A Review of the E-book Industry: U.S. v. Apple, Inc., et al.

Robin Shaban

December 17, 2012

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On April 11, 2012 the American Department of Justice filed a complaint against Apple, Inc., and five

other publishing companies (“the publishers”): Hachette Book Group, Inc.; HarperCollins Publishers

L.L.C.; Verlagsgruppe Georg von Holtzbrinck GmbH and Holtzbrinck Publishers, LLC (d/b/a

Macmillan ); The Penguin Group, a division of Pearson pic and Penguin Group (USA), Inc.; and Simon

& Schuster, Inc.. The six defendants, Apple, Hachette, HarperCollins, Macmillan, Penguin, and Simon

& Schuster are being/have been tried in the Southern District of New York for antitrust violations

under Section 1 of the Sherman Act. Specifically, the Department of Justice (DOJ) accuses Apple and

the publishers of conspiring to reduce price competition in the e-book market and increase the price of

e-books (DOJ, 2012). Apple and the publishers jointly created a plan to force e-book retailers and, and

in particular Amazon, to increase the prices they charge for e-books. The publishers created a cartel and

maintained their agreement long enough to achieve their goal. The result of the collusion was higher

average e-book prices and the removal of price competition in the e-book market.

This paper will outline the case and the results of Apple and the publishers’ alleged conspiracy

in three sections. The first section will be an overview and analysis of the market for e-books. The

second section will look at the agency and wholesale models of the e-book industry in the context of

economic theory. The visible results of the conspiracy and the resolution, thus far, of this suit will be

discussed in section three.

Pre-Cartel E-book Market Overview

The Complaint issued by the Department of Justice gives a through and insightful description of the

trade book industry, which includes both paper books and e-books, as it is relevant to the case. Unless

otherwise stated, information in this section is sourced from the Complaint.

The creation and sale of trade books, both paper books and e-books, is undertaken by publishers

and retailers. For paper books, publishers accept manuscripts from writers, edit them, produce the

physical book, and invest in advertising some of the books they produce. They make decisions

regarding book release dates and the “list price”, or the suggested retail price, of books. The list price is

usually printed on the back cover and is typically the price at which retailers sell the book. Retailers

purchase books from publishers in a wholesale system and establish their own markup that can differ

from the suggested retail price. Publishers and retailers have purchased and sold books in this way for

over 100 years.

For e-books, the roles of publishers and retailers are the same except for the physical production

of the book. In this sense, e-books provide an advantage to publishers because it costs considerably less

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to produce and distribute e-books than paper books. E-books do not need to be warehoused and

undersold stock is never an issue. Retailers also benefit from similar cost savings.

Publishers compete against each other in sales of books, both paper and e-books, to consumers.

The DOJ emphasizes that publishers, and retailers, compete strongly in retail prices of e-books. Product

differentiation is also an important aspect of the competition between publishers, and may serve to keep

e-book prices above marginal cost. They compete in publishing rights to works that they believe will be

successful in the market, and produce other differentiating aspects of the book, such as cover artwork.

There are many e-book retailers in the market and many of them are small and specialized (for

example, All Romance E-Books). However, the industry is concentrated around a few large firms. The

prominent retailers are all associated with their own e-book reader: Amazon has the Kindle, Apple has

the iPad with the iBooks application, Kodo with the Kodo reader, Sony with its Reader, and Barnes &

Noble with the Nook.

The major retailers sell e-books in specific formats. The epub format is the industry-wide

standard for e-books, and is used by Sony in its Reader Store, Barnes and Noble, and other smaller

retailers. It is the most widely compatible and can be read on Microsoft and Mac operating systems, as

well as nearly all mobile devices.

Amazon sells e-books in its proprietary Mobipocket format, which can be read only on the

Kindle and on applications designed for PC, Mac, iOS, Android, Blackberry, and other devices.

Mobipocket files cannot be read on other e-book readers and the Kindle only reads files in Mobipocket

and pdf formats (E Book Architects, Formats, 2011).

