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Introduction

There are two major updates in the DOJ lawsuit.  An additional 17 states have sued the publishers and Apple.  Judge Denise Cote’s filed a denial of Apple, Penguin, and Macmillan’s motion to dismiss.  You may want to read the Primer here if you haven’t already before going forward.

States Attorneys General Amended Complaint

1)  An additional 17 states have joined the existing states that have filed suit against the major publishers and Apple bringing the total number up to 31. Those states include: Texas, Comiecticut, Alabama, Alaska, Arizona, Arkansas, Colorado, Delaware, Idaho, Illinois, Indiana, Iowa, Kansas, Louisiana, Maryland, Michigan, Missouri, Nebraska, New Mexico, New York, North Dakota, Ohio, South Dakota, Termessee, Utah, Vermont, West Virginia, and Wisconsin, the District of Columbia, and the Commonwealths of Massachusetts, Pennsylvania, Puerto Rico, and Virginia.

Highlights from the amended lawsuit include a more detailed description of all the alleged concerted action and more damning quotations.  Prepare for your mind to be blown. Mine was.

  •  Collectively the Big 6 account for approximately 60% of all revenue generated from print titles sold in the U.S. and 85% of all revenue generated from the sale of NYT Bestsellers.  In 2009, the publishers’ market share broke down as follows:  Random House (17.5%), Penguin (11.3%), Hachette (10%), HarperCollins (9.8%), Simon & Schuster (9.1%), and  Macmillan (5.4%)
  • In 2009, Amazon held up to 80% of the digital book marketshare. (Judge Cote’s decision said 90%).
  • Amazon’s price point of $9.99 ‘stoked intense competition among e-book retailers as its rivals priced at or near Amazon’s price point to remain competitive.  As a result, prior to January 2010, consumers could generally purchase NYT Bestselling e-books for $9.99″ (This is an important point because Cote points out in her decision that the price for digital books is identical from retailer to retailer post agency pricing)
  • An executive of the parent corporation of one publisher met with other Big 6 executives ‘to discuss a joint venture’ that would compete with Amazon and hopefully raise prices. (I wonder if this was/is Bookish).
  • Windowing is referred to as ‘the first collective attempt to raise prices.’
  • ‘Months before announcing that they would experiment with Windowing certain titles, certain Publishers shared information among one another about which titles they would Window and their anticipated delay period for e-book publication.’
  • Carolyn Reidy shared information ‘confidentially’ to another publisher of S&S’s plan to window Stephen King’s Under the Dome.  The executive shared this with his boss via email.  ’At the conclusion of the e-mail, the executive urges his boss to ‘double delete’ this e-mail from his files.’
  • Carolyn Reidy emails Les Moonves, CEO of S&S’s parent corporation CBS, regarding windowing and the need to ‘‘gather more troops’ and ammunition first.’
  • ‘[T]he Conspiring Publishers considering Windowing referenced themselves in one email as ‘the Club!’
  • ‘On December 10, 2009, Simon & Schuster CEO Carolyn Reidy discussed systematic Windowing of e-books with Macmillan executive Stephen Rubin, a friend and former colleague of Reidy’s.  In an e-mail to Macmillan CEO John Sargent recounting part of their conversation, Mr. Rubin wrote, ‘In the nicest possible way, she’d [Carolyn Reidy] love for you to join them. She feels if one more publisher comes aboard, everyone else will follow suit.’
  • John Sargent asked Eddy Cue from Apple to take a reduced cut on hardcover first releases because under the new Agency model, revenue would decrease from $14 per book to $9.00.  (This is important because Judge Cote uses this as an example of how anti competitive the actions were – that they would intentionally take a much lower figure in order to slow ebook adoption and raise prices).
