The Publishers and The Department of Justice—What’s It All About?

Still confused about what the Apple lawsuit means for publishing? Here’s what our founder Betty Sargent had to say about it.

Update: Our lawyer, Eric Rayman, has gone in and made a few edits, so now we’re confident that this is the best possible explanation we can bring you!

ereader-library-650x0

The Agency Model vs. The Wholesale Model and What It All Means

It’s confusing, isn’t it? The Department of Justice is suing Apple for price fixing and collusion, but what kind of price fixing, and colluding with whom? If you want to have a somewhat clear idea about what is going on in this precedent setting law suit it is important to understand just what is meant by The Wholesale Model and The Agency Model. I’ve been struggling with all this for weeks now but here’s what I think it all comes down to.

The Wholesale Model

For years books were sold using the wholesale model. This means that the publishers would set a Suggested Retail Price (SRP) for their books. This is the price typically printed on the book. The publisher then sells the books to a retailer or a wholesaler (like Ingram or Baker & Taylor) at a discount off this price. The discounts vary but in general for books sold on a returnable basis to bookstores and book wholesalers, the discount is about 50%. The price the retailer paid for the book was called the wholesale price. Under US law, the retailer is free to resell the book at whatever price it chooses. Usually they would charge the full SRP that had been set by the publisher but they were free to sell the book for less, even less than they had paid for it, if, for some reason, that made sense to them. (They were even free to sell the book for more than the SRP, which would occasionally happen in remote places where there was not any competition.)

Then, when eBooks came along, publishers stuck with the wholesale pricing method. But some retailers, Amazon in particular, wanted to sell new releases and bestselling eBooks at $9.99 or less to help drive sales of its Kindle ereaders. At times, Amazon was selling eBooks for less money than the wholesale price they had paid for the book. Amazon was willing to take a loss on these eBooks, using them as loss-leaders to encourage customers to buy a Kindle and perhaps even other products from the company.

The Agency Model

When Apple launched its iBookstore, instead of agreeing to the wholesale model they signed contracts with the major traditional publishers to use what they call the agency model.

The terms of the agency model allow the publishers, not the retailers, to control the retail price of an eBook. The publisher is the “principal” and appoints Apple as its “agent” to sell the book. Since Apple is an “agent,” not a “buyer” of the eBook, the publisher could set the actual retail price. It was no longer a “Suggested” retail price. Apple or any “agent” selling eBooks would get a commission on the sales of the eBook. Apple’s commission is 30% of the price charged to the consumer.

Most Favored Nation Clause (MFN)

But there’s more. The agency model that Apple established with the traditional publishers includes a most-favored-nation (“MFN”) clause. In traditional contractual agreements, an MNF means that the seller will not offer better terms to any other buyers. The MFN in the agency model that Apple and the publishers have agreed to required that if any other seller of an eBook was selling the eBook for less than the price set by the publisher for the book in the Apple iBookstore, Apple could match that price – whether or not the publisher had any say in the pricing used by that retailer.

Bottom line: the iBookstore would always have the eBook at the lowest price. If any retailer in the U.S. were offering the book at a lower price, the publisher would have to drop the retail price to match it. Since that result would have defeated the publishers’ goal of setting the eBook price (and in many cases, raising that price above what Amazon was charging), the publishers had to implement the agency model across the board for all of their sales of eBooks. And that’s what they did. The agency model became the standard terms of sale for the six largest publishers.

What The DOJ Is Concerned About

As I understand it, the Department of Justice contends that the publishers and Apple colluded to raise the prices of eBooks by switching to the agency model so that retail price competition for books would cease. According to the DOJ, the top executives of five of the six largest publishers communicated with each other to discuss the Apple agency and MFN terms, and Apple itself even acted as the go-between, to confirm that they would all be signing the same agreement with Apple. The DOJ’s position is that the agency model would not have come about without a “conspiracy among the defendants.” The big problem, in the view of the DOJ is that with the adoption of the agency model retailers have lost the ability to compete on price. They also contend that once publishers gained control over prices they limited retail price competition among themselves as well. They contend that “millions of eBooks that would have sold at $9.99 or for other low prices instead sold for…$12.99 or $14.99.”

These five publishers and Apple were sued by the DOJ, and by the Attorneys General of many states and by a group of plaintiffs’ lawyers seeking class action status. The five publishers have settled the claims against them. They did so without admitting or conceding guilt. In fact, they all adamantly deny agreeing to set prices. None of them have been found guilty. They did, however, pay significant amounts in order to settle the charges.

Apple has not settled. Apple is currently on trial before Judge Cote in Federal District Court in New York, NY. The trial is likely to last a few more weeks. If there should be a finding against Apple, it’s likely it will appeal so we may not have a final determination about Apple’s conduct for years.

 

(image via Digital Trends)

Advertisements