There is breaking news this morning that Judge Denise Cote of the U.S. District Court for the Southern District of New York has issued her ruling that Apple conspired to fix e-book prices.  Or, in other words, Judge Cote answered my prior rhetorical question about this case with an emphatic, “no.”

In briefest summary, Judge Cote found that the five publisher defendants, who has all previously settled with DOJ and the plaintiff states, conspired 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.”  According to her opinion, the publishers’ conspiracy would not have succeeded without Apple’s “orchestration.”

Apple, on the other hand, may wonder how its role in the alleged conspiracy was so central when, according to Judge Cote, the publishers were already “acting collectively” to pressure Amazon to charge higher prices for e-books before Apple met with any publisher.

But perhaps I’m getting ahead of myself.  Let me first give you a very simplified sketch of the facts, which as Judge Cote says are largely not disputed by the parties.  In the winter of 2009, two relevant factors came together in a way that sparked the potential antitrust issues.  Book publishers were concerned that the low prices that Amazon was charging for e-books for newly-released bestsellers (generally, $9.99) would erode sales of hard cover books at higher prices.  Meanwhile, Apple was preparing to launch its own e-book service via its new iPad product, that would provide a new, large, non-Amazon outlet for e-books. So to set the stage, Apple wanted to sell e-books, but wanted to do so only if it could offer a broad range of books from the major publishers and sell them at a profit, while the publishers wanted to raise the prevailing prices for e-books.

What happens next is where the dispute lies. Did Apple begin negotiating with each publisher for its own deal to sell e-books, in part by giving assurances that it would be a better partner for them than Amazon (e.g., by entering agreements that would prevent such low prices)?  Or did it set in motion a conspiracy to force up market prices for e-books?

Obviously, Judge Cote decided that it was the latter.  But, frankly, the two things are fairly difficult to distinguish.  Of course Apple wanted protection from retail price competition from Amazon.  And of course the book publishers wanted higher prices for e-books.

The tricky question is still how to characterize the agreements that were reached.  Did Apple enter into a series of vertical agreements with a set of suppliers of similar products?  After all, Apple is not a publishing competitor.  There really isn’t anything unusual in it insisting on similar terms from its competing suppliers. And if it’s Apple, as a customer of the publishers, insisting on common terms in each agreement, where is the conspiracy among competitors?  Does it matter whether the terms that Apple offered could also be used by the publishers to negotiate a new arrangement with Amazon?

Or did Apple facilitate an anticompetitive conspiracy among the book publishers?  The result was higher market prices for e-books, after all.

Let’s try to simply the facts a little to highlight the issues.  Let’s say I’m opening a new retails store specializing in retro-spinning neon widgets.  It’s a specialty store, so it’s important to me to be able to offer a wide variety of products from all of the manufacturers.  But at the same time, those manufacturers feel they’ve been burned by prior deals with retail outlets, which they feel have cannibalized their direct sales efforts.  Given that the manufacturers are wary of doing business with me, I offer to sweeten the deal and assure them that I won’t undercut their prices too much.  But being a savvy businessman wise in the ways of antitrust, I know that even in the post-Leegin world, there’s a lot of antitrust risk involved in agreeing to “vertical price fixing.” Instead, I offer to be the manufacturers’ agent and get paid a commission on each sale at a price set by the manufacturer, rather than earning a margin on the difference between the price I pay the manufacturer and the price I can get at retail.  But I’m running a retro-spinning neon widget store here, so I don’t want an agency agreement with just one manufacturer.  I need all of them or I’m not living up to my business objectives.  Thankfully, the deal appeals to each manufacturer and I’m able to put an agreement in place with each and open my store.

So far, it seems pretty hard to me to conclude that anything illegal took place.  I think DOJ and the plaintiff states would agree. I think we would continue to agree that I had done nothing illegal even if, without my knowledge, the retro-spinning neon widget manufactures had secretly (or not so secretly) been engaged in a conspiracy among themselves to increase retail prices and latched on to my agency idea as a means of implementing it. So the question is where did Apple step over the line?

A few things stand out in the opinion:

  • Apple (and Jobs) recognized that the model could be extended to other retailers (i.e., Amazon)
  • Apple seemed to want higher e-book prices.  (Or did it recognize that publishers wanted higher prices and not care as long as its margins were secure?)
  • Apple didn’t want price competition at the retail level and said so repeatedly
  • Apple sought “most favored nation” clauses that allowed it to match any other retail price and retain its 30% commission rate,  which ultimately constituted a “sever financial penalty” if the publishers didn’t force Amazon and other retailers to switch to an agency model
  • Apple seems to have been involved in the publishers’ negotiations of agency agreements with Amazon

Looking at those factors, it seems that intent played a fairly big role in Judge Cote’s reasoning.  But I can’t help but wonder whether Apple could have achieved everything it wanted and avoided an antitrust challenge had it relied on the publishers’ self-interest to transition Amazon to an agency arrangement rather than an affirmative obligation to Apple in the form of an MFN that had the effect of requiring it (more on MFNs, which are an active and interesting antitrust frontier, in future posts). Obviously, Apple was aware that the publishers wanted Amazon to charge higher prices.  The publishers also obviously knew that an agency model would give them greater control over retail prices.  Finally, the existence of Apple as a significant competing retail outlet would change the relative bargaining power of the publishers and Amazon.  Why weren’t these factors enough assurance on their own?

That really seems to be Apple’s key mistake.  It saw the benefit to it of moving all e-books to an agency model and thereby eliminating retail price competition, and pursued it aggressively.  The irony (in the Alanis Morissette sense) is that it was also sufficiently in the publishers’ interests that Apple may not have needed to.