It's Not E-Books

US v. Apple: What they’re really fighting over as the antitrust case goes to trial

June 2, 2013
June 2, 2013

Apple and the United States are due in a New York courtroom on Monday for the first day of the government’s antitrust lawsuit, which accuses Apple and some of the world’s largest publishers of colluding to set prices on e-books.

Soon before unveiling the iPad on Jan. 27, 2010, Apple reached agreements with the publishers to sell their e-books in the tablet’s new iBookstore. Under those deals, publishers gave Apple a 30% cut of sales but gained the ability to set e-book prices themselves, pushing the typical cost of a new e-book higher by about a third.

The publishers also agreed not to sell their e-books for any less at other retailers, like Amazon, which preferred a price of $10. As a result, the average price of e-books sold in the US jumped immediately after the iPad was released. The question before the court is whether Apple’s negotiating tactics amounted to a conspiracy that reduced competition in the market for e-books. Apple contends it didn’t collude with the publishers or hurt the e-book market.

Much of the case is settled

You can get a flavor for Apple’s negotiations with the publishers in emails that we published last month. “Throw in with Apple, and see if we can all make a go of this to create a real mainstream e-books market at $12.99 and $14.99,” wrote Apple’s then-CEO Steve Jobs to News Corp. executive James Murdoch. Several quotes by Jobs, who died in 2011, are being used by the US to argue that Apple was the “ringleader” in setting e-book prices ahead of the iPad’s launch.

All five publishers that were sued by the US for their involvement—Penguin, Hachette, HarperCollins, Macmillan, and Simon & Schuster—have reached settlements. Those deals prohibit the publishers from setting prices for retailers, which has led to lower prices. The publishers say they did nothing wrong but couldn’t risk a large judgment if they lost at trial.

Apple, however, is holding out. “We’re not going to sign something that says we did something that we didn’t do,” CEO Tim Cook said last week, “so we’re going to fight.” But the judge, Denise Cote, has made clear how she is leaning in the case, which she will decide herself without a jury: “I believe that the government will be able to show at trial direct evidence that Apple knowingly participated in and facilitated a conspiracy to raise prices of e-books,” she said on May 23.

Apple’s most-favored nation status

Since the publishers have already been forced to reach new agreements with retailers, what is there really left to decide? Damages, of course, which could be steep if Apple loses, though the company can afford it.

But the most substantial issue Apple and the US are likely to fight over is something called “most-favored nation” status, which the publishers granted to Apple in their original deals. It meant that Apple would always be able to sell e-books at least as cheaply as other retailers. The publishers couldn’t let others, namely Amazon, sell the same e-books for less.

Most-favored nation clauses are common in media licensing deals, from music to books to television. But the US is concerned the clauses allow the largest players in each industry to force prices higher than they would otherwise be. For instance, the government is investigating (paywall) whether the most-favored nation status of some cable TV operators is limiting competition for networks and their programming, preventing the industry from evolving.

European regulators are equally concerned. More than a year ago, the EU forced Apple to abandon its most-favored nation status with publishers. In the US case, most-favored nation status is a separate issue from price collusion. If the court were to rule that Apple’s most-favored nation status, specifically, amounted to an antitrust violation, that could have enormous implications in all content industries for how prices are set and whether new competitors can more easily emerge.

Fighting a much larger war

The issue, of course, wouldn’t end in Judge Cote’s courtroom, which may explain why Apple is letting this case go to court. The company may think it can win a more favorable ruling on appeal, which Apple would welcome, given the US and EU’s intensifying interest in doing away with most-favored nation clauses more generally.

E-books, after all, are an insignificant portion of Apple’s media business, and it has not made much progress in winning market share from Amazon. The market, in any event, is changing rapidly as self-published authors and small publishers unseat the “big six” publishers. The average selling price of the top 25 best-selling e-books fell below $7 for the first time last month, with $1 titles by amateur authors topping the charts. It’s a whole different industry than the one that was negotiating with Apple in late 2009 and early 2010.

But Apple also sells music, movies, and TV shows, which are much larger industries where the big content producers remain dominant and can sell to an increasing set of competitors—from upstarts (Netflix, Spotify) to fellow tech giants (Google, Amazon). Even the content producers themselves are becoming retailers.

Those shifting dynamics threaten Apple’s dominance in the digital media business, and will affect its ability to enter other areas, like television, in the same it way it entered, say, music. The company, though, maintains enormous leverage through its base of customers who regularly purchase content on their Apple devices. That may help it maintain most-favored nation status in content deals—but only if the US courts say it can.

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