  • An executive to another executive in a parent corp. shared via email that Eddy Cue had indicated that Random House was out ‘and that ne [sic] need the five majors in but maybe four.’
  • On Saturday, January 22, Penguin CEO David Shanks contacted Apple’s negotiator Eddie Cue.  As Mr. Cue reported to Steve Jobs, Shanks ‘wanted an assurance that he is 1 of 4 before signing.’
  • One executive (it must be Hachette by process of elimination) called John Sargent to confirm whether Macmillan was in. Sargent affirmed but the executive told Sargent that the executive’s company would not likely agree.
  • Sargent and Reidy had a conversation wherein Sargent told Reidy he was signing the Apple agreement and would pursue the agency model.
  • Eddy Cue asked Steve Jobs for help reeling in one recalcitrant publisher (whom I am assuming is Hachette).  Jobs writes to an executive at the parent company of the publisher ‘As I see it, [Conspiring Publisher] has the following choices:  1) Throw in with Apple and see if we can all make a go of this to create a real mainstream ebooks market at $12.99 to $14.99″  Within three days, the recalcitrant publisher threw in.
  • The publisher contracts with Apple were virtually identical, particularly as it relates to the maximum price floor, definitions for bestselling titles, commission rate, and the most favored nations clause.
  • Penguin could not switch to Agency Model until June 2010 so it withheld from Amazon all newly released ebooks until Agency Model implemented. (AH HA! Seriously I remember this panicked time a few years ago).
  • ‘The higher retail prices benefitted Apple because it would earn higher revenues from its commissions on each sale. Insulated from e-book price competition with other Outlets, Apple could earn gross margins up to several times higher than in the Wholesale-Retail Model.  The Publishers achieved their long-running collective goal: higher retail prices for e-books.’
  • After Macmillan had its buy buttons removed from Amazon following its demand to go Agency, publishers began to email ‘John Sargent needs our help!’ and ‘Macmillan ‘has been brave, but they are small. We need to move the lines. And I am thrilled to know how A[mazon] will react against 3 0r 4 of the big guys.’  The same executive emailed Sargent saying ‘I can ensure you that are not going to find your company alone in the battle.’
  • The CEO of Barnes & Noble emailed Sargent to let him know that B&N had Macmillan’s back.  ’Barnes & Noble would ‘go to the mat’ for Macmillan. In an attempt to assist Macmillan during the negotiation process, B&N moved its titles to the top of its merchandizing pods & search results on the Nook.’  (these things are so dirty)
  • Amazon learned that five of the six publishers agreed to the Agency model and that these five accounted for about half of Amazon’s ebook business and thus Amazon caved to Macmillan.  (In Judge Cote’s decision we find out that Amazon was presented with this information on the same day (Jan 20) by four different publishers)
  • When Random House refused to move to Agency, David Shanks of Penguin went to Barnes & Noble ‘I would hope that [Barnes & Noble] would be equally brutal to Publishers who have thrown in with your competition [Amazon] with obvious disdain for your welfare.  B&N continued to promote RH titles and so Shanks went back to B&N.  ’Following this contact, B&N’s management decided not to feature Random House in any future advertising.’
  • Random House eventually caves.  I actually feel sorry for Random House for some reason.

