Apple Verdict Marks Digital Power Shift in Book Publishing

E-book prices have fallen sharply since the major publishers settled the case.

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Robert Galbraith / REUTERS

Apple suffered a major legal defeat this week when a federal judge ruled that the tech giant violated U.S. antitrust law by orchestrating a conspiracy with five big publishers to raise electronic book prices. Consumers won’t feel much immediate impact from the decision, however, because e-book prices have fallen sharply since the publishers agreed to settle the charges before Apple’s trial.

The most interesting aspect of the case is the future of the publishing industry itself, says Mark Lemley, a Stanford law school professor and antitrust expert. The settlement limits publishers’ ability to influence the retail price of e-books, underscoring their waning power as the industry hurtles toward a future in which most books are bought and read in digital form.

In her 160-page decision, U.S. District Judge Denise Cote found that Apple hatched a scheme with the five publishers — Macmillan, Penguin, Hachette, HarperCollins, and Simon & Schuster — to raise e-book prices by pushing the industry from the traditional “wholesale model,” in which retailers set the price, to an “agency model,” in which the publishers set the price. The conspiracy increased the cost of e-books for consumers, Judge Cote found. Apple was found guilty of violating the Sherman Antitrust Act.

“This was the publishers’ last-ditch effort to prop up their print business model,” said Lemley. “Over the long-term, it’s going to be very hard for them to maintain their traditional role as intermediaries, in which they take the lion’s share of industry profits.” Judge Cote determined that the goal of the conspiracy was to undermine Amazon, which had spooked the publishers by selling e-books for $9.99 — below wholesale cost — in order to drive sales of its Kindle e-reader.

(MOREApple Found Guilty in E-Book Price Fixing Conspiracy Trial)

As Amazon gobbled up e-book market share after introducing the Kindle in 2007, the publishers feared that $9.99 would become an “entrenched” consumer expectation for e-books, and ultimately drag down the price of hard-cover books. In the traditional wholesale model, the major publishers were able to justify list prices of $25 or more for new print best-sellers because of the fixed costs associated with editing, manufacturing, and shipping books, as well as the system that compensated authors.

Brick-and-mortar retail giants like Barnes & Noble and now-defunct Borders were happy to pay the publishers $15 per best-seller under the wholesale model, because they knew they could mark up the price, perhaps not as high as the $25 list price, but high enough to make a profit and still make consumers feel like they were getting a discount. For decades this system worked well for the publishers, the retailers, and consumers.

Amazon radically disrupted that model, because instead of selling e-books above the wholesale price, the company sold e-books at a loss, in order to drive Kindle sales. As e-books exploded in popularity after the Kindle was introduced, the underlying cost structure of the publishing business began to crumble, because e-books cost much less to publish, store, and distribute than print books. By 2010, Amazon e-book sales had overtaken hard-cover sales.

As a result of Amazon’s e-book discounting, the publishers feared that their profit margins would erode, and they panicked. When Apple approached the publishers with a plan to raise e-book prices, the industry giants seized the opportunity to protect their pricing power. That’s where the price-fixing conspiracy occurred.

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

In the long-term, however, the publishers were fighting a losing battle, because e-books simply cost much less to produce and distribute than print books. Before the Apple trial even started, the publishers struck a settlement deal with the government worth tens of millions of dollars to be paid out to consumers who had been over-charged as a result of the conspiracy.

The agreement required the publishers to end their agency agreements with Apple, which allowed retailers like Amazon to once again set the price for e-books. Almost immediately after the settlement, e-book prices began to decline.

“The settlement had the effect of breaking up the conspiracy and introducing price competition back into the market,” said Lemley. Over the last year, the average price for best-selling e-books has declined by nearly 50%, according to Jeremy Greenfield, editorial director at Digital Book World, a leading trade publication covering the e-book and digital publishing business.

Apple, of course, is in a much stronger position than the publishers, not least of all because the company generates more profit every year than the entire value of the book publishing industry itself. This helps explain why Apple held out after the publishers had already settled. Unlike the publishers, Apple’s litigation and potential settlement costs were minuscule relative to its size, so the tech giant had almost nothing to lose financially by seeking to clear its name.

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

More importantly, Apple had sentimental and even prideful reasons not to settle with the government. Senior Apple executive Eddy Cue, the tech giant’s chief negotiator with the publishers, was keenly aware that the company’s late co-founder and visionary leader Steve Jobs was gravely ill in the run-up to the January 2010 iPad launch. Cue wanted to secure one final media coup for his mentor.

If Apple had settled, it could have been viewed as a tacit acknowledgement that Jobs might have broken the law, Lemley said. After all, some of the most damning evidence introduced during the trial included Jobs’s own statements, such as his now-infamous quote to his biographer Walter Isaacson: “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 continues to maintain that it did nothing wrong, and has pledged to appeal the decision. “Apple did not conspire to fix e-book pricing and we will continue to fight against these false accusations,” Apple spokesman Tom Neumayr said Wednesday. In addition to its appeal, which will take place in the U.S. Court of Appeals for the Second Circuit, Apple faces a new trial to determine damages based on how much money the tech giant made as a result of the conspiracy.