The Everything Store: Jeff Bezos and the Age of Amazon (40 page)

A few days later, under a barrage of criticism for making authors and customers collateral damage in the fight, Amazon relented. Bezos and his Kindle team collaborated on a public message, which they posted on an Amazon online forum: “We have expressed our strong disagreement and the seriousness of our disagreement by temporarily ceasing the sale of all Macmillan titles. We want you to know that ultimately, however, we will have to capitulate and accept Macmillan’s terms because Macmillan has a monopoly over their own titles, and we will want to offer them to you even at prices we believe are needlessly high for e-books.… Kindle is a business for Amazon, and it is also a mission. We never expected it to be easy!”

Ironically, the shift to the agency model made the Kindle business more profitable, since Amazon was forced to charge more for e-books, and Amazon held a near monopoly on e-book sales. That helped Amazon sustain the gradual decrease in the price of the Kindle hardware. Less than two years later, the cheapest Kindle e-reader would cost seventy-nine dollars.

But Amazon wasn’t sitting back or letting others dictate their own terms. Over the next year, Amazon responded forcefully in several ways. Russ Grandinetti, who had moved over to Kindle from apparel, and David Naggar, the new hire from Random House, made the rounds of midsize publishers like Houghton Mifflin. According to several executives at those firms, they were warned that they did not have the leverage to move to an agency pricing model and that Amazon would stop selling their books if they did. Amazon also intensified its focus on its own direct-publishing business, which would cause another wave of distress for publishers in the years ahead.

In trying to loosen Amazon’s grip on the e-book market, the publishers and Apple created a significant new problem for themselves.
A day after the standoff with Macmillan, according to court documents, Amazon sent a white paper to the Federal Trade Commission and the U.S. Department of Justice laying out the chain of events and its suspicion that the publishers and Apple were engaged in an illegal conspiracy to fix e-book prices.

Many publishing executives suspect that Amazon played a major role in provoking the legal brouhaha that resulted. But antitrust investigators likely didn’t need much nudging. Incredibly, even though Steve Jobs passed away in the fall of 2011, his earlier comments dug the legal hole deeper for Apple and the five agency publishers. In the biography
Steve Jobs,
Walter Isaacson quoted Jobs as saying, “Amazon screwed it up… Before Apple even got on the scene, some booksellers were starting to withhold books from Amazon. So we told the publishers, ‘We’ll go to the agency model, where you set the price, and we get our 30%, and yes, the customer pays a little more, but that’s what you want anyway.’ ”

Jobs’s patronizing statement was potentially incriminating. If publishers had engaged in a joint effort to make customers pay “a little more,” that was the foundation on which antitrust cases were built. The Justice Department sued Apple and the five publishers on April 11, 2012, accusing them of illegally conspiring to raise e-book prices. All the publishers eventually settled without admitting liability while Apple alone held out, claiming that it had done nothing wrong and that its intent was only to expand the market for digital books.

The case against Apple was heard the following June in a Manhattan courtroom and lasted for seventeen days. District judge Denise Cote then found Apple liable, ruling that it had conspired with the book publishers to eliminate price competition and raise e-book prices and had therefore violated Section 1 of the Sherman Antitrust Act. Apple vowed to appeal the verdict. A hearing on damages was pending at the time this book went to press.

The e-book battle played out publicly in both the courtroom and the marketplace. But despite the case’s visibility in the media, it was a sideshow to the larger rise of Amazon at the time, an ascent
interrupted by the great recession that resumed with renewed vigor afterward.

Beginning in 2009, as the fog of the economic crisis lifted, Amazon’s quarterly growth rate returned to its pre-recession levels, and over the next two years, the stock climbed 236 percent. The world was broadly recognizing Amazon’s potential—the power of Prime and of Amazon’s mighty fulfillment network, the promise of AWS, and the steady gains seen in Asia and Europe. In part because of the e-book pricing war, investors began to understand that the Kindle could grab an outsize share of the book business and that the device had the potential to do to bookstores what iTunes had done to record shops. Analysts en masse upgraded their ratings on Amazon’s stock, and mutual fund managers added the company to their portfolios. For the first time,
Amazon
was spoken in the same breath as
Google
and
Apple
—not as an afterthought, but as an equal. It had blasted off into high orbit.

