Wednesday, 6 June 2012

United States v Apple – the E-book case

This article first appeared in the CCH Australian Competition & Consumer Law Tracker, Issue 5, May 2012.


The US Department of Justice’s (DOJ) announcement of its legal proceedings against Apple Inc (Apple) and a number of major publishers was accompanied by a great deal of fanfare. For example, Attorney General Eric Holder stated at the press conference which was held to announce the legal action that “[T]oday’s action sends a clear message that the Department’s Antitrust Division continues to be open for business – and that we will not hesitate to do what is necessary to protect American consumers.”[1]

Despite the rhetoric, the DOJ’s case against Apple is far from being an antitrust success story. This is because the DOJ has decided to yet again take civil proceedings against Apple for engaging in a naked price fixing arrangement in breach of section 1 of the Sherman Act. It is difficult to understand why the DOJ commenced civil proceedings against Apple and the five major publishers given that the parties were involved in a blatant high-level cartel which, according to some estimates, may have cost US consumers alone more than $100 million. [2]

The DOJ’s decision to take civil proceedings against Apple is even harder to understand given that it is only a year since the DOJ decided to settle yet another serious cartel investigation into Apple on a civil basis.[3] Ultimately, the DOJ’s approach to Apple’s serious antitrust indiscretions will achieve little unless it starts seeking the imposition of criminal sanctions. Indeed, it is only through the imposition of criminal sanctions that Apple may start thinking differently about antitrust laws.


The commencement of legal proceedings against Apple and the five publishers was highly anticipated. This is because the enforcement action followed the commencement of a number of private class actions against both Apple and the publishers in the US during 2011. There had also been a number of rumours that the DOJ, the European Commission and other regulators were investigating the conduct of Apple and its alleged co-conspirators.

The DOJ’s action against Apple and five different book publishers – Hachette, HarperCollins, Macmillan, Penguin and Simon & Schuster was for allegedly entering into an illegal cartel to force up the prices of e-books. In response to the allegations, three of these publishers – Hachette, HarperCollins and Simon & Schuster agreed to settle. These proposed settlements will be discussed in more detail below.

In general terms, the DOJ alleged that senior executives at each of the publishers worked together in an elaborate plan to eliminate competition among stores selling e-books, ultimately increasing prices for consumers. The focus of their plan was to eliminate the “wretched $9.99 price point” for new releases and bestsellers introduced to the e-book market by Amazon.

As explained in the DOJ’s Complaint,[4] the publishers had long feared that the lower retail prices for e-books would eventually lead to lower wholesale prices for all books. However, whilst senior executives met regularly to bemoan this particular development, they also recognised that individually they were unable to do anything about Amazon’s discounting activities.

The publishers understood that if any of them decided to unilaterally cease supplying books to Amazon because of their $9.99 price point for new release and bestseller e-books, they were likely to lose a large volume of sales which would make the decision highly unprofitable. As stated by one of the executives of the publishing companies:

…we’ve always known that unless other publishers follow us there is no chance of success in getting Amazon to change its pricing practices…without a critical mass behind us Amazon won’t negotiate, so we need to be more confident of how our fellow publishers will act.[5]
The publishers were not only worried about Amazon’s low prices for e-books, but also that Amazon may decide to establish its own digital publishing business in competition with the publishers. This would have meant that Amazon would be in a position to sell its own e-books rather than having to rely on supply from the major publishers.

The major publishers had some legitimate cause for concern about this development. As stated in the DOJ’s complaint, Amazon had in fact taken the first steps in establishing its own digital publishing business. On 18 January 2010, Amazon had a meeting with a number of prominent authors and agents in New York to explain its plan to become a digital publisher. Amazon advised its audience that in future authors would be able to take their books directly to Amazon to be digitally published and sold through Amazon’s online bookstore. In return, Amazon would pay royalties of up to 70% which was far in excess of the royalties which traditional book publishers paid authors. When the major publishers heard about this particular meeting, they became incensed.[6]

Unlawful conduct

According to the DOJ, the publisher’s alleged unlawful conduct started in late 2008. At this time, the senior executives of the major publishers started discussing ways of dealing with the “Amazon problem”. There were a series of meetings and telephone discussions between these executives to work out a strategy to counter Amazon’s pricing strategy.

The DOJ alleged that all five publishers had agreed by 2009, at the latest, to act collectively to try to raise retail prices above the $9.99 price point for the most popular e-books. However, even though the publishers had agreed on the outcome which they wanted to achieve, they could not decide on a mechanism to achieve that outcome.