Apple's reader, iBooks, is an application available on any mobile Apple device (iPads and

iPhones) that supports e-books in Apple’s proprietary format as well as the epub format. Customers

who own Apple devices can download iBooks for free from iTunes and the application provides the

consumer access to the iBookstore (Apple INC., 2012).

Amazon is known as the biggest e-book retailer (E Book Architects, Retailers and Distributors,

2011). According to the DOJ's complaint, Amazon possesses considerable clout as an e-book retailer

due to its large share of the e-book retail market. However, it is impossible to find any accurate data

regarding how much market share Amazon really possesses. All publishers relied on Amazon to sell

their e-books, suggesting that Amazon possessed some degree of monopsony power.

One of Amazon's most successful strategies was to offer best-selling and newly released books

for $9.99. The result of the “$9.99 strategy” was that other e-book retailers matched Amazon's prices,

which drove down the price of popular e-books in the market, ultimately benefiting consumers.

Publishers feared that Amazon's $9.99 strategy may permanently reduce e-book prices and put

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downward pressure on wholesale prices for e-books. As well, low prices for e-books may alter

consumer's price expectations for paper books, and thus force downward the retail and wholesale prices

for paper books. The $9.99 strategy was known as the “[w]retched $9.99 price point” (par.32).

Publishers felt they had to re-establish higher e-book prices before the low prices for books

became an “entrenched consumer expectation” (par.3). The publishers recognized that individually

they could not force Amazon to abandon the $9.99 strategy. Due to Amazon's sizable market share in

the e-book retail market, it would not suffer greatly if it were to stop selling a publisher's books.

However, if a publisher were barred from selling its books to Amazon, the publisher would be

disadvantaged. Publishing companies realized that the only way to influence Amazon would be to

collude and, effectively, jointly offer Amazon an ultimatum: “either increase prices or we will not sell

our books to you”. Collectively, the five publishers produced over half of the New York Times best

seller's list for both fiction and non-fiction at any given time. Without the books produced by all the

colluding publishers, Amazon would surely suffer.

Outside of prices, Amazon also posed another threat to publishers. Prior to their collusion in

January 2010, the publishers speculated that Amazon was making moves to publish its own e-books,

making it a direct competitor with the established publishers. The publishers’ speculations were correct;

Amazon had begun to contract directly with authors and offered them a higher royalty rate than the

publishers currently offered. The threat of Amazon's entry into the publishing business further

motivated the publishers to undermine Amazon.

Apple and the Publishers shared a common interest. In April 2010, Apple was interested in

launching its own e-book retailing service to go along with its new device, the iPad. This move would

make Apple a direct competitor with Amazon and its Kindle reader. However, the prevailing prices for

e-books established by Amazon's $9.99 strategy did not provide a profit margin that could justify

Apple's entry into the market. In particular, Apple wanted a 30% margin on the e-books it sold.

Analysis

Both Apple and the Publishers were motivated to increase the prices of e-books. Apple required higher

prices in order to justify entry. The publishers desired higher prices in order to prevent retailers from

pressuring them to reduce their wholesale prices for both e-books paper books. The best way to satisfy

both Apple's and the Publisher's goals were to create a scheme that would force upward the retail prices

for e-books. This scheme, which includes explicit collaboration between all the publishers and Apple,

is the issue that the DOJ is addressing in the suit.

However, there is a major problem regarding the DOJ's argument. In the Complaint, the DOJ

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defines the market as only e-books. They assert that e-books have no reasonable substitutes. The

technology of e-books and their readers, and the added benefits the technology provides, is clearly

different than paper books. So long as there is an internet connection, E-books can be found and

purchased anywhere. One can carry thousands of books on one e-book reader. As well, the DOJ argues

that since Apple and the Publishers were able to impose higher prices on only e-books, e-books should

be viewed as their own market.

According the Complaint, the publishers believed that low e-book prices would force downward

the prices for paper books. Consumers would expect the prices for paper books to be similar to the

price of e-books because they do not strongly differentiate between paper books and e-books. This

relationship implies that e-books and paper books are highly substitutable. It may be more appropriate

to identify the relevant market as the market for trade books (including both paper books and e-books)

rather than just the market for e-books.

