The Complete 2012 User's Guide to the Amazing Amazon Kindle: Covers All Current Kindles Including the Kindle Fire, Kindle Touch, Kindle Keyboard, and Kindle (2 page)

But now the U.S. Department of Justice Anti-Trust Division, with its announcements of April 11, 2012, has made it easy on us.

Now there’s a new name for this wild bunch:
The Defendants
.

Many in the traditional publishing world believed that adoption of the ” agency model” was the biggest news of 2010 in the book business, and perhaps many of the same people will see the demise of the agency model as the biggest news of the next year or two.

Let’s take a look at how we got here, and where we are going. We’ll start back before April Fools Day, 2010 — the day that the agency model took effect — and continue right through to today and beyond by looking at some of the available tea leaves to see where prices, and the book business in general, are likely to go in the future.

The Defendants’ purpose in adopting the agency model was to end competitive pricing for ebooks, and to slow the growth of ebooks in general, and the growth of Amazon’s dominant market share in particular. They did this by foisting a new pricing model on all retailers — including Amazon’s Kindle Store — that had the effect of raising “new release” and many other ebook prices by 30% to 100% over the $9.99 price point that Amazon had established and maintained since the launch of the Kindle in November 2007.

That $9.99 price point involved Amazon taking a loss on some new-release bestsellers and selling others at breakeven, since most of the “copies” sold in the Kindle Store cost Amazon something in the $9 to $13 range, based on a wholesale pricing structure that involved a 50% discount on digital list pricing. Amazon’s strategic decision to lose money or only break even on such a significant part of its ebook sales was based on its belief that the overall “sweet spot” for ebook prices topped out at $9.99.

This limit on ebook prices would make them a compelling value proposition for consumers. Prices would be even lower in many cases for books from lesser known authors or books that had passed beyond new-release status. Beyond that consumer-driven approach to pricing, of course, the company was also pursuing two perfectly logical corporate goals: to achieve a dominant market share among ebook sales, and to grow the market share for the ebook format among all trade book formats.

Not surprisingly, publishers were terrified that Amazon’s loss-leader pricing for the Kindle Store would make it so dominant a player that it would be able to dictate wholesale and retail pricing terms throughout the marketplace. By the time Barnes & Noble launched the Nook in November 2009, Kindle owned a market share of well over 80% for ebook sales, and Nookstore pricing was, for the most part, roughly identical to Kindle Store pricing. Amazon had a powerful weapon that no longer existed for Barnes & Noble: its cash supply and overall marketplace power would allow it to continue taking retail losses or miniscule profits on the big publishers’ ebooks for years to come — or for however long it took Amazon, publishers feared, to be “the last man standing” in the book business.

It was this confluence of terrors — and the $9.99 price point that was at the heart of it — that drove five of the Big Six publishers (all except Random House) to enter into an obviously collusive price-fixing scheme with Apple to try, early in 2010, to block Amazon’s path to dominance. The publishers worried aloud to one another that the $9.99 ebook price point would lead to the erosion of hardcover prices, to ever-greater ebook popularity, and ultimately, perhaps, to demands by Amazon that the publishers lower their wholesale prices.

It’s worth noting here that the publishers might have taken a different, more innovative path. They could even have followed such a path collectively without fear of violating anti-trust laws. Although the agency-model publishers place the blame on Amazon for the business model disruption that the ebook revolution ignited, the fact is that Amazon’s highly successful entry into the ebook marketplace came, itself, out of its own private set of terrors. We have speculated before that back in 2003 and 2004 when Jeff Bezos, Steven Kessel, and others began dreaming up the Kindle and its associated publishing and retail platform, they were driven by fears that the rise of ebooks — with some other parties in the drivers’ seats — could, within a decade, destroy the retail print book business that was then the core of their business. It was only a matter of time.

So, it was Amazon that created the new, disruptive ebook business model, beginning ever so slowly at first in November of 2007. And publishers decided to fight back: not by reimagining the book business with new, innovative, profitable roles for themselves, but by marching in lockstep behind the late Apple CEO Steve Jobs in a baldly illegal and ultimately futile strategy to wield collusive power to save the past and block the future. They could have created their own retail outlets to offer their titles in Kindle-compatible ebook form. They could have worked with brick-and-mortar booksellers to bundle ebook and digital formats at handy little kiosks in every bookstore. They could have turned ebooks into the 21st century reincarnation of Literary Guild and the Book-of-the-Month Club, those 20th century behemoths that managed to sell millions of hardcover books for 99 cents each without creating any significant scare over the erosion of “the value of the book.” They could have tried to strip away the excess weight of unsustainable corporate costs and their reckless addiction to gamble huge advances for bestsellers, to rework their economics at new, competitive price points. They could have said, “We’re no longer going to pay for intermediaries that add no value.” They might even have pursued one of the collective strategies that they considered and rejected back in 2009, called Project Z, to create a joint venture that would establish a new ecommerce platform to sell ebooks wholesale to retailers, or retail to the ebook-buying public.

There were plenty of other publishers who wanted no part of the agency model. Venerable publishers like Houghton Mifflin Harcourt, Scholastic, Norton, Workman, Bloomsbury, and Disney’s Hyperion charted their own course, as did new and innovative companies like Open Road Media. Even Random House resisted considerable pressure from the Defendants and followed its own path — they held themselves out of the agency model for a long time and eventually used the agency model to take a more creative approach to price-setting. And then, of course, there were the most innovative new publishers on the scene — AmazonEncore, AmazonCrossing, Thomas & Mercer, Montlake, 47North and all the new imprints that have been rolled out over the past two years by Amazon Publishing. All of these companies — and I do mean all of them — have joined with independent authors and hundreds of small presses as well as millions of readers to take market share away from the Defendants and turn the book business upside down. It will never be the same again.