As stated by an executive of one of the publishing companies at that time:

In the USA and the UK, but also in Spain and France to a lesser degree, the ‘top publishers’ are in discussions to create an alternative platform to Amazon for e-books. The goal is less to compete with Amazon as to force it to accept a price level higher than 9.99…I am in NY this week to promote these ideas and the movement is positive with [the other publishers].[7]
The initial approach contemplated by the publishers was to establish a number of “sham” joint ventures. As stated by John Makinson, CEO of the Penguin Group:
Competition for the attention of readers will be most intense from digital companies whose objectives may be to disintermediate traditional publishers altogether. This is not a new threat but we do appear to be on a collision course with Amazon, and possibly Google as well. It will not be possible for any individual publisher to mount an effective response, because of both the resources necessary and the risk of retribution, so the industry needs to develop a common strategy. This is the context for the development of Project Z [joint ventures] in London and New York.[8]
In late 2009, the publishers changed their approach. They decided that a more effective way of getting Amazon to “return to acceptable sales practices” would be to move away from a wholesale model to an agency model.

The traditional way that books are sold is through a wholesale model. Under this model, publishers sell books to retailers at wholesale prices and leave it up to the retailer to set their own retail prices.

However, under the agency model it is the publisher that retains control over retail pricing by retaining property or ownership of the books until they are sold to the end customer. A publisher appoints a retailer as its agent who must then sell the e-books at the price determined by the publishers.

It was at about this time, in late 2009, that Apple became involved. Apple had long been contemplating entering the e-book market, but the low prices were proving to be a disincentive. As stated in the complaint: 

Apple had long believed that it would be able to “trounce Amazon by opening up [its] own ebook stores, but the intense price competition that prevailed among e-book retailers in late 2009 had driven the retail price of popular e-books to $9.99 and had reduced retailer margins on ebooks to levels that Apple found unattractive.[9]
Interestingly, the first alternative which Apple considered when deciding how to enter the e-book market was whether it should enter into a global cartel with Amazon to carve up the market. As stated in the DOJ’s complaint, the first strategy that Apple considered was to enter into a cartel with Amazon to illegally divide “the digital content world” allowing each to “own the category of its choice – audio-visual to Apple and e-books to Amazon.”[10]

It appears that Apple abandoned its plans to enter into a cartel with Amazon in favour of facilitating a cartel between the five major publishers.

Towards the end of 2009, Apple started actively pursuing its plan to enter the ebook market – a plan which it described in internal documents as its “aikido move”.[11]

In early December 2009, Eddie Cue, Apple’s Vice President of Internet Services telephoned each of the publishers to schedule exploratory meetings in mid December 2009 in New York.

After receiving these calls from Cue, the senior executives from HarperCollins and Hachette contacted each other to discuss their preferred strategy. They agreed that the way forward was to move to an agency model.

Over the next couple of weeks, all of the publishers advised Apple of their intention of moving to an agency model.

A second round of meetings between Apple and the publishers occurred during the week commencing 21 December 2009. During these meetings Apple proposed that each of the publishers force all of their retailers, not just Amazon, to move to an agency model. As stated in the complaint, this proposal appealed to the publishers because “wresting pricing control from Amazon and other e-book retailers would advance their collusive plan to raise retail e-book prices”.[12]

After these meetings, Cue reported to the late Mr Steve Jobs, the CEO of Apple, that the publishers saw the “plus” of working with Apple to “solve the Amazon problem”. However, he added that the publishers did not like Apple’s proposed pricing of $12.99 for new release and bestseller e-books, which they believed was too low.

Apple realised that it had considerable leverage with the publishers who were desperate to solve the Amazon problem. Accordingly, Apple demanded a commission of 30% on the sale of every e-book sold through its iBookstore. The publishers were even more reluctant to agree to this level of commission given Apple’s proposed pricing of $12.99 for new release and bestseller ebooks.

Negotiations between Apple and the publishers continued throughout late December 2009 and January 2010. Apple became the go-between for the publishers, keeping each publisher informed of the progress of negotiations with the other publishers. Apple also assured each publisher that its proposals to each of the publishers were the same – ie that it was not planning to cheat on the cartel by doing a more favourable deal with any of the publishers.

In early January 2010, Cue emailed a proposal to all the publishers which contained the following features:

  • the publishers would become the principals and Apple the agent for e-book sales;

  • the publishers would introduce an agency model for all other e-book retailers;
  • Apple would receive a 30% commission on each e-book sale; and
  • each publisher would have identical pricing tiers for e-books sold through Apple’s iBookstore.
On 11 January 2010, Apple emailed a formal e-book distribution agreement to all the publishers. This formal agreement contained three significant changes to the earlier proposal – namely Apple:
  • demanded that the publishers provide Apple with their complete e-book catalogs;
  • demanded that the publishers not delay the electronic release of any title behind its print release; and
  • introduced a most favoured nation clause (MFN).
The way the MFN clause operated was to require that each publisher guarantee that it would lower the retail price of each book in Apple’s iBookstore to match the lowest price offered by any other retailer, even if the publisher did not control that other retailer's ultimate retail price.