Regardless of the scope of the market, according to the description of the market(s) outlined in

the overview, the markets for e-books and trade-books generally could be defined as a differentiated

Bertrand game: The market is concentrated with a small number of firms; the books are differentiated

in terms of genre, author, artwork, etc.; and retailers, and sequentially publishers, compete in price. The

price decreases in e-books as a result of Amazon's $9.99 strategy is clear evidence that the retailers

compete in price similar to that of a typical differentiated Bertrand model.

Cartel Creation and the Agency Model

Similar to the previous section, Apple and the publishers' conspiracy will be fully outlined using the

information provided in the DOJ's Complaint. The outline will be followed by an analysis of the

wholesale and agency models.

Both Apple and the defendants shared the same desire to raise e-book prices. The defendants

understood that in order to enact the change they desired they had to collude to develop and implement

a scheme that prevented retailers from setting retail prices. In particular, they had to take away

Amazon's ability to drive down prices in the market. The result of their plan would be to eliminate

price competition in the e-book industry.

The conspiracy allegedly began in summer 2009, and by late 2009 the publishers and Apple had

solidified their cartel and were prepared to implement their plan. Their plan was to replace the

traditional wholesale model of e-book sales with an agency model. The publishers would enter into

agency agreements with all their retailers, enabling the publishers to collectively set retail prices for

their e-books. They would set the prices of e-books subject to pricing tiers developed jointly by the

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publishers and Apple. The retailers, as agents to the publishers, would sell e-books according to the

pricing tiers.

In order to force Amazon to accept the publisher's agency agreements, and thus the pricing tiers,

the publishers offered an ultimatum to Amazon simultaneously. Since the five colluding publishers

made up so much of Amazon's e-book collection, Amazon had no choice but to enter into agency

arrangements with all five of the publishers. As a result, e-book prices increased.

From September 2008 into 2010, the CEOs of the six most prominent publishing companies

held meetings approximately once a quarter to discuss industry issues, and in particular, Amazon's

pricing strategy. Random House participated in the talks however, it did not engage in the final

conspiracy. All the publishers agreed that Amazon's $9.99 strategy was detrimental to them, and

replacing the wholesale model with the agency model across the e-book industry would be the best

strategy to raise prices.

Coincidentally, in December 2009, Apple contacted all six of the major publishers to discuss

Apple' possible entry into the e-books market. The publishers and Apple, at this point, recognized their

joint goal of increasing e-book prices. Hachette and HarperCollins communicated to Apple their desire

to replace the wholesale model with the agency model, and the other publishers told Apple that they

would like to change the current system. The defendant publishers (the six publishers, less Random

House) and Apple resolved to collude in order to instate the agency model and create a market-wide

pricing standard.

Apple's role in the conspiracy was to facilitate the creation of the cartel. For each publisher,

Apple would negotiate an “Apple Agency Agreement”. By signing the Apple Agency Agreements, the

publishers “locked” themselves into the cartel. All the Apple Agency Agreements contained a most

favored nation (MFN) provision that implicitly required each publisher to enter into agency agreements

with all other e-book retailers, and thus transform the e-book industry's wholesale model into an agency

model.

Throughout the contract negotiation process, Apple assured the publishers that the other

publishers would not deviate from the plan and informed the publishers as to the status of its

negotiations between the other publishers. Amongst each other, the publishers frequently

communicated, and exchanged assurances.

Due to this valuable role in the contract negotiations and cartel formation, Apple could bargain

favorable terms for itself. Apple demanded that the Publisher Defendants provide their complete e-

book catalogs to Apple and that they not delay the electronic release of any title behind its print release.

More importantly, Apple guaranteed a thirty percent commission on the books it sold (with the other

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seventy percent going to the publishers) which was a substantially greater margin than the market

average.

