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Apple e-book price-fixing lawsuit reveals Cupertino's weakness

E-books cost more here.
E-books cost more here.
Photo by pablofalv via Flickr Creative Commons

Apple and a couple of holdout publishers have been hit by a Department of Justice lawsuit accusing them of colluding to fix e-book prices at a level higher than Amazon's flat $9.99 rate for the Kindle reader and other devices. The practice, which was allegedly timed to happen when the original iPad was released, allowed publishers to set the price at as much as $14.99, with Apple taking its customary 30 percent cut.

This is from the Wall Street Journal:

The government's lawsuit, filed in Manhattan federal court, described CEO-only meetings of publishers at which the alleged conspiracy was hashed out. The suit alleged that the publishers' chief executives met starting in September 2008 or earlier "in private dining rooms of upscale Manhattan restaurants" and "no legal counsel was present at any of these meetings."

The suit describes the shift from the traditional "wholesale" pricing model, under which retailers set the price of both electronic and physical books, to an "agency" model under which publishers set the price and retailers take a commission.

For the record, three publishers of the five originally named in the suit already settled.

In this case, Amazon was the traditional wholesaler, while Apple and the publishers were the agency. You can see why publishers would want to throw in with Apple: the iPad is a premium product, produced by a company that likes its 30 percent profit margins and manages its business accordingly; and publishers are completely terrified that Amazon is going to set their prices for them at the consumer end of the equation and potentially provide major authors with a more direct route to the e-book market.

A while back, Slate's Matt Yglesias presented the issue in a vaguely Apple-positive light:

Publishers were, of course, free not to release Kindle editions of their titles, but most could see the need to get on the digital bandwagon. This was a very dangerous situation for major publishers. They’d gone from lording it over a landscape of thousands of independent retailers to dealing with just a handful of major chains. Now they were threatened with being suppliers to a monopsony purchaser of e-books, perennially stuck under Amazon’s thumb. Enter Apple, the tech giant with an insatiable appetite to “control the whole widget.” Even though the Kindle Reader for iPad is, in my opinion, the very best way in the whole world to read books, Apple wanted its own iBooks store. And to get it, they were prepared to give publishers what they wanted—the right to set their own prices, in exchange for sending a hefty 30 percent cut to Cupertino, Calif.

So far, so good. Except the government is alleging that Apple didn’t just show up offering a better deal. They’re saying it actively colluded with the five major publishers to raise prices.

Which, allegedly, Apple did. But this was only because Apple always wants to dictate pricing terms — or more accurately, base pricing on its cut, which is a massive one-third, on top of the 30 percent margin it demands on device sales. 

This is why Apple's share price is headed (maybe) toward $1000 — and the company toward a trillion-dollar market cap.

Yglesias is right to sortakinda remove the publishers from the equation: "Whether they merge, collude, or simply find a convenient confluence of interests around Apple’s efforts to compete with Amazon, there’s no real threat to competition here."

But therein lies the rub: the publishers are just a desperate sideshow here. The real issue is whether Apple was using its control of the iPad and the iBooks store to bolster its profit model against the Amazon threat. Amazon's business model — very much unlike Apple's — is to sell commodity devices (the Kindle, the Kindle Fire) that are just good enough to entice consumers to buy them and then use them as a gateway to Amazon's humongous content-delivery system. 

It's the old Gillette razor-and-razor-blade model. You don't need a better razor. You just need a good-enough razor to support the endless purchase of new blades.

It's easy to overlook how big a threat to Apple's precarious profit model this is. Amazon could care less how much it loses on the Kindle or the Kindle Fire. The mega-retailer will make it all back on heavily discounted e-book sales, along with many other flavors of content, from movies to apps. It's already gone all-in with this strategy, and its profits margins really have nowhere to go but up. They're near a probable bottom at 1.3 percent.

So Amazon doesn't have to defend its margins, while Apple urgently does. 

So if Apple and the two holdouts, Penguin and Macmillan, lose the lawsuit, the wholesale model will be re-established, the agency model invalidated (for e-book, anyway) and Apple will have to consider adjusting the iBooks store pricing model to be closer to Amazon's. This could very easily be a formula for (a) Apple getting out of the e-books distribution business or (b) traditional publishers getting out the publishing business, as Amazon pretty much takes over everything.

Then is will be Amazon's turn to be taken to court for running a monopoly.

Ah, innovation!

Follow Matthew DeBord and the DeBord Report on Twitter.