Thursday, April 12, 2012

What did Apple do wrong?

Some big news from yesterday:

The Department of Justice sued Apple and five of the world’s largest book publishers on Wednesday, alleging that they colluded to increase the price of ebooks and cost consumers “tens of millions of dollars”. 
The complaint, filed in the Southern District of New York, alleges that Apple and publishing executives agreed on a common response to Amazon’s pricing policy over phone calls, emails and meals in the “private dining rooms of upscale Manhattan restaurants”. Amazon, which had challenged the industry with a maximum ebook price of $9.99, is not named as a defendant.
The full story is here.

Essentially, Apple representatives (including Steve Jobs) sat down with five other publishing companies to develop an "agency pricing model", where publishers sell their titles to Apple at a reduced price and Apple will receive 30 cents of every sale. One of the kickers is that the five publishers signed onto the "most favored nation" clause, where they agreed not to sell to other vendors (i.e. Amazon) at lower prices.

If you've taken Econ 101 - you might say that this sounds very cartel-esque, with all the talk of price fixing and colluding.

Richard Epstein writes about how this isn't necessarily the case:
Right now under the so-called “wholesale” pricing model, the retailers of eBooks set the prices however low they choose.  Clearly they cannot set these prices below the cost of production that has to be paid for the eBooks they peddle.  But the marginal price for the production of an additional eBook is close to zero, so the retailers know that if they pay very little under this model the publishers will have no choice but to go along with the low prices.  This strategy has let to price eBooks at around $9.99, which is a steep discount over the hard cover version. 
In dealing with these matters, Apple proposed to all publishers that they shift to an agency model, whereby the publishers set their own prices and that Apple receive a 30 percent commission for the sales over its network.  This same model could be offered to Amazon, which would allow it to compete on even terms with Apple, but would raise its prices, lower its margins and reduce its profits. 
And there are a few reasons why this wouldn't fall under traditional antitrust violations.

For one, this new pricing model can work for Amazon too. It's not like Amazon is being locked out of this deal. As Epstein pointed out, the marginal cost of an eBook is so low, so Amazon/Apple (the big bad retailers) can charge as little as they want as long as it doesn't fall below marginal cost. The only problem is that when the price is so low there is increased disincentive to produce titles.

I think Epstein's biggest point is that this new model could have been proposed by a publisher, as well. And it's probably a more efficient system, where consumers are paying for the "real" price of the eBook. It just so happened that Apple (which has large influence over the market) started a trend that was bound to happen eventually.

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