But none of that for Apple and the Defendants. Instead of innovating to become leaner, faster, and more profitable in the new world of publishing, they decided to try to stop time by breaking the law. “Come on,” you say, they didn’t decide “to break the law,” did they? It couldn’t have been that simple, could it?

Well, it always seemed pretty simple to us. I’m sure I was not the only observer, back in the early days of 2010, who watched the actions of Apple and their five co-conspirators and wondered, “Don’t they have corporate counsel with the guts to speak up and tell them they won’t get away with this?” But it turns out, according to the court documents, that none of the Defendants’ CEOs brought their corporate counsel along to the secret conspirators’ meetings that they held regularly at ritzy Manhattan eateries beginning in September 2008.

Sure, companies “collude” every day on a million little details, and most of the time they aren’t breaking the law. But there’s a big on-off switch that counts for a lot when anyone, including the Department of Justice or a federal court, is trying to figure out whether an instance of collusion is illegal: when companies collude or conspire to raise prices to the detriment of consumers, they are on thin ice. In this case, because of the Defendants’ collusion, consumers paid millions more than they would otherwise have had to pay for ebooks. So there it is in the most simple terms, but the more one looks into it, and the more one discovers about the law and the case history, the more it is clear that these
jokers
companies should have had someone protecting them from themselves. Because of what they did, they’ll not only have to stop doing it, but they will be under close regulatory scrutiny (spelled out in the court papers) for years, and they may well be required to pay tens of millions, and ultimately perhaps hundreds of millions, in restitution to consumers like you and me.

Strangely, in hindsight, one has to wonder if they thought they were invisible, or above the law. Part of their problem was their abject cowardice. Anything but fearless, they didn’t dare challenge Amazon’s pricing alone by pulling their books from the Kindle Store unless Amazon stopped its deep discounting of ebook prices. Had one of them done so, it might well have led to a different kind of legal High Noon where Amazon might have been vulnerable to regulatory scrutiny for monopolistic behavior of its own. After all, the point where the rubber hits the road for monopolies or near-monopolies is not whether they exist, but whether they use their monopolistic power to control the marketplace to the detriment of other parties. But Amazon has not — yet — had to defend itself on this terrain precisely because Apple and its co-defendants broke the law first. And with multiple smoking guns, many of them bearing Steve Jobs’ fingerprints.

Smoking guns? Here are a few choice tidbits from the
court documents
:

In December 2009, Apple approached each Publisher Defendant with news that it intended to sell e-books through its new iBookstore in conjunction with its forthcoming iPad device. Publisher Defendants and Apple soon recognized that they could work together to counter the Amazon-led $9.99 price. 

In its initial discussions with Publisher Defendants, Apple assumed that it would enter as an e-book retailer under the wholesale model. At the suggestion of two Publisher Defendants, however, Apple began to consider selling e-books under the “agency model,” whereby the publishers would set the prices of e-books sold and Apple would take a 30% commission as the selling agent. In January 2010, Apple sent to each Publisher Defendant substantively identical term sheets that would form the basis of the nearly identical agency agreements that each Publisher Defendant would sign with Apple (“Apple Agency Agreements”). Apple informed the publishers that it had devised these term sheets after “talking to all the publishers.” 

The volume of Publisher Defendants’ communications among themselves intensified during the ensuing negotiation of the Apple Agency Agreements.  Through frequent in-person meetings, phone calls, and electronic communications, Publisher Defendants, facilitated by Apple, assured each other of their mutual intent to reach agreement with Apple.  After each round of negotiations with Apple over the terms of their agency agreements, Publisher Defendants’ CEOs immediately contacted each other to discuss strategy and verify where each stood with Apple.  They also used Apple to verify their position vis-à-vis other Publisher Defendants.  Penguin, for example, sought Apple’s assurance that it was “1 of 4 before signing”—an assurance that Apple provided.  Two days later, Penguin and two other Publisher Defendants signed Apple Agency Agreements.

To the extent Publisher Defendants expressed doubts during the negotiations about whether to sign the Apple Agency Agreements, Apple persuaded the Publisher Defendants to stay with the others and sign up.  For example, Apple CEO Steve Jobs wrote to an executive of  one Publisher Defendant’s corporate parent that the publisher had only two choices apart from  signing the Apple Agency Agreement:  (i) accept the status quo (“Keep going with Amazon at  $9.99”); or (ii) continue with the losing windowing policy (“Hold back your books from  Amazon”).  According to Jobs, the Apple deal offered the Publisher Defendants a superior alternative path to the higher retail e-book prices they sought:  “Throw in with Apple and see if we can all make a go of this to create a real mainstream e-books market at $12.99 and $14.99.”

The Apple Agency Agreements contained two primary features that assured Publisher Defendants of their ability to wrest pricing control from retailers and raise e-book retail prices above $9.99.  First, Apple insisted on including a Most Favored Nation clause (“MFN” or “Price MFN”) that required each publisher to guarantee that no other retailer could set prices lower than what the Publisher Defendant set for Apple, even if the Publisher Defendant did not control that other retailer’s ultimate consumer price.  The effect of this MFN was twofold:  it not only protected Apple from having to compete on retail price, but also dictated that to protect themselves from the MFN’s provisions, Publisher Defendants needed to remove from all other e-  book retailers the ability to control retail price, including the ability to fund discounts or  promotions out of the retailer’s own margins.  Thus, the agreement eliminated retail price competition across all retailers selling Publisher Defendants’ e-books.