Boudicca: From “Publishers’ Lunch” 5/31/2012

Publisher defendants Penguin and Macmillan filed their first answers to the Department of Justice’s antitrust law suit in Federal Court on Tuesday, with both companies categorically denying the charges. Most broadly, Penguin repeats its contention that it “did not conspire to fix the prices of eBooks with other publishers or with Apple. Penguin, at the invitation of Apple, independently negotiated and ultimately entered into a vertical distribution agreement with Apple.” They argue “a vertical distribution agreement is presumptively pro-competitive. New entry is presumptively pro-competitive. Broader distribution is presumptively pro-competitive. Lower barriers to entry are presumptively pro-competitive. Yet the Government intentionally ignores these facts with regard to Penguin’s decision to distribute its eBooks through Apple and instead sides with a monopolist.”

Penguin’s 74-page answer is by far the more detailed of the two, offering point-by-point rebuttals to many of the government’s allegations. Among their very specific points Penguin notes that in December 2009 it was not windowing ebook releases, “nor did it ever have plans to do so,” which “was contrary to that undertaken by other publishers” and contrary to the theory that this was evidence of collusion on their part.

They deny that the wholesale model was firmly established for the nascent ebook market and note that they were selling ebooks directly to consumers from their web site before the agency model was launched, setting their own prices, “which was clearly not a ‘wholesale model.'” As Apple underscored in their answer, Penguin also points out that they were already “selling ebooks through the Apple App Store under the agency model prior to the introduction of the iPad” (and prior to the alleged conspiracy).

Penguin confirms that Project Z was the name for the aNobii joint venture and Project Muse was the name for the Bookish joint venture, and they say those projects were the focus of worldwide ceo John Makinson’s strategic plan prepared on August 4, 2009 for the Pearson board that the government then “excerpted out of context” in saying that he wrote “the industry needs to develop a common strategy.”

They argue that the restaurant dinners–attended by Makinson rather than US ceo David Shanks–were primarily “purely social matters” and that when “general book industry issues and trends were discussed at high-levels of generality, Makinson did so pursuant to antitrust legal advice and avoided competitively sensitive topics like terms of trade, prices, or confidential competitive matters. Certain potential joint venture proposals were also discussed. Penguin specifically denies that the purpose of any such gathering was to coordinate or fix prices or that any agreements to fix prices were reached at any such gathering.”

Penguin says e-mails to Apple’s Eddy Cue prior to the execution of a contract for the iBookstore actually show that the publisher was not “part of a publisher conspiracy; otherwise it would not have to have asked Apple for confirmation” that multiple other publishers were also participating. The company says it had a legitimate business concern in seeking “an assurance from Apple…that a number of publishers would be selling their eBooks in the iBookstore because Penguin wanted to sell its eBooks on a platform that would attract the greatest number of customers.” They also “wanted to be assured that Apple was committed to a full-scale, viable iBookstore,” in part in case “Amazon punitively refused to sell Penguin titles on its website in retaliation for Penguin entering a business relationship with a new competitor.”

To further refute the conspiracy charge, Penguin cites internal emails that show as late as January 25, 2010, Penguin “decided not to agree to the agency terms as proposed by Apple, and not be part of opening the iBookstore. Only after negotiating new and different deal terms–which Penguin believes are unique to it and its business model–did Penguin change course and enter into an agency agreement with Apple. ”

David Shanks testified that his alleged pressure on Markus Dohle of Random House was to argue that “the largest publisher needs to help to assure that there are book stores” and “we never talked about pricing or doing anything else.”

Penguin also produces Shanks’ entire March 4, 2010 email to Steve Riggio at Barnes & Noble and says “the email speaks for itself”:

Hi Steve. I wanted to share something that has me concerned. You know that we are working with your guys to come up with a formula where all of our accounts will be able to have the same prices on our ebooks. It will level the playing field for Penguin books and hopefully allow us to sell both paper and ebook product. The one discouraging thing as you no doubt know is that Random House has chosen to stay on their current model and allow retailers to sell at whatever price they wish. That is their prerogative. When you go on the Kindle website it could be the Random House home page. Amazon is showing us what they do to people who do not do what they want. As Penguin is looking out for B&N at what appears to be great cost to us, I would hope that B&N would be equally brutal to Publishers who have thrown in with your competition with obvious disdain for your welfare. You told me once that you were nice and Amazon played hardball and they were winning. I hope you make random House hurt like Amazon is doing to people who are looking out for the overall welfare of the publishing industry. I hope you can see how strongly I feel about this. They should not be allowed to be selfish and win. Thanks for listening. I hope to see you soon.

