digital Business Negotiation

  1. Joe R says:

    The ordinariness of the negotiations is striking — especially when compared to the disruptive technology and business model the negotiations were haggling over.

  2. Addicted says:

    What is interesting about this is that apple is being punished for trying to create what appears a sustainable market which works for both suppliers and consumers.

    OTOH, Amazon is clearly dumping their product on the market with the intention of destroying value. And their intention is to destroy competition. This isn’t just true in Ebooks but all other products amazon deals with. I have seen this intimately as an amazon reseller.

    The only flaw with Steve jobs’s argument is that amazon also has shareholders. Amazon shareholders seem okay with Bezoa throwing away all their money but keeping their shares inflated at ridiculous PEs. I am not sure what is going on there.

    Either way, while the DOJ may have a decent legal argument, they are being counterproductive to the market both on the supply and demand side by targeting apple here.

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