Original URL: http://www.theregister.co.uk/2012/03/13/apple_ebooks_cases_cost/

Could tiny ebooks really upset the mighty Apple cart?

Steve Jobs' last big deal may turn into costly roadblock

By Brid-Aine Parnell

Posted in Media, 13th March 2012 15:32 GMT

Analysis You wouldn't think that Apple had any problems right now. Its share price is so grossly high that it is ranked as the most valuable company in the world. Fans will queue up in their thousands for the chance to buy its latest iDevice – the new iPad – so much so that there won't be anywhere nearly enough devices in stock to satisfy demand on launch day.

And finally, none of the myriad patent litigation cases Apple is involved in have managed to do it any serious damage, or much damage at all.

But in recent weeks, Apple seems to be courting disaster in a rather surprising arena: ebooks.

The European Commission, the US Justice Department and a group of plaintiffs in a US class action suit are all looking very closely at the fruity firm for that sin amongst sins in the modern world of anti-competition legislation: price-fixing.

The allegations stem over the switch to agency model pricing when Apple entered the market. Its detractors claim that Apple and the publishers colluded to raise their prices under the new model – simultaneously ensuring that no one else could get a better price – and then, according top the allegations, told Amazon that it could like it or lump it.

Some widely reported quotes from the late Steve Jobs to his biographer Walter Isaacson that have been bandied about as a "smoking gun that proves collusion" haven't helped either.

"We told the publishers ... you set the price, and we get our 30 per cent, and yes, the customer pays a little more, but that's what you want anyway," Jobs reportedly said.

"[The publishers then] went to Amazon and said, 'You're going to sign an agency contract or we're not going to give you the books'."

One of Jobs' last big deals before he became too ill to continue at Apple was to pull the firm into ebooks. And he was a man that was used to getting his own way.

The agency model is how Apple likes to do business, with the firm – in this case the publishers – supplying the content and setting the price and Cupertino merely taking its cut. But it is the timing of the ebook pricing change that forms the main argument for those who think Apple and the five major publishing houses named in the three cases are guilty.

"Apparently Apple made some comments at the time that the pricing was going to change and then very shortly after that all of the publishers followed up with a threat to Amazon that it adopt the agency model or face a boycott," Robert Vidal, UK Head of Competition, EU and Trade at law firm Taylor Wessing, told The Register.

"So the fact that they all did that more or less at the same time after some meetings with each other would indicate that it was done in concert and so the allegation is that they got together and decided to bring in this new pricing model in order to fix pricing."

Proving that the publishers decided together on the prices is the key to the anti-competition case against Apple. Apple has argued that it was in the publishers' interests to go with the agency model so they all went for it independently.

"If they all came to the decision by themselves, their defence would stand," Vidal said, "however the point is how likely is it that all the publishers independently came up with exactly the same strategy to basically stop Amazon from pricing its ebooks aggressively – most people would argue that it's unlikely.

"Competitors such as publishers shouldn't get together and discuss issues like pricing and strategy – any information exchange of that sort which has an impact on the market is generally regarded as uncompetitive."

And that's not the only way that Apple and the publishers might be infringing competition laws. Agreeing to fix prices is called "horizontal pricing" and it's one way to get anti-competitive pricing. Vertical pricing can also be a violation, where publishers tell the sellers what price its products should be. The companies only sidestep this allegation if they can prove that their agency agreements are genuine.

There's also a third issue: the so-called "favoured nation clause" in the agreements. Here the publishers sign a clause agreeing to ensure that they don't offer the ebooks at a lower price to any of Apple's rivals. Because Apple has the lowest possible price and this is the lowest price the publishers can offer, the market ends up in a situation like what we're seeing in the ebook market: all the books are the same price.

All this compares to the previous way ebooks were sold, the wholesale model. In this pricing structure, the firm selling the product pays a percentage of the recommended price and then they can sell it for whatever price they wish.

Under the wholesale model, Amazon was big in ebooks. It was selling the books on at huge discounts, often below cost, in order to establish a sizeable lead in the market and plenty of appetite for its Kindle ereaders, which it was also pricing favourably.

"The thinking behind all of this was that Amazon was determined to become the iTunes of the ebook world so it wanted to drive that objective by pricing the Kindle at a very low price, probably below cost, and the ebooks also priced as aggressively as possible," Vidal said.

