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DOJ lays out case against Apple in opening statements in e-book trial

updated 06:47 pm EDT, Mon June 3, 2013

Opening statements center on negotiations by Eddy Cue, not Jobs

The opening statements by the Department of Justice and Apple at the start of the trial between the two over e-book pricing have been given, with the DOJ claiming that Apple facilitated agreements with the big four publishers (five at the time; Hatchette and Penguin later merged) to present a unified front that demanded the "agency model" of pricing (where publishers set the e-book prices) in order to break Amazon of its predatory pricing habit of pricing e-books below its own cost -- which was having a deleterious effect on both e-book competitors and physical book sales.

Before Apple got into the e-book business, Amazon had more than 90 percent of the e-book market -- and used that monopoly to force agreements with publishers that used the "wholesale" model of pricing. Publishers would sell Amazon e-books at roughly 50 percent of the recommended digital selling price, allowing Amazon to set the price it wanted. For example, a book with a $25 "physical" price might have a recommended digital price of $20. However, rather than mark up the price to some degree in order to generate a profit on the sale, Amazon began routinely pricing e-books at $9.99 regardless of the suggested price or its own cost to buy the e-book.

Amazon's decision to sell e-books at a loss was intended to bolster both its own volume of sales as well as support its own Kindle e-book reader hardware. By taking a loss on every e-book sale, Amazon hoped to keep any competitor resellers from entering the e-book market (since they would have to take a huge loss) and shut out competing e-book devices such as Kobo or Sony's products.

Perhaps unintended by Amazon, however, was the effect such loss-leader pricing had on actual bookstores: with e-books selling for nearly one-third the price of physical books, demand for actual books collapsed, with smaller bookstores in the US all but wiped out -- the move even played a significant role -- though it was not the only factor -- in the demise of Borders, a successful "brick and mortar" bookstore chain that made the mistake of not developing its online and e-book divisions fast enough to compete with a company willing to take on heavy losses.

The DOJ's opening statement, however, overlooks these factors in favor of simple cost comparisons. E-books sold for about $10 before Apple entered the market, it said, and cost $12 to $15 afterwards -- the result, it says, of a conspiracy among publishers and Apple to force Amazon to use the "agency model" (publisher-set pricing) to put an end to the ruining effect of discounted e-books. The DOJ believes the change resulted in consumers paying "hundreds of millions of dollars" more than they otherwise would in a market where Amazon would continue to sell e-books at a loss indefinitely. "I'm not sure we can be competitive" if Amazon is not made to go along with agency pricing thanks to the unified front of publishers threatening to withhold books if it doesn't, one publisher notes in an email to Apple Vice President of Internet Software and Services Eddy Cue, who was handling the negotiations.

Cue's phone calls and emails as part of the negotiating process are the focus of the DOJ's 81-slide presentation (seen below), which suggest that Cue would often tell one publisher's representative what the other publishers had been saying or thinking about various models, outcomes and agreements -- the crux of what the DOJ calls a conspiracy. In rebuttal, Apple attorney Orin Snyder said that Cue's statements were not passing actual details or insider information along, but instead giving each player a general overview of the state of play with the competitors. In the DOJ's own presentation, publishing reps repeatedly mention that it would be illegal for them to meet with each other and directly negotiate prices.

Apple's former CEO, Steve Jobs, mentioned a common value for new e-books of around $12-15 as the foundation of a sustainable model, Snyder said, but not as a dictate that prices must be set as such -- just a barometer of what the market would likely bear. Wholesale prices for e-books, he noted, were already around that price range, and Amazon was just undercutting it. However, the Apple contract capped new e-book releases to that price range, the DOJ noted. "What the government is trying to do is reverse engineer a conspiracy from a market effect," Snyder said, noting that publisher had side deals outside of the Apple agreement, and that the DOJ has no evidence to contradict that.

After the books were no longer considered "new releases," publishers were completely free in their contracts with Apple to set prices at whatever level they wished to, with Apple having no influence or input into the pricing. Apple would get its 30 percent distributor fee based on whatever the price set, reports the Wall Street Journal (which, as the article notes, shares a parent company with book publisher HarperCollins).

DOJ attorney Lawrence Buterman also focused on the "most favored nation" clause in Apple's agreements with the publishers, saying that the clause amounted to a requirement that publishers force Amazon to move to agency pricing. The clause required that publishers -- who were using agency pricing with Apple -- could not sell the books for less with other companies such as Amazon. If publishers chose to sell a given e-book on Apple's iBookstore for $12, for example, Amazon could not sell the book for less than $12. Following the agreements with Apple, the publishers then renegotiated new contracts with Amazon that used the agency pricing model.

However, the first witness in the case, Apple associate counsel Kevin Saul, testified that breaking Amazon's monopoly was not any part of Apple's interest in wooing the publishers, inferring that that part of the overall deal was fostered by the publishers' strong dislike of Amazon's predatory pricing policies -- also indicated in correspondence shown by the DOJ. Apple's interest, Saul said, was strictly in being price-competitive while preserving competition and diversity in the marketplace.

The Apple agreements had the effect of levelling the playing field, allowing both Apple and other competitors -- most notably Barnes & Noble -- to enter the e-book market, since they could now compete with Amazon without taking on debt and unsustainable losses. Amazon, unlike most bookstore competitors, made money in other departments that allowed them to aggressively offer loss-leader pricing on e-books until they had total control of that market.

Butterman pointed out that Cue would often send nearly-identical emails to publisher representatives outlining the terms of Apple's proposal. Apple's attorney countered that this is normal negotiating protocol when entering a market that is dominated by a single entity, and called opening for Judge Denise Cote to "hit the delete button" on her repeated previous opinions that Apple was likely guilty and would lose the case. Snyder noted that even the DOJ's own slide showing a short-term increase in e-book prices following the launch of the iBookstore also showed that overall e-book prices actually fell, not rose, once competitors began to arrive. Snyder noted that if Apple colluded with willing publishers, as the DOJ alleges, there would have been no reason for the months of difficult back-and-forth and negotiation on specifics that the DOJ's own presentation shows.

In addition to overall e-book prices staying low, the overall sales of e-books rose significantly, and the number of e-book marketplaces and the inherent diversity therein improved dramatically, Snyder said. "Every single indicator of market health improved after Apple entered the market." Cue himself will testify at the trial, but is not scheduled to appear until June 13. CEO Tim Cook has called the case "bizarre," characterized it as a fundamental misunderstanding on the DOJ's part, and been adamant that the reason the company went to trial is because it did nothing wrong. Snyder also noted that Cue and Apple pursued the publishers for the iBookstore deal in exactly the same manner it had set up the iTunes Store with record companies -- proposing a standard that was somewhat less than the companies originally wanted, but intended to shake up the market and grow demand.



By Electronista Staff
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