Apple Found Guilty in E-Book Price Fixing Conspiracy Trial

U.S. District Judge Denise Cote found the testimony of Apple's star witness "not credible."

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Robert Galbraith / REUTERS

Apple “facilitated a conspiracy” with major book publishers to raise the price of e-books, costing consumers millions of dollars, a federal judge ruled Wednesday, in a significant blow to the world’s largest technology company. The decision, handed down by U.S. District Judge Denise Cote in Manhattan, is a major victory for the U.S. government, and could have important implications for the digital media market. Even as Judge Cote called for a new trial to determine damages in the case, Apple maintained its innocence and said it would appeal the decision. The major publishers had previously settled with the government.

“The plaintiffs have shown that the publisher defendants conspired with each other to eliminate retail price competition in order to raise e-book prices, and that Apple played a central role in facilitating and executing that conspiracy,” Judge Cote wrote in her 160-page ruling. “Without Apple’s orchestration of this conspiracy, it would not have succeeded as it did in the Spring of 2010.”

The closely-watched trial provided a rare glimpse into the secret negotiations and hardball tactics employed by the publishers – Macmillan, Penguin, Hachette, HarperCollins, and Simon & Schuster – and Apple, who were intent on defeating Amazon’s strategy of discounting e-book best sellers in order to drive sales of its Kindle e-book reader. During the trial, the government described how publishing executives engaged in cloak-and-dagger secret meetings at upscale Manhattan restaurants during which they plotted the conspiracy, and later tried to conceal their communications “to avoid leaving a paper trail.”

(MOREHow Apple’s Steve Jobs and Book Publishers Cost Consumers Millions)

Judge Cote’s ruling is a doubly bitter blow to Apple, because after initially signaling that the Justice Department had a very strong position, she seemed to indicate during the trial that she had doubts about whether Apple “forced” the five major publishers to demand that Amazon change its business model, resulting in higher prices for consumers, which was a central legal issue in the trial. Apple maintained that it did nothing wrong and insisted that the publishers sought to raise prices on their own, out of self-interest. But in the end, Judge Cote found that Apple “facilitated this conspiracy and changed the face of the e-book industry.” She further found the testimony of Apple executive Eddy Cue, who led negotiations with the publishers, “not credible.”

“This result is a victory for millions of consumers who choose to read books electronically,” the Justice Department said in a statement. “As the department’s litigation team established at trial, Apple executives hoped to ensure that its e-book business would be free from retail price competition, causing consumers throughout the country to pay higher prices for many e-books. Companies cannot ignore the antitrust laws when they believe it is in their economic self-interest to do so. This decision by the court is a critical step in undoing the harm caused by Apple’s illegal actions.”

In a statement emailed to TIME, Apple maintained its innocence. “Apple did not conspire to fix ebook pricing and we will continue to fight against these false accusations,” said Apple spokesman Tom Neumayr. “When we introduced the iBookstore in 2010, we gave customers more choice, injecting much needed innovation and competition into the market, breaking Amazon’s monopolistic grip on the publishing industry. We’ve done nothing wrong and we will appeal the judge’s decision.”

The origins of the case date back to 2007, when Amazon released the Kindle e-reader, which quickly became the dominant force in the mass e-book market, with nearly 90% market share. Amazon priced popular electronic titles at $9.99, taking a loss under the prevailing “wholesale” model, because publishers sold books to Amazon and other retailers for $13, and then allowed retailers to mark the books up in order to make a profit. The publishers believed that Amazon was taking advantage of the wholesale model by taking a loss on the e-books themselves, in order to drive Kindle sales. According to the government, the publishers were eager to raise e-book prices before $9.99 became an “entrenched consumer expectation.”

(MOREApple Says It’s Not an E-Book Crook as Price Fixing Trial Begins)

Apple, which by late 2009 was preparing to launch its iPad tablet and iBookstore, offered the publishers a solution to their “Amazon issue” by proposing that the industry shift from the wholesale model to a so-called “agency model,” in which the publishers would set the retail price — from $12.99 and $14.99 — and Apple, as the “agent,” would receive a 30% commission. Crucially, Apple’s arrangement with the publishers included a so-called “most-favored-nation” clause, which ensured that if a retailer like Amazon undercut the publisher’s designated price — which it had shown a willingness to do — Apple had the right to do so as well.