Mind blown?

Judge Cote’s Denial of Apple, Penguin and Macmillan’s Motions to Dismiss

2)  Judge Cote issued a ruling denying Apple, Penguin and Macmillan’s motions to dismiss in the civil class action.  The civil class action has been stayed against Hachette, Simon & Schuster, and HarperCollins, pending the outcome of the state attorney general lawsuits.  A motion to dismiss is measured against a standard that does not favor dismissal. Every pled fact is assumed true and every inference is read in favor of the complainant (or plaintiff).  The short version is that Judge Cote found that the class action petition made a plausible claim for per se antitrust violations based on horizontal price fixing agreements.  That is doom, in my opinion, for the publishers and Apple.  In fact, reading Judge Cote’s decision, my first thought was that she might reject the settlement because it doesn’t go far enough to protect consumers and punish the conspiring parties.

Here are some highlights from Judge Cote’s decision

  •  ’By the Fall of 2009, the Publisher Defendants had come to see the growth of eBooks, combined with retailers’ discount pricing strategies, as a significant threat to their business model and to the publishing industry as a whole.  Traditionally, hardcover book sales have been publishers’ most profitable product.  Hardcovers typically provide publishers with the highest margins per unit of sale.’
  • The Publisher Defendants feared that low-cost eBooks sales would cannibalize sales of physical books, especially hardcovers, eat into publishers’ profit margins, and harm brick- and-mortar retailers.  They also feared that in the future, Amazon might use its market power to reduce publishers’ share of the profit margins for eBooks.  Most fundamentally, the Publisher Defendants worried that Amazon’s low price point would condition consumers to believe that a book was only ‘worth’ $9.99, and that this consumer expectation would exert powerful downward pressure on prices for eBooks and physical books alike. In the face of these pricing pressures, the Publisher Defendants feared that their business model would prove unsustainable over the long term.’
  • Windowing decisions were announced by 4 of the big 6 within days of each other.  Dec 4 – Hachette; Dec 7 –  S&S; Dec 10 – HC; and Dec 16 – Macmillan.
  • ‘In January 2010, Apple signed nearly identical contracts (the ‘Agency Agreements’) with each of the Publisher Defendants. Each of these Agency Agreements allegedly included four major elements.  First, each Agency Agreement specified that beginning with the launch of Apple’s iPad and iBookstore on April 3, 2010, the publisher would sell its eBooks in the iBookstore under the agency model.  For each sale in the iBookstore, Apple was to receive a commission of thirty percent of the sales price. Second, the contracts included MFN clauses.  These clauses stipulated that the final sales price for eBooks sold through other distribution channels could not be lower than the prices for those titles in the iBookstore.  Third, each Agency Agreement set the prices for eBooks according to a formula tied to the list price of physical books.  Under this formula, the eBook prices would range from $12.99 to $14.99 for most newly- released general fiction and nonfiction titles.  Lastly, each Agency Agreement explicitly required the Publisher Defendants to use the agency model when selling eBooks through other vendors of any meaningful size beginning on April 1, 2010.’
  • The complaint alleges that the Publisher Defendants’ average per unit revenue for eBook sales decreased by 31 percent following the adoption of the agency model.
  • After adoption of the agency model, the price of new bestselling eBooks increased by forty percent on average, even though there had been no corresponding increase in costs.
  • ‘The CAC plausibly alleges that Apple and the Publisher Defendants took part in a conspiracy in restraint of trade, that an object of this conspiracy was to raise prices for eBooks, and that this restraint was unreasonable per se.  The Complaint describes specific conversations from which it is fair to infer that the Publisher Defendants had agreed among themselves to adopt a joint strategy to force an increase in the price of eBooks.  These include Hachette’s representation to Amazon on December 3, 2009 that the ‘industry’s’ problem with eBook pricing would be solved if Amazon raised its prices by two or three dollars, and the separate meetings on a single day, January 20, 2010, in which four Publisher Defendants each presented Amazon with the identical demand that it adopt the agency model.  There are ample allegations that Apple became an integral member of this conspiracy and well understood that the upshot of its participation would be the elimination of price competition at the retail level, forcing consumers to, in Jobs’s words, ‘pay[] a little more’ for eBooks. (my emphasis)
  • ‘Although the Complaint does not claim that Apple had an interest in higher retail prices, per se, it does plausibly allege that Apple had an interest in limiting retail competition.  The Agency Agreements were a means to accomplish both these goals through a single tool.  The switch to the agency model meant that the Publisher Defendants could control retail prices, whereas the MFN clauses protected Apple and its 30 percent commission from price competition by other retailers.’
  • The hub in a hub and spoke conspiracy need not be a dominant player.  (This was one of my concerns about the hub/spoke conspiracy.)  Judge Cote said ’ Second, the above-quoted dicta in Dentsply does not establish that a hub must be a dominant purchaser or supplier; it merely states that this is ‘generally’ the case. This observation should not be surprising: a hub’s existing market power provides an obvious incentive to horizontal competitors to sign agreements in restraint of trade. In this case, however, existing dynamics in the publishing industry provided powerful incentives for the publishers to sign such agreements.’
  • Cote also wrote (and I think this is important) ’ These arguments do not address the fundamental claim in the CAC. It alleges that the defendants conspired to eliminate retail price competition and to raise the price of eBooks above the $9.99 price set by Amazon. This states a claim for violation of the law. That the eBook prices may now fall within a range, albeit one typically well-above $9.99, does not render the Complaint’s description of the conspiratorial agreement implausible. Similarly, as explained in the Complaint, the publishers perceived that their financial interests and business model, taken as a whole, were better protected by raising the prices of eBooks even if it meant reducing their profit margins in that line of their business. In the words of Macmillan’s CEO, the publishers believed the agency model would allow them to ‘have a stable and rational market,’ and that the tradeoff was in their long-term business interests. ‘
  • Cote ultimately found that the price restraint allegations were horizontal (between firms) and not merely vertical (within the firm) & conscious parallelism and thus measured under a per se standard but that even under a rule of reason would be illegal.

