How Apple’s Steve Jobs and Book Publishers Cost Consumers Millions

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U.S. Attorney General Eric Holder

The U.S. Department of Justice complaint against Apple and five major publishing houses reads like a case study: a powerful, entrenched industry desperately tries to confront an economic disruption caused by the rise of a new technology, only to face charges of violating federal law. Threatened by an upstart, potentially existential digital rival, five major publishing houses joined with Apple in a conspiracy to raise e-book prices, costing consumers millions of dollars, the complaint charges.

The lawsuit provides a rare glimpse into the secret negotiations and hardball tactics employed by the publishers and Apple, who were allegedly intent on defeating Amazon’s strategy of discount e-book best sellers. The publishers were terrified that lower e-book prices could empower Amazon, threatening their grip on the book industry. Apple was only too happy to participate, using its own iPad-fueled market power to persuade the publishers to join a scheme that would deal a blow to Amazon, its e-commerce rival.

The origins of this case date back to 2007, when Amazon released the Kindle, which effectively launched the mass e-book market. When the giant online retailer started selling popular e-books for $9.99 — in part to drive Kindle sales — the five publishers, Macmillan, Penguin, Hachette, HarperCollins and Simon & Schuster, seem to have panicked, according to the lawsuit. After all, they were used to list prices on new hardcover best sellers of generally $25 to $35. The publishers were concerned that lower prices would lead to a “deflation” of hardcover-book prices, “with accompanying declining revenues for publishers.”

(MORE: Sued: DOJ Brings E-Book Antitrust Lawsuit Against Apple, Publishers)

So the publishers worked urgently to hatch a scheme to raise e-book prices before $9.99 became an “entrenched consumer expectation,” according to the lawsuit. Publishing executives are said to have plotted, cloak-and-dagger-style, during meetings at upscale Manhattan restaurants, and tried to conceal their communications “to avoid leaving a paper trail.” A favorite meeting spot was the Chef’s Wine Cellar, a private room at Picholene, just off Central Park West. It’s clear from the complaint that the Department of Justice went so far as to obtain the mobile-phone records of major-publishing-house CEOs.

Meanwhile, Apple was debating business models as it planned to storm onto the e-book market with the iPad. At one point, according to the lawsuit, Apple “contemplated illegally dividing the digital content world with Amazon,” with audio-video going to Apple and e-books to Amazon. Instead, Apple, led by content honcho Eddy Cue, reached out to the publishers to propose that the industry shift from a wholesale model, in which retailers set the price, to an agency model, in which the publishers set the price and Apple, as the “agent,” would receive a 30% commission.

Apple’s then CEO Steve Jobs described the talks in a now infamous quote that appeared in Walter Isaacson’s Jobs biography: “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.’” Apple played a special role in the plot, according to the government, acting as the “spoke” of a wheel of conspiracy by playing the major publishers off one another to ensure they all participated.

(MORE: Justice Department Threatens Apple, Publishers over E-Book Pricing)

Additionally, Apple struck a “most favored nation” deal with the publishers that effectively prevented them from selling their product for less through other retail outlets like Amazon and Barnes & Noble. Newly emboldened by the launch of the iPad, the publishers gave Amazon a stark choice: adopt the agency model, with higher prices, or lose the ability to sell new e-book best sellers. Amazon initially balked but quickly capitulated, publicly announcing that it had no choice but to accept the agency model.

The plan worked. Virtually overnight, this conspiracy to fix prices caused e-book prices to increase by as much $5 per unit, costing consumers tens of millions of dollars, according to the lawsuit: “Millions of e-books that would have sold at retail for $9.99 or for other low prices instead sold for the prices indicated by the price schedules included in the Apple Agency Agreements — generally, $12.99 or $14.99.” According to the suit, Apple boasted of the successful scheme as an “Akido move,” after the Japanese martial art.

None of the publishers have admitted to price-fixing, but three of them (Hachette, HarperCollins and Simon & Schuster) have settled with the government and agreed to pay over $50 million in restitution to e-book customers around the U.S. Sharis A. Pozen, the acting director of the Department of Justice’s antitrust division, said the settlement “will begin to undo the harm caused by the companies’ anticompetitive conduct and will restore price competition so that consumers can pay lower prices for their e-books.” The deal requires the publishers to end their “most favored nation” contracts with Apple and allows retailers to offer e-books at a discount.

(MORE: Thanks to E-Books, Flat Revenue Is No Problem for Publishers)

Apple, Macmillan and Penguin did not agree to the settlement — and have denied the charges. The Department of Justice has vowed to pursue the case against them aggressively. “There is little chance that the Department of Justice will fail,” according to Mark Cooper, director of research at the Consumer Federation of America. “This is a slam-dunk case of collusive, anticompetitive behavior.”

The Department of Justice is not seeking money damages, but Apple and the remaining two publishers also face a class-action lawsuit over the price-fixing conspiracy led by Seattle-based law firm Hagens-Berman. “While Attorney General [Eric] Holder’s actions, if successful, will put an end to the anticompetitive actions, our class-action is designed to pry the ill-gotten profits from Apple and the publishers and return them to consumers,” attorney Steve Berman said in a statement.

By any measure, the settlement is a huge victory for Amazon, which wasted no time trumpeting the deal (and plugging its popular e-reader). “This is a big win for Kindle owners, and we look forward to being allowed to lower prices on more Kindle books,” the company said.

But even as the government aims to increase e-book competition, left intact are other anticompetitive features of the e-book market, as Wired.com pointed out, including efforts by both Apple and Amazon to limit consumers’ ability to buy and read e-books from rival companies.

MORE: What Would Steve Jobs Do?

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