CHAPTER 10

Expedient Convictions

The spectacular rise of Amazon’s visibility and market power in the wake of the great recession brought the company more frequently into the public eye, but the attention was not always flattering. During the years 2010 and 2011, the company battled a growing chorus of critics over its avoidance of collecting state sales tax, the mechanics behind two of its large acquisitions, its move into the business of publishing books (in competition with its own suppliers), and what appeared to be its systematic disregard for the pricing policies of major manufacturers. Almost overnight, the company that viewed itself as the perennial underdog now seemed to many like a remote and often arrogant giant who was trying to play by his own set of rules.

Bezos (and the few Jeff Bots that Amazon allowed to speak in public) perfected an attitude of bemused perplexity when addressing criticisms. Bezos often said that Amazon had a “willingness to be misunderstood,” which was an impressive piece of rhetorical jujitsu—the implication being that its opponents just didn’t
understand
the company.
¹
Bezos also deflected attacks by claiming that Amazon was a missionary company, not a mercenary one. That dichotomy originated with now former board member John Doerr, who formulated it after reading his partner Randy Komisar’s 2001
business-philosophy book
The Monk and the Riddle.
Missionaries have righteous goals and are trying to make the world a better place. Mercenaries are out for money and power and will run over anyone who gets in the way. To Bezos, at least, there was no doubt where Amazon fell. “I would take a missionary over a mercenary any day,” he liked to say. “One of those great paradoxes is that it’s usually the missionaries who end up making more money anyway.”
²

Amazon spokespeople approached these controversies with simple, direct points that they repeated over and over, rarely veering into the uncomfortable details of the company’s aggressive tactics. The arguments had the advantage of being completely rational while also serving Amazon’s strategic interests. And it was these expedient convictions that, to varying degrees, helped steer Amazon through the period of its greatest public scrutiny yet.

While the recession was in many ways a gift to Amazon, the deteriorating finances of local governments in the United States and Europe prompted a new fight over the collection of sales tax—the legal avoidance of which was one of the company’s biggest tactical advantages. It was a high-stakes battle where there were more than two sides, no one played it entirely straight, and Amazon’s deeply held convictions just happened to be conveniently expedient for its own long-term interests.

Beginning in late 2007, when governor of New York Eliot Spitzer introduced a proposal to raise millions of dollars by expanding the definition of what constituted a taxable presence in his state, Amazon was faced with the disconcerting possibility that its long exemption from adding 5 to 10 percent in sales tax onto the prices of most of its products—which had shaped its earliest decisions about where to conduct operations and place its headquarters—was about to end.

Spitzer’s proposal flopped, at first. He withdrew it the day after introducing it, amid his own slumping approval ratings and a backlash over what his budget director said was concern that residents might consider the bill a tax increase.
³
But New York State had a
$4.3 billion budget gap that desperately needed to be filled. The following February, a month before Spitzer’s political career imploded in a prostitution scandal, Spitzer reintroduced the bill. David Paterson, his successor, embraced the proposal, and in April it was passed by the state legislature in Albany.

The law cleverly eluded a 1992 Supreme Court ruling,
Quill v. North Carolina,
stipulating that only those merchants who had a physical presence or nexus, like a storefront or an office, in a state had to collect sales tax there. (Technically, the tax was still due for online purchases, but customers were supposed to pay it themselves.) The New York law specified that an affiliate website that took a commission for passing customers on to an online retailer was an agent of that retailer, and thus the retailer officially had a presence in that affiliate’s state. By this ruling, if a Yankees-fan website in New York made money every time a visitor clicked a link on its pages and bought former manager Joe Torre’s memoir on Amazon.com, then Seattle-based Amazon had an official storefront in New York and so had to collect sales tax on all purchases made in that state.