The Apple Agency Agreements outlined pricing tiers in Apple's iBookstore where books were

priced either at $16.99 or $19.00, depending on the hardcover price of the book. As well, there were

special pricing schemes for books on the New York Times best sellers list. For books that were less

than $30 in paper, publishers could set a price of $12.99, and for books more than $30, publishers could

set the price to be $14.99.

The MFN provision in the Apple Agency Agreements insured that the pricing tiers were

implemented in the e-books market. It guaranteed that the publishers would set e-book retail prices in

the iBookstore to match the lowest price offered by any other retailer, even if the publisher did not

control the prices of that retailer. Since the publishers received seventy percent of the retail price of

their e-books sold through the iBookstore, they would carry some of the burden of a price reduction. In

this way, the MFN clause provided an incentive for the publishers to gain control of e-book retail prices.

The publishers created and entered agency agreements with all their retailers and succeed in

guaranteeing the pricing tiers in the market.

Within four months after the Apple Agency Agreements were signed, all the major e-book

retailers had signed an agency agreement with each publisher. The negotiations between the publishers

and all the other retailers are not specified in the complaint. However, the complaint does describe the

publishers' negotiations with Amazon.

The first publisher to approach Amazon with an agency agreement was Macmillan. Macmillan

presented Amazon with an ultimatum: “either accept our agency agreement, or we will not let you sell

the e-book versions of our hardcover titles for the first seven months of their release”. Amazon refused

Macmillan's proposal, and retaliated by ceasing to sell any Macmillan books. The conspiring publishers

rallied behind Macmillan and Amazon began to face similar propositions from the other publishers.

Amazon soon had no choice but to accept all the agency agreements offered by the publishers.

The publisher Random House did not participate in the cartel. Although the Complaint does not

explicitly name Random House as the hold-out firm, the Complaint does list Random House as a

member of the original talks from September 2008 to 2010. As well, Random House is one of the

major publishers in the book industry (Digital Inspiration, 2010). According to the Complaint, Random

House was gaining market share after the agency model due to its deviation.

Apple attempted to entice Random House to join the cartel. Apple failed, so the cartel sought to

punish Random House for not joining the collusion. Apple refused to sell Random Houses' books

unless it signed an Apple Agency Agreement similar to the ones it arranged with the other publishers.

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Penguin tried to encourage an (unnamed) e-book retailer to cease carrying Random Houses' books. In

an email sent to the retailer by Penguin's CEO David Shanks, he said,

"Since Penguin is looking out for [your] welfare at

what appears to be great costs to us, I would hope that [you] would

be equally brutal to Publishers who have thrown in with your

competition with obvious disdain for your welfare .... I hope you

make [the publisher] hurt like Amazon is doing to [the Publisher

Defendants]." (par. 87)

Mr. Shanks argument was that by signing agency agreements with the colluding publishers, and

participating in instating the agency model, retailers would be protected from the aggressive pricing

strategy of Amazon. The retailer should retaliate against Random House to protect the publishers like

the publishers have protected the retailer from Amazon.

Analysis

The Apple Agency Agreements, and the MFN provisions in particular, were the mechanism that

established and maintained the cartel. It provided incentives that prevented the publishers from

deviating from the collective strategy. The DOJ argues in the Complaint that the MFN provision in the

Apple Agency Agreements and the implementation of pricing tiers was anticompetitive because it

prevented price competition in the e-books market.

Through the Apple Agency Agreements, the publishers were able to replace the e-book

industry's wholesale model with an agency model combined with pricing tiers. This agency model

enforced market-wide pricing tiers resulting in the elimination of price competition, and an increase in

retail e-book prices. For this analysis, three different models for the e-books market will be presented:

the wholesale model, the agency model, and the agency model with Apple's MFN clause.

Under the original wholesale model, retailers set prices according to consumer demand, subject

to their firm costs and the per-unit wholesale prices of the e-books they sold. Given the total output in

the retail market, publishers could determine wholesale demand for e-books and set the optimal

wholesale price and output.

To illustrate the wholesale model, let there be two retailers and two publishers. The retailers

engage in Bertrand Competition. Each publisher produces one e-book that directly competes with the

other publisher's e-book where the two e-books are differentiated. For example, both publishers may

release a book in the same genre, but written by different authors.