Throughout the answer, Penguin pulls no punches in discussing “the predatory, below-cost pricing practices of monopolist retailer Amazon, apparently designed to exclude competition and control the pricing of eBooks, that was the reason for the $9.99 price point for certain eBook titles.” They also underscore, in even more detail than Apple’s answer, their belief that the government acted on incorrect information about the state of ebook prices prior to the agency model, in which “Amazon offered some new release and other eBook titles for approximately $9.99 for some period of time after the date of release. Penguin denies that this practice was by any means consistent. For some significant points in the life cycle of nearly every new release eBook, the price at might be as high as $16.99 or more—significantly higher than new release eBooks are ever priced under Penguin’s agency agreements…. Penguin also denies that Amazon’s $9.99 pricing, when it occurred, involved anything other than selling product at a loss.”

The publisher admits “it viewed some of Amazon’s business practices…as anticompetitive and detrimental to the long term process of expanding opportunities for developing authors and creating more content. As the Complaint is careful to avoid stating, prior to Apple’s entry, Amazon’s share of eBook sales was 80 to 90 percent. While Amazon undoubtedly may have furthered its own interests in using eBook best sellers as loss leaders to  install itself as a permanent monopolist and sell its Kindle (a closed device), it threatened the long-term, overall health of the book publishing industry by creating barriers to entry, undercutting the margins and incentives of other sellers, fostering a perception of eBooks as low-cost commodities, and threatening the viability of book publishers and authors, as well as other book selling outlets vital to the marketing and promotion of books.”
Penguin’s filing

Macmillan’s initial answer to the Justice Department’s antitrust suit filed on Tuesday May 29 is less extensive on a point-by-point basis than Penguin’s response, but it is no less definitive in denying the government’s allegations. “Despite an extensive investigation including production of the e-mails, calendars, and telephone logs of Macmillan’s CEO and other senior management, extensive interrogatories, and two full days of deposition of Macmillan’s CEO…the lack of direct evidence of conspiracy cited in the Goernment’s complaint is telling.” They add that the case is “based entirely on the little circumstantial evidence it was able to locate during its extensive investigation, on which it piles innuendo on top of innuendo, stretches facts and implies actions that did not occur and which Macmillan denies unequivocally.”

Their concise argument is to repeat that “Macmillan independently adopted the agency model for ebooks because the wholesale model…led to Amazon’s monopolization of ebook distribution.” They add that “Macmillan did not engage in collusion with anyone prior to, while, or after adopting the agency model, and it flatly denies the substance of the government’s complaint.”

The company’s answer to the charges of improper dinner conversation among publishing executives is to say that ceo John Sargent “dined once or at most twice with peers from certain other publishing houses, but these dinners were social in nature,” one of which was to welcome Markus Dohle of Random House–“a house not even alleged to be part of the alleged conspiracy”–to New York.

Of the telephone logs that show a number of calls to and from other executives at key periods, including shortly before the announcement of the iBookstore, they note that “more than half of these telephone ‘conversations’ lasted no more than a few seconds and were nothing more than missed calls…. [and] Macmillan denies that any telephone conversations between Sargent and other publisher CEOs involved collusion.”

Similarly to Penguin, Macmillan indicates that some of what the government alleges was improper conversations long before the agency model was launched related to discussions of Bookish–and Macmillan “formally, and in writing, withdrew from consideration of this joint venture in early fall 2009.” At the same time, they argue that the government willfully ignores this as a topic and recognizes that the venture and its creation were completely legal: “The government’s deafening silence about Bookish indicates its acceptance of the legitimacy of the joint venture itself and its formative process.”
Macmillan filing

CEO of RoyaltyShare, co-founder of eMusic, and former general counsel of companies including Borland Software Bob Kohn has dispatched a 55-page letter to the Department of Justice objecting to their price-fixing complaint in what probably qualifies as the most interesting legal brief to emerge in this case so far–even though it’s technically just a letter.

