Second Circuit Continues The Ebook Saga By Affirming Apple's Role In An Unlawful Price Fixing Conspiracy

Author:Mr Bruce Sokler and Timothy J. Slattery
Profession:Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.

On June 30, 2015, the same day as the launch of Apple's new streaming music service, the Second Circuit Court of Appeals coincidentally affirmed a district court ruling that Apple conspired with five of the country's largest book publishers to fix prices for ebooks and coerce Amazon to change its pricing model to accommodate those higher, fixed prices. United States v. Apple, Inc., No. 13-3741, Slip Op., (2nd Cir. June 30, 2015). The Second Circuit held that while Apple's agreements with the publishers were vertical, they were a component of a horizontal conspiracy among the publishers that was a per se violation of § 1 of the Sherman Act.

Factual Background1

A few short months before its anticipated January 27, 2010 iPad launch, Apple commenced negotiations with the six largest publishers in the U.S. In doing so, Apple recognized the publishers' collective loathing2 for Amazon's $9.99 price point for new releases and New York Times bestsellers - a practice that was not only a loss-leader for Amazon to encourage adoption of its electronic reader, the Kindle, but it was also cannibalizing the publishers' hardcover sales, driving down hardcover prices, and cutting into their profitability. Slip Op. at 9.3 Throughout the negotiations and subsequent iBookstore launch, Apple took advantage of the publishers' desire to move off that price point toward more economically favorable conditions.

In response, Apple developed three novel contract terms: move ebooks to an agency model, develop price caps for equivalent categories of ebooks and printed books, and require a most-favored nations clause. Each of these clauses, according to the Court, were innocuous on their own by effectively anticompetitive collectively.

First, Apple noted that the wholesale model, in which publishers' sold ebooks to retailers at a wholesale price and the retailers made profit on a small markup, was unfavorable and sought to switch to an agency model, in which the publisher sets the price and Apple receives a fixed commission of 30 % for each sale. Slip Op. at 21-25. The Court found that this ensured each sale net Apple a profit, but created the added risk that Apple could open the iBookstore with higher prices than Amazon and be "brimming with titles, but devoid of customers." Slip Op. at 24. To combat this risk, Apple knew it needed to cap prices for selected categories of titles and it needed to ensure the publishers' had sufficient incentive to switch all other ebook retailers, particularly Amazon, to an agency model. Slip Op. at 24-25.

Second, Apple negotiated for price caps that would set maximum price limits for various categories of titles based on the equivalent title's hardcover list price. Under the new caps, New York Times bestsellers were capped at $14.99 if the hardcover price was over $30 and $12.99 if under $30. For new releases, there were caps of (1) $12.99 for hardcovers between $25 and $27.50, (2) $14.99 for hardcovers between $27.50 and $30, and (3) $16.99 to $19.99 for hardcovers over $30. The caps incentivized publishers to raise their hardcover prices to shift books between the cap brackets. Prices on new releases rose 24.2% and bestsellers jumped 40.4% in the year following the iBookstore launch.

Third, Apple realized that its successful entry into ebooks hinged on its ability to competitively price with Amazon at the higher prices the publishers wanted. To do so, Apple needed a way to induce the publishers to collectively compel Amazon to sell its ebooks on the agency model. The most-favored nation clause ("MFN") was precisely the elegant solution Apple needed. The MFN required the publishers "to offer any ebook in Apple's iBookstore for no more than what the same ebook was offered elsewhere, such as from Amazon." Slip. Op. at 26. With the 30 % Apple commission, the MFN actually resulted in a lower per-book profit for the publishers in the iBookstore, meaning that profitability hinged on the publishers' ability to regain pricing control with Amazon via the agency model and set higher prices on new releases and bestsellers.

Critically, Apple's efforts to reach these agreements also included constant communications with each of the publishers to encourage tougher negotiations with Amazon that would require agency model adoption. The Court listed several instances in the weeks leading up to and the weeks following the iBookstore announcement on...

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