While the DOJ described this MFN clause in the complaint as being “unusual”, this is not entirely correct in the context of an agency model. Because the publishers were proposing to set the retail prices for all e-books, there was no point having a traditional MFN forcing publishers to reduce their wholesale e-book prices to match the lowest wholesale prices in the market. Rather what Apple needed was some assurance that the publishers would not be able to offer e-books through other retailers at prices which were below the prices which Apple was selling the same e-books. As is apparent the practical effect of the MFN was to fix the retail prices for e-books.

However, the illegal conduct did not end there. The publishers were still concerned about Apple’s proposed $12.99 pricing point, particularly if they were going to have to pay Apple 30% commission. In response to the publisher’s concerns, Apple agreed to modify the agreement.

On 16 January 2010, Apple sent a revised agreement to all the publishers which included two significant concessions to the publishers:
  • the addition of new maximum pricing tiers for e-books of either $16.99 or $19.99 depending on the books hardcover list price; and
  • a carve out for e-book versions of books on the New York Times fiction and non-fiction bestseller list – namely a maximum e-book price of $12.99 for bestsellers with a hardcover price which was $30 or less and a maximum e-book price of $14.99 for bestsellers with a hardcover price between $30 and $35.
Between 24 January 2010 and 26 January 2010, all of the publishers signed the distribution agreements with Apple. The Apple Agency agreements took effect simultaneously on 3 April 2010 with the release of Apple’s new iPad.

Once the agency agreements took effect, the publishers raised e-book prices at all retail outlets to the maximum level permitted under the agreements.

Steve Jobs’ involvement

It is also apparent from the DOJ’s complaint that Steve Jobs was heavily involved in the events. The Complaint records the following statement allegedly made by Jobs to publishers about Apple’s e-book strategy:

We go to an agency model, where you [the publishers] set the price, and we get our 30% and yes, the customer pays a little bit more, but that’s what you [the publishers] want anyway.[13]
The Complaint also refers to a report in the Wall Street Journal following the 27 January 2010 iPad unveiling event. A journalist apparently asked Jobs why customers would buy an e-book from Apple at $14.99 when they could get the same book from Amazon for $9.99. Jobs apparently responded by saying “…that won’t be the case…the prices will be the same”.[14]

Finally, the Complaint recounts how Jobs personally intervened to try to get a publisher who had not agreed to sign an agency agreement to change their mind. Apparently, Jobs called the CEO of the “holdout” publisher,[15] at the behest of the respondent publishers, to advise that Apple would refuse to sell any of its e-books unless it agreed to enter into an agency agreement.[16]


As stated above, three of the five publishers, namely Hachette, HarperCollins and Simon & Schuster, have agreed with the DOJ to a proposed settlement. Under the settlement, these publishers will be required to: 

  • grant retailers the freedom to reduce the prices of their e-book titles; and

  • terminate their anticompetitive most-favored-nation agreements with Apple and other e-books retilers. 
The settlement also includes injunctions prohibiting the publishers from placing constraints on retailers’ ability to offer discounts to consumers and from conspiring or sharing competitively sensitive information with their competitors.

Violations Alleged

The DOJ has alleged that the conduct of Apple and the publishers constituted a conspiracy and agreement in unreasonable restraint of interstate trade and commerce in violation of Section 1 of the Sherman Act. In particular, the defendants are alleged to have conspired:

  • to raise, fix and stabilise retail e-book prices;
  • to end price competition among e-book retailers; and
  • · to limit retail price competition among publishers by fixing retail e-book prices.
The DOJ stated that the conduct had resulted in obvious and demonstrable anticompetitive effects on consumers in the trade e-books market by depriving consumers of the benefits of competition among e-book retailers. As stated above, one estimate has placed the total loss arising from the illegal cartel at $100 million in relation to US consumers alone.


The question arises as to why, given the seriousness of the conduct, the DOJ decided to take a civil action against Apple and the publishers rather than commence a criminal prosecution. In deciding whether to pursue cartel conduct through a criminal prosecution, an antirust agency would generally consider a range of factors including:
  • the anticompetitive effect of the cartel conduct;
  • whether the conduct had been blatant;
  • whether senior executives had been involved in the cartel conduct;
  • whether the members of the cartel had taken any steps to conceal their conduct
  • the level of remorse and contrition shown by the cartel members once they have been discovered;
  • the duration of the cartel; and
  • whether the participants in the cartel had previously been found to have engaged in similar cartel conduct.
It seems that even on a cursory consideration of the above factors, the DOJ should have pursued a criminal prosecution against Apple and the publishers. First, it appears that the alleged illegal anticompetitive conduct has created a great deal of consumer detriment, up to a $100 million overcharge in relation to US consumers alone. Second, the conduct appears to have been quite blatant with senior executives of each company, including the late Steve Jobs, being instrumental in creation of the cartel. Third, the Complaint also states that steps were taken by the publishers to conceal their illegal conduct. Finally, half of the participants in the alleged cartel have shown no apparent remorse or contrition, vowing the fight the case to the end.

