Yesterday federal judge Denise L. Cote, of United States District Court in Manhattan, ruled against Apple in the United States vs. Apple Inc., et. al. ebook case. You can read Cote’s ruling here.
Anyone who thinks this isn’t a terrible outcome for publishers, authors, and readers, isn’t paying attention.
Amazon (who is at the crux of this story) sells ebooks under the wholesale model. This means that they can set prices as they wish, usually at $9.99. They can sell the title for $9.99 even if their agreement with the publisher stipulates that they must pay the publisher a royalty of more than $9.99. Meaning, Amazon chooses to lose money on many of the books it sells, a fact documented in the Department of Justice’s (DOJ) suit (see page 17 of the ruling).
That sounds great for both publishers and readers, right? Publishers receive more revenue and readers, subsidized by Amazon, pay less. What is not to like?
Here is the catch. Some books are niche titles, such as those published by university presses or other independents. They don’t sell enough copies to recoup their costs at $9.99. Other books, such as those by bestselling authors sold by larger publishers, can command high prices that are needed to offset the losses such publishers incur on other titles. This is why different books have historically had different prices and why niche titles and blockbusters (at least when the first come out) often cost more. But because Amazon chooses to sell an ebook at $9.99 (or whatever price they like), the ebook can’t be sold anywhere else for more. Who is going to buy the ebook for $19.99 via the publisher’s site or Barnes & Noble or anywhere else when they can get it via Amazon for $9.99? Amazon is selling the book below cost to forestall competition in ebook distribution.
Enter Apple. Back in 2010, Steve Jobs had a magical new invention called the iPad. It was like an iPhone except you could more easily read books on it because it had a larger screen. Unfortunately, Amazon had beaten him to the ebook market with the introduction of the Kindle. Moreover, they had used Jobs’ own playbook to do so. Amazon essentially copied what Apple had done with iTunes and the iPod with their Kindle and Kindle Store. Jobs therefore knew this game well and knew he had no hope of competing against Amazon in ebook distribution as things stood without touching off a price war and losing money on every sale (which he could have afforded to do but that just isn’t how Jobs rolled). Jobs needed to change the playing field.
He did this by getting publishers to agree to the agency model whereby publishers set their own prices with Apple receiving a percentage of each sale. Moreover, publishers agreed to what has been called a “most favored nation” clause which stipulated that Apple could match the price in any other ebook store (e.g. Amazon’s Kindle Store).
Five of the so-called “Big Six” trade publishers (Hachette, Penguin, HarperCollins, Macmillan and Simon and Schuster) agreed to Apple’s terms (Random House was the only large publisher who did not participate at the time of the iPad’s launch). The publishers then went back to Amazon and used the deal with Apple, and the hype around the new iPad, to pressure Amazon into accepting an agency model on the same terms as Apple, ceding more pricing control to publishers (and the free market).
This, says Judge Cote (page 9), constituted a “conspiracy” to raise prices:
“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. Without Apple’s orchestration of this conspiracy, it would not have succeeded as it did in the Spring of 2010.”
Due to browbeating by the Department of Justice and fear of a protracted suit and punitive fines, all five publishers settled out of court and agreed to reinstate the wholesale model with Amazon for at least two years. Yesterday’s ruling against Apple has made it less likely that publishers will have the leverage to revert to the agency model in the near future after the two-year period dictated by the settlement ends.
What this means is that anyone wishing to enter the ebook distribution space will face an ebook pricing war against an entrenched competitor that is willing to sell at a loss, propped up by a seemingly limitless supply of cash from investors who do not seem to care about margins so long as market share is growing.
The result is likely to be an ebook market (at least in trade publishing – professional and scholarly publishing is a different matter) with little innovation – why would anyone bother? Not only must a new entrant invest in new technology, negotiate complex, multi-national rights agreements with publishers, and market their new product to consumers, they must then slog it out in a price war. And while a very few entrants such as Kobo are trying, one of the few companies with the cash hoard to withstand Amazon is Apple (Google is another and Microsoft, reported to be flirting with the idea of purchasing Barnes & Noble’s Nook business, is a third), though a price war goes against their DNA and it is not clear that ebooks are important enough to them to be worth the cost.
In case anyone thinks that this is overstating the bleakness of the situation, I direct you to the recent departure of Barnes & Noble’s CEO, William Lynch, a former Palm executive who was brought into the company to grow their reader business, in what Reuters called “an acknowledgement that its digital division Nook has failed to compete successfully in the e-reader and tablet markets“. Furthermore, after reporting that Nook sales dropped 34% last quarter, the company announced it was pulling the plug on its hardware division.
So what, you might say, if Amazon controls the market so long as they keep prices low? Anyone who has looked at Amazon’s price to earning ratio will tell you that Wall Street is assuming the company is engaged in a market share maximization strategy. As CNN has pointed out, whereas it would take 13 years for Apple to pay back your investment based on their current P&E ratio, it would take Amazon nearly three millennia (and while Jeff Bezos is known to play a long game, I suspect even his horizon is quite a bit closer). The aim of a market maximization strategy is to dominate the market and, once all credible competition is vanquished, to raise prices and substantially grow margins unfettered by competitive pressures. While Wall Street has, of course, been wrong before, this one looks like a good bet – there is even some evidence this is happening already.
This view of Amazon’s strategy is shared by publishers as evidenced by the recent Penguin/Random House merger, completed just last week, which reduces the Big Six to the Big Five. The primary motivation for the merger is reportedly to establish a publishing house with enough size to have leverage with Amazon. More mergers may be yet to follow. And while such consolidation may indeed improve the publishing industry’s leverage with Amazon, there are consequences for readers as Boris Kachka observes in an op-ed in the New York Times. These may include lower bids on author manuscripts, few options for authors, more homogenized titles (you think there are too many vampire novels now), and a even greater focus on genres and blockbusters.
So we now have a market in which ebooks are steadily commandeering a larger slice of the book market, but sales for which are dominated by a single player intent on keeping competitors out even if it means selling at a loss. Moreover, when this loss-leader strategy falters we have a Department of Justice ready to step in to “protect consumers” from potentially spending a couple extra bucks in the short term, meanwhile all but ensuring we will see even higher price increases over the longer term given the lack of competitive preassure. We have decreasing incentive to innovate in ebooks, with even established firms such as Barnes & Noble exiting the market. And we have market conditions that are forcing publishers to consolidate, leading to a less diverse offering of titles and lower royalty checks for authors.
And while there is, at the same time, a growing array of self-publishing options (including directly via Amazon) and there remain independent trade publishers such as McSweeny’s as well as the university presses (and, of course, the professional publishers such as Wiley, Elsevier, Springer, etc.), these are typically not options for professional writers who require substantive advances to, you know, eat. Moreover, these smaller and independent houses face the same pricing challenges with regard to ebooks.
Apple intends to appeal this decision and they have strong motivation to do so. That motivation has little to do with the ebook market at this point, however. The iPad was the last major product Jobs was closely involved in developing and he was personally involved in negotiations with publishers – emails written by Jobs (that may or may not have been sent) were used as key evidence against Apple. The fight is now first and foremost about the legacy of Apple’s iconic founder. Publishers will have to fend for themselves.