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Let there be Publisher 1 and Publisher 2 who sell e-book 1 and e-book 2, respectively. Retailer

A and retailer B each purchase both e-book 1 and e-book 2 from the publishers, and sell the books to

the consumers.

The retailers, although selling only e-books 1 and 2, can be viewed as together providing four

different goods; each retailer provides two e-books that are substitutable in varying degrees. Retailer A

provides e-books 1 and 2 where e-book 1 is a perfect substitute for e-book 1 that retailer B provides.

Likewise, retailer A also sells e-book 2, which is a perfect substitute for the e-book 2 that retailer B

sells. As well, e-books 1 and 2 are substitutes for each other, but not perfect substitutes.

The residual demand functions are defined as,

( )

( )

( )

( )

Where ( ) are firm i’s output and price for e-book j.

The profit functions of the retailers are,

( ( )) ( ( ))

( ( )) ( ( ))

Where each firm’s marginal cost is the same for both e-books they provide.

Since retailer A's e-book 1 is a prefect substitute with retailer B's e-book 1 (and likewise for e-

book 2), assuming that retailers are symmetric, the Nash equilibriums for retailer A and retailer B's

price competition are,

However, if costs are not equal, there is an incentive for the low cost firm to undercut the high

cost firm and monopolize the market. This issue will be discussed in more detail in the next section.

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It may be that e-books 1 and 2 are not perfect substitutes when they are provided by the two

retailers. For example, if the two retailers sell e-books in proprietary formats, only those customers

with readers compatible with the formats can read the e-books. In this case, the market prices for e-

books 1 and 2 are found via the reaction functions of the retailers. The retailers will maximize profits

with respect to the prices of e-books 1 and 2.

( ) ( )

( ( ))

( )

( ( ))

( ) ( )

( ( ))

( )

( ( ))

( ) ( )

( ( ))

( )

( ( ))

( ) ( )

( ( ))

( )

( ( ))

To satisfy the first order conditions, prices must be sufficiently larger than the marginal cost and

the wholesale price in order to equal the magnitude of the other terms in the equation.

The prices derived in the case where the retailer sells two differentiated products are greater

than when the retailer only provides one e-book. In the case where the retailer only provides one e-

book, price is set such that

( ( ))

By selling both books, the retailer has an incentive to increase prices by more than the price of selling

one e-book. By selling two substitutable e-books, there is a “multiplying” effect on the price of e-books.

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Solving the system of first order conditions gives all four prices as functions of the costs

( )

( )

( )

( )

The optimal prices are used to derive each retailers output as a function of their costs and the

wholesale price.

(

)

(

)

(

)

(

)

The retailer outputs are horizontally summed in order to get total output for each e-book,

( )

( )

which are the inverse demand functions for publishers 1 and 2. From these functions, the publishers can

derive their optimal wholesale prices.

Generally, publishers price their books as a percentage of their suggested retail price. The

typical wholesale price for e-books could be approximately fifty percent (DOJ Competitive Assessment,

2012). It is possible that because publishers sell differentiated products, publishers engage in Bertrand

competition. However, regardless of the type of competition present in the publisher’s wholesale

market, price is likely to be greater than the publisher’s marginal cost. It follows that there is a case for

double marginalization in the wholesale model.

Under an agency model, the retailers relinquish their power to set prices to the publishers and

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the publishers directly compete amongst themselves in the retail e-book market. The retailers receive a

percentage of the retail price of the e-book which translates into a marginal cost by the publishers.

In the case where there are no proprietary formats, if there are publishers 1 and 2 selling e-

books 1 and 2, the residual demand functions and profit functions for the two publishers are,

( )

( )

( )

( )

where alpha is the percentage of retail sales revenue that the publishers receive.

The first order conditions are,

( )

( )

Solving the system for prices will give the market prices for the two e-books as functions of the

two publisher’s marginal costs.