Another very significant factor in deciding whether to pursue a cartel criminally is whether the company has been found to have engaged in illegal cartel conduct in the past. Therefore, a highly relevant factor for the DOJ should have been that just a year before, in May 2011, Apple settled a serious cartel investigation with the DOJ involving three illegal cartel agreements. These cartel agreements with Google, Adobe and Pixar had the purpose of prevented each of the companies from poaching the other’s technical staff.

The DOJ concluded that these particular agreements (as well as a number of similar agreements between Google, Intel, Intuit and LucasFilms) constituted naked restraints of trade in violation of section 1 of the Sherman Act. In particular, the DOJ described the competitive effects of these agreements as follows:

The effect of these agreements was to reduce Defendant’s competition for highly skilled technical employees (high tech employees), diminish potential employment opportunities for those same employees and interfere with the proper functioning of the price-setting mechanism that would otherwise have prevailed.[17]

For more details about this case see the previous post on this blog entitled Monsters Inc - No Headhunting Allowed, dated 4 August 2011 which can be found at:

Despite these earlier blatant contraventions, the DOJ again decided to take civil proceedings against Apple in relation to a serious cartel allegation.The most likely explanation for the DOJ’s decision not to take criminal proceedings is due to a concern that they may not be able to prove their case to the criminal standard. This concern may arise from the fact that the agreements specify a maximum price, rather than a minimum price below which the publishers are not permitted to set their prices. Accordingly, the DOJ may have taken the view that because publishers retained at least the theoretical ability to set prices at levels which were lower than the maximum prices listed in the agreements, they had not technically agreed to fix prices.

However, it is hard to see how Apple or the publishers will be able to succeed with this argument, given the compelling evidence identified in the DOJ’s complaint. It is clear that the publisher’s goal was to eliminate Amazon’s $9.99 price point for new releases and best sellers. Furthermore, the evidence referred to in the Complaint shows that the publishers agreed to charge the maximum prices listed in the agreements, which is also what they ended up doing.


The DOJ has touted its case against Apple and the publishers as a significant achievement. Unfortunately, it is difficult to agree with the DOJ’s assessment of its case. Cartels of the type entered into by Apple and the publishers should, in all but the most exceptional cases, be punished with the imposition of criminal sanctions – they should not be resolved through civil proceedings.

Not only is it wrong as a matter of principle to resolve blatant cartel conduct engaged in by senior executives which has caused immense consumer detriment through civil proceedings, but civil such proceedings will not achieve either of the main goals of antitrust – namely, specific and general deterrence. Only through the imposition of criminal sanctions will large corporations, such as Apple, be deterred from engaging in illegal cartel conduct in the future.

Finally, it is hard to understand why Apple has again been subject to a civil proceeding for engaging in an apparently blatant cartel in relation to e-books given that only 12 months previously the DOJ settled an equally blatant cartel investigation against Apple on a civil basis. One thing is clear – it is only through the imposition of criminal sanctions that Apple may start thinking differently about antitrust laws.

[2] Two U.S. Publishers and Apple, Inc. Charged with Price-Fixing for E-books that Resulted in more than $100 Million of Overcharges, Attorney General of Massachusetts, Media Release, dated 11 may 2012 -

[3] United States v Adobe Systems, Inc., Apple Inc., Google Inc., Intel Corporation, Intuit, Inc., and Pixar – (United States v Adobe)

[4] United States v. Apple, Inc., Hachette Book Group, Inc., HarperCollins Publishers L.L.C., Verlagsgruppe Georg Von Holtzbrinck GmbH, Holtzbrinck Publishers, LLC d/b/a Macmillan, The Penguin Group, A Division of Pearson PLC, Penguin Group (USA), Inc., and Simon & Schuster, Inc.

[5] Ibid., p. 11.
[6] Ibid., p. 23.
[7] Ibid., p. 15.
[8] Ibid.
[9] Ibid., p. 3.
[10] Ibid., p. 16.
[11] Ibid., p. 4. The description of Apples’ plan as the aikido move seems quite ironic given the essence of aikido is a form of self-defence – ie to protect a person from attack by using the attacker’s force against the attacker.
[12] Ibid., p. 18.
[13] Ibid., p. 4.
[14] Ibid., p. 26.
[15] It appears that the “holdout” publisher was Random House.
[16] Ibid., p. 29.
[17] Competitive Impact Statement, United States v Adobe Systems, Inc.-

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