Apple’s Agency Model Was Not Invented For E-Books

Recently we brought you news that the U.S. Justice Department had sued Apple and five major publishing houses. The suit alleges that ahead of the 2010 launch of the original iPad (and iBooks) Apple co...
Apple’s Agency Model Was Not Invented For E-Books
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Recently we brought you news that the U.S. Justice Department had sued Apple and five major publishing houses. The suit alleges that ahead of the 2010 launch of the original iPad (and iBooks) Apple colluded with Macmillan, Penguin, Hachette, HarperCollins, and Simon & Schuster to raise e-book prices by adopting a agency model for pricing.

Before the iPad launched in 2010, Amazon effectively owned the e-book market with its Kindle e-reader. Operating on a wholesale model for pricing, Amazon paid a wholesale price for e-books, then set its own prices for them. Much to the publishers’ frustration, Amazon used books in a way no retailer had done before: as a loss leader. It sold the e-books below wholesale in order to drive sales of the Kindle. Publishers feared that this would create unreasonable expectations among customers, and that it would drive down the cost of hard copy books – especially hardcovers, which are the publishers’ biggest money makers.

While Barnes & Noble tried to elbow its way into the e-book market with its Nook e-reader (which was arguably superior to the Kindle in terms of hardware), it met with little real success, never getting closer than a distant second to the Kindle. When Apple launched the iPad and its iBooks e-reader software, though, it also announced new deals with the five publishers named in the Justice Department’s lawsuit. Under the agency model, it’s the publishers who set the prices of e-books, and the retailer – in this case Apple – gets a 30% cut off the top for every book sold. Once the iPad took off in popularity – to the point that it harmed sales of e-readers like the Kindle and Nook – the publishers were able to force Amazon and Barnes & Noble to enter into the same sort of agency model agreements they had with Apple.

All of this raised major concerns with the Justice Department (and the European Commission), which thought the switch to the agency model smacked of anti-competitive collusion. They finally filed an antitrust suit against all six companies earlier this month. While three of the companies – Hachette, HarperCollins, and Simon & Schuster – reached quick settlements to avoid a costly legal battle, the other three did not. Macmillan, Penguin, and Apple all issued statements insisting they had done nothing wrong. What’s more, they claimed that although the agency model did result in higher e-book prices, it actually fostered competition by breaking Amazon’s stranglehold on the e-book market.

What’s interesting is that they appear to be right. There are a couple of important points to consider. First and foremost, the agency model is certainly not the result of collusion. It wasn’t invented by Apple or the publishers just for e-book pricing. It has existed in other industries for quite some time. What’s more, it’s been in use by Apple for several years: the iOS App Store operates on the exact same pricing model. Developers set the price of their apps, and Apple gets 30% off the top. If a developer sells their app for $0.99, Apple gets 30% ($0.297). If a developer sells their app for $4.99, Apple gets 30% ($1.50). If a developer offers their app for free, Apple gets 30% ($0).

That in and of itself creates a major problem for the Justice Department’s case. Even if the government can prove that the publishers colluded, it will be nearly impossible to prove that Apple did so. All Apple did was offer e-book publishers the same pricing model that it offers app developers. The publishers, in turn, saw a model that offered them a chance to get out from under Amazon’s thumb, and they took it.

Competition is another place where the government will have trouble making its case. As previously noted, Amazon’s pre-iPad grip on the e-book market was strong. While other e-readers and e-book retailers existed, none was able to offer a serious challenge to Amazon and the Kindle. The best challenge was Barnes & Noble, who was never able to do better than a distant second. Since the switch to the agency model, though, the Kindle’s market share has dropped, making room for an increased Barnes & Noble presence, and for the iPad, which is the Kindle’s greatest challenger. The problem that the government faces, then, is that it has to argue that a pricing model that demonstrably increased competition is somehow anti-competitive.

In the meantime, though, things are already starting to change. As Gordon Crovitz of the Wall Street Journal points out, Barnes & Noble is already starting to suffer in the wake of the lawsuit. Though the terms of the government’s settlements with three of the five publishers are not known, it’s almost certain that they include a return to the wholesale model, which will allow Amazon to return to using e-books as a loss leader.

The publishing industry is not without its flaws. Indeed, in many ways the rise of e-books has been handled horribly by an industry that is as married to a moribund business model as its counterparts in Hollywood. Nevertheless, it’s looking more and more like the publishers might actually be in the right on this one, and that if e-book readers want a genuinely healthy e-book market, they might have to be willing to pay slightly higher prices for their books.

What do you think? Is the agency model anti-competitive? Do low prices trump a genuinely competitive market? Does the wholesale model risk turning Amazon into the Walmart of the e-book world? Let us know in the comments.

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