In the case where retailers sell e-books in proprietary formats, the model is similar to the one set

up in the wholesale case. Each publisher sells two “types” of their e-book that are imperfect substitutes.

Let there be two formats for e-books; format A and format B. The residual demands for e-books 1 and

2 are,

( )

( )

( )

( )

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The first order conditions for the publisher’s profit functions are,

( ) ( )

( )

( )

( )

( ) ( )

( )

( )

( )

( ) ( )

( )

( )

( )

( ) ( )

( )

( )

( )

In the wholesale model where e-books are perfect substitutes and firms have identical costs,

price is equal to marginal cost plus the wholesale prices set by the publishers. The wholesale price is

greater than the publisher’s marginal cost because there is market power in the publisher’s wholesale

market.

.

In the agency model where e-books 1 and 2 are homogeneous, price is sufficiently larger than marginal

cost such that,

( )

Assuming that, under the agency model, the publishers would pay the retailers a share of revenue just

to break even,

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( )

It follows that,

( )

Given the form of the partial derivative of the retail market demand function, the retailer’s costs,

and the publisher’s costs, the retail price under the agency model must be great enough to satisfy this

first order condition. Although the agency agreement solves the double marginalization issue, it is not

clear if the agency model’s retail price is less than or greater than the wholesale model’s retail price. In

order to compare prices, more information is required regarding the retail demand functions, and the

magnitude of alpha, and the costs of the retailers and publishers. In this model, there are no obvious

simplifying assumptions that can be made.

In the case when the e-books are not perfect substitutes (that is, there are two e-book formats),

the differences between prices under the wholesale model and the agency model are also ambiguous.

The first order conditions in both cases share the same partial derivatives. However, in the wholesale

case, prices depend on the wholesale prices whereas in the agency model, prices depend on the

publisher’s share of revenue. Again, given the values of alpha and the wholesale price, the prices under

the two models can be determined.

However, in the agency model that Apple and the publishers created, prices were clearly higher

than the wholesale model retail prices. The price increase was due to the pricing tiers implemented by

the publishers that created market conditions where the publishers did not have to compete in price.

The prices chosen by the publishers may be the monopoly prices for specific classes of books, or

simply a price that was large enough to deter consumers from switching from paper books to e-books.

Result and Legal Resolution of the Collusion

The agency agreement created by Apple and the publishers was maintained for 2 years and it

successfully raised prices in the e-book market. Between summer 2009 and summer 2010, e-book

prices increased by an average of 10 percent. Some titles have had price increases of thirty to fifty

percent (DOJ Competitive Impact Statement, 2012; p. 9).

On March first, 2011, Random House joined the agency model. It created agency agreements

with its retailers and Apple, and began to sell its books on the iBookstore (Trachtenberg, 2011).

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Although, according to the DOJ's Complaint, Random House did gain market share from deviating

from the cartel, perhaps the payoff from deviating was less than the gains from colluding. By

participating in the agency model, Random House was able set higher prices in the e-books retail

market and sell its books in the iBookstore. However, the DOJ in their Competitive Impact Statement,

points out that although Random House could not sell their books in the iBookstore, they did have

applications that allowed consumers to purchase and read their books on the iPad. Therefore, it may be

that Random House gained nothing more than the ability to set higher retail prices for its books.

In January 2010, Amazon submitted a white paper to the DOJ regarding the new agency model

(Floyd, 2012) and on April 11th, 2012, the DOJ brought their case against the publishers and Apple.

Three days later, Hachette, HarperCollins, and Simon & Schuster settled with the DOJ while Apple,

Penguin and Macmillian continue to fight the case. The Final Judgment for Hachette, HarperCollins

and Simon & Schuster was delivered September 6th

, 2012. In a press release, the DOJ implied that

Penguin and Macmillian are still operating under their original agency agreements (the U.S.

Department of Justice: Office of Public Affairs, 2012).

The DOJ’s Final Judgment stipulated that the three settling publishers had to terminate their

Apple Agency Agreements. For their other agency agreements, the publishers had to take measures to

terminate the contracts or, if the contracts cannot be terminated, leave the contracts to expire. For two

years after the termination of their contracts, the publishers were prohibited from restricting retail

prices. As well, publishers are never to enter into agreements with retailers with MFN clauses.

