Five questions that may explain some aspects of the Apple e-books litigation

As I've been reviewing the documents and the posts around the Web on the Apple e-books price-fixing litigation, I've seen a few things that it seems people don't understand. To help give some background I'll explain so that you can have an easier time following this important litigation.

First a summary for those of you who don't know the full allegations. The Department of Justice is alleging that 5 major publishing firms: Hachette, HarperCollins, Macmillan, Penguin, and Simon & Schuster, along with Random House who isn't charged, all wanted to break Amazon's $9.99 pricing for e-books. At the same time Apple wanted to get into the e-books market, and offered to the publishers that it would allow them to set their own pricing for e-books so long as the publishers ensured the same e-books wouldn't be available cheaper elsewhere. According to an email from Steve Jobs quoted by the DOJ in its Complaint: "yes, the customer pays a little more, but that's what you want anyway." The DOJ has brought charges against these six companies for violating the US antitrust laws.

1. So what's the illegal activity in this situation? The technical term is something called horizontal price maintenance. There's two types of price maintenance: horizontal and vertical. Vertical is the one we're more familiar with: the manufacturer sets the price and everyone else agrees to pay it. Horizontal is less common because it requires a conspiracy among competitors: it occurs when everyone at a certain level in the market (e.g. the publishers) agrees on the cost for a certain good (e.g. e-books).

It's illegal because it harms consumers. Everyone in the chain of commerce before the consumer actually benefits from this. The DOJ has explained it in the Apple context so let's use that: publishers get higher prices therefore higher profits, and Apple gets a percentage of those prices therefore higher revenues as well as gets to make sure its competitors can't undercut it. (And don't forget authors: higher prices means higher royalties for them too.) The only people who lose out are consumers. That's why it's illegal: because if it wasn't then everyone would do it.

2. How can Apple and the publishers be conspiring if Apple isn't a publisher? The DOJ's claim against Apple and the 5 publishers is what's called a "hub and spoke" conspiracy in antitrust law.

It gets its name from the fact that the various spokes (here, the publishers) would love to conspire with each other.(*) But they can't do it alone. They need someone who can provide common ground for them to give effect to their conspiracy. Here, that's Apple through iTunes. The theory is that the publishers want to conspire to raise prices for e-books but they can't do it because Amazon is the retailer and Amazon is pricing the books lower than they want. Under antitrust law, the retailer is the one who gets to set the price. So before Apple came along the publishers had a problem: if they wanted to set higher pricing they couldn't do it; their only option was just not to sell e-books at all.

Apple offered the agency pricing model. In the agency model Apple isn't actually the entity making the sale. Apple collects a commission to cover its iTunes store, make a profit, etc., but technically it's the publisher selling directly to the customer. In that world the publisher can set the price for the product directly. At that point the publishers could pull their books from Amazon and sell them exclusively through iTunes because they would have a market to sell them and make money.

The thinking is that Apple and the publishers may have had different goals (publishers: higher prices; Apple: enter market and maybe knock out Amazon), but their goals could be achieved through a common method. That's fine if the method is legal, but here the claim is that it wasn't.

3. Why did the DOJ sue publishers that were willing to settle? Although the DOJ brought charges against 5 publishers, 3 of them were willing to settle immediately. So why charge them? Two reasons:

1. If the DOJ gets a settlement from a publisher, it has a contract with them. If the publisher breaches the contract, the DOJ can sue them. But if it charges first and settles in the context of the trial, then it gets a judgment. If the publisher breaches a judgment, that's contempt of court.
2. Antitrust laws exist to protect the public, so it's important not to settle a criminal offence in quiet behind closed doors. Think of this as similar to a plea bargain: even where both sides agree on a plea charges still have to be filed so that a judge can review the arrangement and decide whether it should be acceptable. In an antitrust case there's also a law called the Tunney Act that requires the court to solicit, receive, and review comments from the public before accepting a settlement, which has happened here and about which I've written a few times (links below).

4. Why isn't the FTC involved? Price-fixing is a criminal issue, not just a civil one. The Federal Trade Commission brings civil claims, but only the Department of Justice can prosecute a federal crime on behalf of the US government. So even though the FTC did all the legwork to assemble the case and the evidence, the DOJ is running this show. (Note: I've been a bit sloppy in some posts and referenced the FTC and DOJ interchangeably. I'll stop that.)

5. Where's Random House? The DOJ complaint repeatedly mentions Random House as having been involved in the facts but as I noted above Random House wasn't charged.

To be clear: I have no proof of this, but it's possible that Random House may have been the one who told the FTC about the conspiracy. In the US there is a very serious prisoner's dilemma aspect to price-fixing conspiracies. The first member that goes to the FTC and helps build the case gets immunity. Reading the complaint it's clear that the FTC and DOJ had access to hundreds of documents, emails, meeting notes, etc. Things they could only have if someone who was in the room gave them up.


So that's an overview of the situation. I hope it helps people to understand as they follow along to see where this goes next.


(*) MANDATORY WEASEL COMMENT: Nothing has been proven in this lawsuit, no judgment rendered, insert "allegedly" above as many times as it takes for me not to be libeling anyone, etc. etc.


LINKS:
Legal Minimum post on DOJ's response to Apple's comments:
http://bit.ly/OoKd9p
Legal Minimum post on motion filed in connection with the settlement:
http://bit.ly/OvREwW
Legal Minimum initial post on comments to settlement:
http://bit.ly/MCngi5