Kohn essentially offers a more thorough and artful explanation of why he believes the agency model was pro-competitive rather than anti-competitive than what the defendants themselves have provided. Without the burden (or evidence) to deny the allegations themselves, he argues in broad form that “something has gone terribly wrong with the formulation and prosecution of this case,” which the Department of Justice got the entire investigation wrong from the start, ignoring their own rules and Supreme Court case history, and he says the court should throw out the case entirely. Kohn also tells us that he wonders why the publisher defendants did not move for dismissal of the charges rather than deny the allegations.

He starts by assuming “that all of the facts alleged in the Complaint are true, drawing all reasonable inferences in favor of the government—i.e., that horizontal price fixing took place.” But he says the Supreme Court “has held that horizontal price fixing is not always illegal” and notes “music publishers engage in horizontal price fixing all the time (e.g., ASCAP/BMI), but it has been held perfectly legal.”

Kohn writes that DOJ “ignored the important intersection of antitrust law and copyright law in the formulation of its allegations.” He points to the Antitrust Guidelines for Licensing Intellectual Property jointly issued by the DOJ and the FTC–formulated in the early 1990s (“when the unique characteristics of software and digital goods were finally being understood”)–which “recognize that intellectual property, such as a copyrighted work of authorship, has characteristics that are unlike other forms of property.”

Significantly, Kohn argues that Justice “forgot that e-books have no use or value to consumers without the aid of a machine or device” and treated them just like paper books. But DOJ’s “own guidelines say you must consider the impact of defendants’ actions on ‘upstream’ markets, such as the market for the device, and e-book systems as a whole.” This is the big conceptual twist on evaluating whether competition was helped or harmed.

If the lens is changed to look at the market for ebook systems–all of which are much more expensive than individual ebooks–then the defendants’ imposition of the agency model, even by the alleged means, was “clearly pro-competitive.” Consumers may–or may not–have paid a few dollars more for individual ebooks, but the ebook reader market became intensely more competitive, and those device prices have continued to fall dramatically. Thus “if you look at the results of Defendants’ actions on the correct relevant market (e.g., e-book systems), the economic consequence was that they were clearly pro-competitive.” And if “if Defendant’s actions are pro-competitive, they cannot be a violation of antitrust law, even if the result involved higher prices of one of the components of the e-book system.”

Kohn elaborates the point further: “Appreciating this critical distinction between e-books and printed books is crucial to this case. E-books are not just digital versions of books…. E-books cannot just be read on hardware devices; they must be read on hardware devices. E-books have no value or use to a consumer without the aid of machine or device. Every reader of e-books knows this.” He concludes that “increased competition among e-books systems providers is good for consumers, even though it raises some e-books prices, because it will reduce the cost of using the e-book systems and will promote innovation among systems.”

Kohn also addresses what he terms “the abuse of overwhelming market power of Amazon.” In his view, “it should also be clear that, should Amazon succeed in monopolizing the e-book systems market, it could exact monopolistic pricing not only for e-books, but it could also raise the consumers’ switching costs. For example, suppose a consumer started to use an alternative e-book system for purchasing new e-books. Amazon will soon know that the consumer has not purchased an e-book from them in some time. It may then start charging the consumer for access to the Amazon cloud platform, in which the e-books he or she previously purchased are stored, until the consumer resumes buying e-books from Amazon.”

He tells the DOJ that acceptance of the settlement “risks the promotion of an unlawful monopoly in the e-books systems market to the detriment of e-book consumers and the public generally, one that would be very difficult to undo by the Defendant Publishers themselves (should they survive) or even by government action…. A winner-take-all monopoly over the digital gateway to works of literature, history, and science will increase prices in e-book systems and slow innovation in those systems.”


Separately, Peter Glassman from Books of Wonder raises an interesting technical point that supports Penguin’s contention that the wholesale model was not established practice for ebooks and employing a different sales model was not as radical as decision as the government concludes: ” publishers have never sold e-books under the wholesale model. Rather, they have sold them under the consignment model. Amazon and other e-book sellers never purchased or took ownership of the e-books they resold. Rather, they advertised the product, handled the transaction, and only after they had received payment and concluded the transaction did they pay the publisher for the e-book.  That is consignment, not wholesale. Amazon never placed any buy orders or made any commitments to purchase specific quantities of any e-books. Unless the DOJ is seeking to change the very nature of property ownership in the United Sates and allow vendors to set prices on property they do not own nor have any commitment to purchasing, the precedent the DOJ would be setting should the DOJ win this lawsuit and go forward with its settlements could have grievous unintended consequences.”

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