“Apple and the Publisher Defendants shared one overarching interest — that there be no price competition at the retail level,” Judge Cote wrote in her decision. “Apple did not want to compete with Amazon (or any other e-book retailer) on price; and the Publisher Defendants wanted to end Amazon’s $9.99 pricing and increase significantly the prevailing price point for e-books. With a full appreciation of each other’s interests, Apple and the Publisher Defendants agreed to work together to eliminate retail price competition in the e-book market and raise the price of e-books above $9.99.”

Having struck their deal with Apple to move to the agency model, the publishers presented Amazon with an ultimatum, according to the government: Either adopt the agency model as well, or lose the ability to sell new best sellers for several months after publication, a practice known as windowing. Amazon was furious with this strong-arm tactic, but quickly capitulated and moved to the agency model. Almost overnight, e-book prices increased by as much as 50% per unit, Judge Cote found.

Apple’s participation in the scheme — which the tech giant boastfully called an “Akido move,” after the Japanese martial art – was crucial, the judge found, because without its help, the publishers would not have had the leverage they needed to pressure Amazon to move to the agency model. Apple and the publishers “frequently coordinated their efforts to increase the pressure on Amazon and decrease the likelihood that Amazon would retaliate — an outcome each Publisher Defendant feared if it acted alone,” Judge Cote found.

(MOREApple E-Book Trial, Week 2: The Emerging Case for Letting Apple Off the Hook)

The combination of the move to the agency model and the publisher’s willingness to grant Apple the most-favored-nation clause was crucial. That’s because if Amazon sold e-books at below cost, which it was allowed to do under the wholesale model, Apple had the right to match that lower price. But if Apple matched Amazon’s $9.99 price point under the agency model, the publishers would only get $7 — after paying Apple a 30% commission — which is far less than the $13 they were getting from Amazon under the wholesale model. The most-favored-nation clause therefore “eliminated any risk that Apple would ever have to compete on price when selling e-books, while as a practical matter forcing the Publishers to adopt the agency model across the board,” Judge Cote found.

During the trial, Judge Cote seemed to breathe new life into Apple’s position that it didn’t “force” the five major publishers to demand that Amazon change its business model, when she suggested a distinction between Apple “requiring” the publishers to “require” Amazon to shift to the agency model, and the publishers acting on their own once they realized that the most-favored-nation clause made it “technically impossible” for them to agree to continue a wholesale relationship with Amazon. During the trial, Cue admitted that Apple “expected” each of the publishers to demand that Amazon move to an agency model, but denied actually “knowing” that they would.

In the end, however, Judge Cote did not find Cue’s testimony on this issue credible, she wrote in her decision. Judge Cote found Cue’s testimony “particularly brazen,” given emails between the publishers and Apple that made clear that the publishers would pressure Amazon to move to the agency model. And she pointed to an exchange that Apple’s late CEO Steve Jobs had with a reporter on the day the iPad was launched. Asked by the reporter why consumers would pay $14.99 to Apple to purchase an e-book that was selling at Amazon for $9.99, Jobs replied, “Well, that won’t be the case.” The reporter then asked, “You mean you won’t be 14.99 or they won’t be 9.99?” Jobs paused, and “with a knowing nod” responded, “The price will be the same.”

With that statement, Judge Cote wrote in her decision, “Jobs acknowledged his understanding that the Publisher Defendants would now wrest control of pricing from Amazon and raise e-book prices, and that Apple would not have to face any competition from Amazon on price.” Shortly thereafter, faced with a unified front from the major publishers, Amazon realized it had no choice but to accept agency agreements, and prices for e-books soon went up. “The increases at Amazon within roughly two weeks of moving to agency amounted to an average per unit e-book retail price increase of 14.2% for their New Releases, 42.7% for their NYT Bestsellers, and 18.6% across all of the Publisher Defendants’ e-books,” Judge Cote found.