However, the Final Judgment explicitly states that, although publishers cannot enter into agency

agreements with retailers for two years after the complaint, they can enter into agency agreements that

prevent retailers from selling e-books at a loss. In such an agreement, the publisher could provide a

suggested retail price and sell the e-books to retailers at prices that are a percentage of the suggested

retail price. So long as the agreement does not inhibit the retailer from determining its own retail prices,

publishers can create agency agreements that prevent the retailer from setting prices that are less than

the per-unit cost of the e-book. The agency agreements permitted by the DOJ, as well as the contracts

that Penguin and Macmillan maintain, may be the reason why the retail prices for e-books have not

fallen back to their pre-cartel level. However, it is not clear whether, as of yet, a contract under these

conditions has been formed.

In an article from Paid Content, Laura Owen demonstrates that after only four days of the

DOJ’s settlement with the three settling publishers, Amazon’s prices for HarperCollins books had fallen.

On the Amazon website, Amazon specifies whether a certain title’s price was set by the publisher.

Owen shows that on September 10th

, 2012, HarperCollins no longer set the prices of its e-books on the

Amazon website. She provides an example of two titles, one offered by Penguin and one by

HarperCollins, where prices fell for the HarperCollins book, but not for the Penguin book. Today on the

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Amazon website, the HarperCollins book is even less expensive than it was on September 10th

whereas

the price of the Penguin e-book is the same. As well, Hachette and Simon & Schuster titles are not

listed as having prices set by the publishers. This may suggest that the settling publishers have not

made any new agency agreements with Amazon.

Barnes & Nobel provided a comment on the DOJ's final judgment where they argue that the

agency model benefited consumers more than the wholesale model. The agency model prevented

Amazon from monopolizing the e-books retail market resulting in more choice for consumers, higher

product quality, and lower prices. Barnes & Noble claimed that prior to the agency model, Amazon had

a ninety percent market share in the e-books market. Once the agency model was implemented,

Amazon’s market share fell to sixty percent. Within the less concentrated market, retailers were able to

bring forward new products, like Barnes & Nobel with its new versions of the NOOK reader.

Under the wholesale model, e-books were typically released twenty-two days after their

hardcover versions in order to prevent product cannibalization. Under the agency model, there was

essentially no delay in the release of e-books; e-books were released three days after the hardcovers.

Barnes & Nobel also claim that under the agency model, average e-book and hardcover prices, and e-

book wholesale prices fell.

Barnes & Nobel argue that Amazon engaged in a “below cost pricing” strategy (p.9) that

created artificial prices in the market. In this way, Amazon was driving other retailer out of the market.

The result of Amazon’s monopolization of the e-book retail market would be higher retail prices, less

consumer choice, and lower product quality. Therefore, Barnes & Nobel argue that it is critical that the

DOJ maintain the current agency model and thus prevent Amazon from becoming a monopoly.

It may not be necessary that Amazon engage in “below cost pricing” pricing in order to drive

out retailers. As the model in the previous section suggests, if Amazon is the lowest cost firm in the

market, this is sufficient to drive competitors out of the market. However, if Amazon did sell e-books at

a loss and thus forced other retailers to do the same, it may be possible that average e-book prices were

higher under the wholesale model. Retailers would be forced to cross-subsidize by selling other titles at

higher prices to compensate for the losses incurred by selling low priced titles. This relationship

between e-book prices is ambiguous at best.

In conclusion, it is reasonable to believe that most e-book retailers share the same opinion as

Barnes & Nobel since the agency model protected e-book retailers from competing with Amazon in

prices. As the case progresses, it will be interesting to see what data regarding the e-book industry will

be revealed and, in particular, whether the agency model did raise average e-book prices. As well, the

decisions to come from the DOJ’s trial with Apple, Penguin, and Macmillan will surely influence the

future of the e-book industry and may have relevant implications for other technology-based industries.

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