"And the reason for that is it's thinking long-term: 'If we get the pricing down now then we will gain market share, everyone will buy a Kindle and they'll get into the habit of buying all their ebooks from Amazon and we will become the place that everyone comes to for their ebooks'."

This was the point at which the publishers and bookshops were screaming that Amazon was undercutting them, destroying the publishing world and robbing authors of their fair due. But whether you believe that or not, it probably wasn't illegal.

"You'd have establish that Amazon was dominant in relation to ebooks and then if it priced at below cost, you could claim that it was predatory pricing," Vidal explained.

"The theory behind this is that you sell at below cost for a period of time until all your competitors have been driven out of business and then you raise the prices afterwards in order to recoup your losses."

But it's not a situation that he thinks would carry much weight in court, because it's just not anti-competitive.

"The general principle is if you drop your pricing, then that's going to be good for consumers because they get access to cheaper books. So to claim that a company is somehow acting in an anti-competitive manner by dropping its prices ... It's a strange argument, particularly from a regulator," he said.

"The way that regulators would see this is that Amazon entered the market and started selling ebooks really aggressively and that was great because consumers could get access to cheaper books. They're looking at the market now and all the ebook prices have gone up and there's thousands of consumer complaints."

Apple: 'But we had nothing to gain'

Apple hasn't been saying much about the cases in public, but it has presented a defence in the US class action suit. The fruity firm insists that it had nothing to gain by fixing the price of ebooks because it doesn't have a presence in the physical book market. And as for the theory that it was trying to smash the Kindle out of existence because if people got used to having one and Amazon then pimped it up into a tablet, they wouldn't want an iPad, Apple said it thought that was kind of ridiculous.

Its filing in the case said:

For example, if Amazon was a “threat” that needed to be squelched by means of an illegal conspiracy, why would Apple offer Amazon’s Kindle app on the iPad? Why would Apple conclude that conspiring to force Amazon to no longer lose money on eBooks would cripple Amazon’s competitive fortunes? And why would Apple perceive the need for an illegal solution to the “Kindle threat” when it had an obvious and lawful one which it implemented – namely, introducing a multipurpose device (the iPad) whose marketing and sales success was not centred on eBook sales?

But the involvement of two regulators on top of a class action suit isn't making that argument look too steady.

The European Commission's antitrust chief Joaquin Almunia said yesterday that it would be happy to settle with Apple and the publishers providing they addressed the EC's "objections".

Vidal said that the very fact that the EC has objections and is publically talking about them could be a sign that it already has evidence of the firms' collusion on pricing.

"The signal there from the Commission is that they have objections, it's not very clear what those objections are, but there's clearly some problem with the current arrangement so it's effectively threatening the publishers with a fine unless they decide to settle this, and I would imagine that's because they've found some sort of evidence of collusion," he said.

And if the evidence is already there, Apple and the publishers would be in big trouble. The EC can fine them up to 10 per cent of worldwide turnover, which is likely to be a pants-wettingly high sum, so the smart thing for them to do would be to settle. But there's a problem with that too.

Assuming that Apple and the publishers settle the regulator cases in Europe, the US or both, even if the settlement agreements don't mention culpability, it's basically a tacit admission of guilt. And that is going to lend a lot of weight to the existing class action suit, or indeed any other class action suit anyone would like to bring.

"It's very difficult for you to defend your case once you've settled because a settlement is effectively an admission of guilt and everyone accepts that, even if it's not in the settlement," Vidal said.

"There would be no reason for a settlement if there hadn't been some sort of infringement."

In the US, plaintiffs who win class action suits can reap triple damages from companies. And even if the current class action suit fails on some legally flawed argument, there's nothing to stop anyone else from starting another.

In Europe, there's no triple damages, but if the regulator decides you've infringed the competition law, anyone can then bring a follow-on suit. In these cases, they don't have to prove liability, they only have to prove "quantum" (amount) – in other words, show how many ebooks they bought at the unfair prices – and the company will have to pay up.

Neither Apple nor the five big publishers – Harper Collins, Hachette Livre, Simon & Schuster, Penguin and Macmillan – are exactly short a dollar or four, but suffering the fines and numerous lawsuits could hit them hard.

If they have colluded, their only real choice is to settle and cut their losses, at least avoiding the full fines from the regulators, according to Vidal. Just how much those losses could be remains to be seen. ®