Amazon was not amused. The New York law went into effect over the summer of 2008 and, along with Overstock.com, another retailer, it sued in state court—and lost. Publicly, the company complained that state-by-state tax collection was complex and impractical. “There are currently about seventy-six hundred different jurisdictions in the country that tax, including things like snow-removal and mosquito-abatement districts,” says Paul Misener, Amazon’s vice president of global public policy and the public face of its tax battles.

Amazon had avoided sales-tax collection for years with various clever tricks. In states where it had fulfillment centers or other offices, like Lab126, it skirted the definition of what constituted a physical presence by classifying those facilities as wholly owned subsidiaries that earned no revenue. For example, the fulfillment center in Fernley, Nevada, operated as an independent entity called Amazon.com.nvdc, Inc. These arrangements were unlikely to hold up
under direct scrutiny, but Amazon had carefully negotiated with each state when opening its facilities, securing hands-off treatment in exchange for the company’s generating new jobs and economic activity. Bezos considered his exemption from collecting sales tax to be an enormous strategic advantage and brought a libertarian’s earnestness to what he believed was a battle over principle. “We’re not actually benefiting from any services that those states provide locally, so it’s not fair that we should be obligated to be their tax collection agent since we’re not getting any of the services,” he said at a shareholder meeting in 2008.

Bezos also thought his exemption from collecting sales tax was a big benefit for customers, and the prospect of losing it triggered his apoplectic reaction to raising prices. He had good reason to be worried about the effects of sales-tax collection. When New York passed its Internet sales-tax law, Amazon’s sales in New York State dropped 10 percent over the next quarter, according to a person familiar with Amazon’s finances at the time.

New York’s law spread like a bad cold. Similarly cash-strapped states like Illinois, North Carolina, Hawaii, Rhode Island, and Texas tried the same bank-shot approach of declaring that affiliate websites constituted nexuses. In response, Amazon borrowed a hardnosed tactic that Overstock had used in New York and severed ties with its affiliates in each state. These sites were often run by bloggers and other entrepreneurs who needed their affiliate commissions, and they were angered to find themselves wedged between a cash-starved state government on one side and an online giant belligerently clinging to a blatant tax loophole on the other.

The affiliates were not the only victims at this stage of the sales-tax fight. Vadim Tsypin was an Amazon engineer who often worked from his home in Quebec, Canada. In late 2007, around the time Eliot Spitzer was proposing his tax bill and Amazon’s lawyers were growing more anxious, Tsypin’s manager showed him the company’s restrictive Canada policy, which declared that Amazon had no employees working in that country. His manager allegedly told Tsypin they had to cover up his history of working from home
and, according to court documents, said that “Amazon can have multimillion-dollar problems. If we have even one employee on the ground there, it is a big violation of U.S. and Canadian law.”

Tsypin refused to alter his old time sheets and evaluations, believing that it wouldn’t stand up to scrutiny. He claimed that his Amazon bosses then started to harass him into quitting, which led to his getting sick (“constant migraine headaches and frequent seizure-like blackouts”) and taking a medical leave of absence. In 2010, he sued Amazon in King County Superior Court for wrongful termination, breach of contract, emotional distress, and negligent hiring—and he lost. The judge acknowledged Tsypin’s condition was work related but said the claims were not strong enough to impose a civil liability.

Large companies like Amazon are frequent targets of wrongful-termination claims. But Vadim Tsypin’s case was unusual because it grew out of Amazon’s own growing sales-tax anxieties and because the discovery phase brought Amazon’s extensive tax-avoidance playbook into the public record. Dozens of pages of internal company rulebooks, flowcharts, and maps were filed with the King County Superior Court on Third Avenue in downtown Seattle. Together, they revealed a fascinating portrait of a company desperately contorting itself to accommodate a rapidly shifting tax climate.

The guidelines approached the surreal. Amazon employees had to seek approval to attend trade shows and were told to avoid activities that involved promoting the sale of any products on the Amazon website while on the road. They couldn’t blog or talk to the press without permission, had to avoid renting any property on trips, and couldn’t place orders on Amazon from the company’s computers. They could sign contracts with other companies, such as suppliers who were offering their goods for sale on the site, only in Seattle.