Judge Cote pointed to elements that she felt were supportive of an agreement (the essential ingredient for a horizontal cartel)

  • Specific conversations from which it is fair to infer that the Publisher Defendants had agreed among themselves to adopt a joint strategy to force an increase in the price of eBooks.
  • Signing agency agreement with Apple and demanding the same from Amazon would not have been in the publishers’ self interests unless there was a conspiracy of action.
  • The rapid and simultaneous switch to the agency model — a model heretofore unknown in the publishing industry — by multiple competitors with every major eBook retailer was similar to the frowned upon action in Twombly.  Twombly, 550 U.S. at 556 n.4.

Other notes of interest

Penguin argued that it was entitled to arbitration based on the user agreements between the customer and retailers like Amazon.  This is based on the premise that Amazon is merely an agent of Penguin and thus any agreement a customer  has with Amazon passes to Penguin.  According to the docket, Penguin appears to be abandoning this claim.  Penguin was ordered to advise the court by April 30, 2012, whether it intended to proceed with its arbitration argument.  No filing by Penguin exists in the record which likely means that Penguin has waived the right to arbitrate.

 ORDER: ORDERED that, unless Penguin advises the Court by April 30, 2012 that it wishes its March 2 motion to stay proceedings and compel arbitration to be addressed, the motion will be deemed withdrawn. IT IS FURTHER ORDERED that in the event Penguin files a renewed motion to arbitrate, any party opposing the motion may present any arguments that are appropriate, including that Penguin has waived its right to arbitrate. (Signed by Judge Denise L. Cote on 4/25/2012) Filed In Associated Cases: 1:11-md-02293-DLC et al.(djc) (Entered: 04/26/2012)

The emphasis on windowing is new to me and I don’t know why I missed it. It’s genius of the DOJ/States Attorneys General to argue this because it sets a pattern of concerted behavior regarding price controls. In this study by Yu Hu and Michael D Smith, the scholars collected quotes by major publishers regarding windowing:

Table 1: Delaying Ebooks

page4image8696
page4image9504Eventpage4image11424
page4image12008Quotepage4image13648
September 2009: HarperCollins delays the ebook release of Sarah Palin’s memoirs by 5 months after the hardcover release date. ‘The publishing plan is focused on maximizing velocity of the hardcover before Christmas.’Brian Murray, CEO HarperCollins
page4image18816November 2009: Viacom/Schribner delays the ebook release of Stephen King’s new novel by 6 weeks after the hardcover release date. page4image22504‘We think that this publishing sequence gives us the opportunity to maximize hardcover sales’Adam Rothberg, Spokesperson Schribner
Early 2010: Hachette Book Group delays the ebook release of nearly all of its titles by 3-4 months after the hardcover release date. ‘I can’t sit back and watch years of building authors sold off at bargain- basement prices.’David Young, CEO Hachette
Early 2010: Simon & Schuster delays ebook release for 35 major titles by 4 months after the hardcover release date.page4image32768 ‘The right place for the e-book is after the hardcover but before the paperback,’Carolyn Reidy, CEO Simon & Schusterpage4image36616

My guess is that the publishers felt like discussing windowing and plans to window books wasn’t illegal collusive behavior because there was no price discussed but the objective remained the same – how to raise digital book prices.

What’s Next?

Discovery is next as well as the approval or rejection of the settlement.I wouldn’t be surprised if the DOJ or the States Attorneys General to ask for a temporary injunction to halt any agency agreements based on the language in Judge Cote’s decision.  The publishers would be hard pressed to argue that they couldn’t make a change quickly given how they were able to move from Wholesale to Agency.

A motion to dismiss merely means that a case can proceed forward but the explicit finding by Judge Cote that the evidence supports a per se violation makes it difficult for the defendants.  They are going to have to convince Judge Cote and then a jury (if they get by Cote) that there was no agreement.  Business justifications are not allowed in a per se claim.  Cote points to these facts as supportive of agreement:

the early efforts to induce Amazon to raise its prices for eBooks, first through Hachette’s request on behalf of the ‘industry’ in December 2009, and when that proved unsuccessful, through windowing eBooks, are principally relevant as evidence of the willingness of Publisher Defendants to work together to effect market change, and specifically, to raise the prices of eBooks through collusion. That evidence of earlier jointly undertaken activity render more plausible the claim that the Publisher Defendants were indeed colluding when they acted to end the wholesale model for distribution of eBooks and thereby to raise the prices of these books.

I think that the defendants (Apple, Penguin and Macmillan) have two options here. Settle now or take their slim chances to jury where I am convinced they will lose and hope that the 2nd Circuit slaps down Judge Cote’s per se finding on appeal.

Documents in PDF form.

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