Apple Loses Its Fight With the Feds

Apple Loses Its Fight With the Feds

A battle over the e-book market has been brewing for years. After the U.S. Department of Justice launched an antitrust suit against Apple and the major book publishers, alleging that the companies all participated in a price-fixing conspiracy, Apple was the only one who decided to fight it out with the Feds.

The one and only
Every single one of the publishers decided to settle, paying over $166 million combined, in order to avoid a lengthy and costly legal battle, despite maintaining innocence. Apple stuck to its guns, arguing that it didn't do anything wrong as it doesn't set the e-book prices. At the D11 conference in May, Tim Cook reiterated Apple's stance on the matter, "We're not going to sign something that says we did something that we didn't do, so we're going to fight."

U.S. District Judge Denise Cote has now sided with the DoJ, saying, "Apple played a central role in facilitating and executing that conspiracy," adding that the colluding would have never happened if it weren't for "Apple's orchestration."

The DoJ had already shown that publishers were meeting behind closed doors to discuss a collaborated move away from Amazon. Apple wasn't directly a part of these conversations, and the company's legal defense maintained that it was not aware of these secret meetings. That might not pass the sniff test, though, as clearly all publishers needed to pressure Amazon simultaneously for a broad shift to the agency model to succeed.

Most favored Apple
Apple offered publishers the agency model in the e-book market, as publishers loathed the wholesale model that was using to become a loss leader in the e-book market. Apple argued that it was "indifferent" to whether or not publishers forced Amazon to adopt the agency model, but the Mac maker had included a most-favored nation, or MFN, clause that allowed it to match the lowest competing e-book prices.

The MFN legalese within these contracts conveyed the idea that Apple just wanted competitive prices, but it could also be considered a roundabout way of forcing publishers to force other e-book sellers to adopt the agency model. For example, if a publisher sold an e-book under the wholesale model to Amazon for $13, and Amazon turns around and sells that title for a loss at $9.99, the publisher still gets $13. If a publisher offered the same title through Apple's iBookstore under the agency model where it keeps a 70% cut and Apple is allowed to match Amazon's $9.99, the publisher only gets $7 -- just over half as much.

The MFN clause key to Apple's strategy, but alone doesn't prove that the Mac maker was guilty of price-fixing and collusion. Emails told a different story, though.

That's what he said
Steve Jobs penned some particularly incriminating emails that the DoJ presented. Jobs suggested to NewsCorp'sJames Murdoch that HarperCollins "throw in with Apple," but predicted that Amazon would eventually try to pay even less for books because "they have shareholders too."

In a separate email, Jobs notes that Amazon had sold an estimated 1 million Kindle e-readers in the roughly 18 months it had been on the market, and Apple's "new devices" (referring to the then-unreleased iPad) would outsell the Kindle within "the first few weeks." He warned that sticking with Amazon would mean "sitting on the sidelines of the mainstream ebook revolution."

When more competition is bad
After everything was said and done, the net result was a precipitous increase in e-book prices throughout the market, as shown in the DoJ's closing arguments.

The entire situation is extremely peculiar, in part because of Amazon's disruptive ways. On one hand, this is perhaps the first time that the DoJ has filed suit against a company entering a market to challenge an incumbent with a near-monopoly position. The DoJ almost always prefers more competition to less competition. On the other hand, most companies leverage monopoly positions to raise prices instead of lowering prices to take a loss. Amazon threw out all the traditional business school books in that regard.

Instead, the DoJ is focusing on the rising e-book prices, which was a detriment to consumers even if there was technically now more competition in the e-book market. Cote has ordered a trial to determine damages, but Apple has already said it intends to appeal the ruling. Investors don't appear overly concerned with the ruling. After a brief dip, shares promptly recovered.

Overall, Jeff Bezos is surely pleased with this ruling.

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Fool contributor Evan Niu, CFA, owns shares of Apple. The Motley Fool recommends and Apple. The Motley Fool owns shares of and Apple. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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