Apple e-books defense may hinge on absence from dinner meetings

Apple Inc.'s best defense against accusations it conspired to fix e-book prices may turn on its absence from meetings in Manhattan restaurants where publishing executives allegedly worked out the scheme.

The maker of the iPad will need to show it negotiated pricing arrangements separately with each of the five publishers named in the Justice Department's lawsuit, avoiding group gatherings such as those in The Chef's Wine Cellar at Picholine described in the government's complaint, antitrust lawyers said.

“If Apple agreed with each single publisher and can show it talked to them individually and didn't suggest they collude, then those agreements would be legal,” said Herbert Hovenkamp, a professor and antitrust specialist at the University of Iowa College of Law in Iowa City. “If Apple in fact orchestrated the agreements, then I don't think it has a defense.”

The antitrust suit filed last week by the U.S. Justice Department is already reshaping the fast-growing market for e- books. Settlements with three of the publishers will allow retailers to return to setting their own prices after their agreements with Apple shifted pricing power to book producers.

Amazon.com Inc., which opened the digital books market in 2007 with $9.99 titles for its Kindle e-reader, may be the biggest beneficiary of the suit and settlements.

As the world's largest online retailer, Amazon can afford to sell e-books at a loss to gain market share, said Michael Norris, an analyst for Simba Information Inc., a Stamford, Connecticut-based researcher. Amazon said last week it plans to drop e-book prices again.

Market Share

The Seattle-based company is the largest U.S. seller of digital books with about 60 percent market share, followed by Barnes & Noble Inc. with about 30 percent and Apple with about 10 percent, according to Mark Harding, an analyst at JMP Securities in New York.

E-book discounting may erode Barnes & Noble's market share, said Michael Souers, a retail analyst for Standard & Poor's in New York. New York-based Barnes & Noble, the largest U.S. bookstore chain, has been losing money on developing and marketing its Nook e-reader and is less able to subsidize e-book sales, Souers said.

Meanwhile, book publishers are likely to see smaller sales and margins with the return of aggressive e-book discounts, said Tom Forte, an Internet analyst with Telsey Advisory Group in New York.

Amazon shares are little changed from before the Justice Department sued on April 11, while Barnes & Noble fell almost 10 percent. Apple shares have declined almost 7 percent amid speculation that demand for the iPad may wane.

Alleged Conspiracy

The Justice Department complaint portrays Apple's deals with the publishers as a conspiracy that raised prices and hurt consumers. At Apple's suggestion, the publishers agreed to raise retail prices and give Cupertino, California-based Apple a 30 percent cut, according to the complaint. Amazon was eventually forced to fall in line.

“Conspiracy to raise prices, especially among competitors, is the essence of the most evil thing we have in antitrust,” said Robert Lande, executive director of the American Antitrust Institute.

Comments cited in the complaint by Apple's late co-founder, Steve Jobs, indicate that's exactly what he was thinking about, said Andrew Gavil, an antitrust law professor at Howard University in Washington.

“Throw in with Apple and see if we can all make a go of this to create a real mainstream e-books market at $12.99 and $14.99,” the complaint quotes Jobs as saying.

‘Not True'

Natalie Kerris, an Apple spokeswoman, said the government's accusation of collusion “is simply not true.”

“The launch of the iBookstore in 2010 fostered innovation and competition, breaking Amazon's monopolistic grip on the publishing industry,” she said. “Just as we've allowed developers to set prices on the App Store, publishers set prices on the iBookstore.”

Apple, in court papers filed in a private antitrust case, contends its agreement with each publisher to serve as a distribution agent was negotiated separately. Each set its own prices without Apple's interference, the company said in the filing in federal court in Manhattan.

“It would be a perverse use of antitrust law to condemn Apple for successfully entering a market with an innovative new product,” Apple said in the filing, seeking to throw out the lawsuit.

Disruptive Player

Apple has a track record of being a disruptive player when it enters new markets, working independently and driving hard bargains to secure content and service for its devices. When it created the iTunes store in 2001, Apple pushed music companies to sell all songs as singles for 99 cents, something not all labels wanted to do. Apple also extracted service revenue from AT&T in exchange for giving it the first iPhone, something unheard of at the time.

Pearson Plc's Penguin and Macmillan, which is a unit of Verlagsgruppe Georg von Holtzbrinck GmbH, have also denied wrongdoing and vowed to fight the government's accusations.

CBS Corp.'s Simon & Schuster, Lagardère SCA's Hachette Book Group and News Corp.'s HarperCollins, agreed to settlements, saying they denied liability but wanted to avoid protracted litigation.

Daniel Wall, an antitrust lawyer for Latham & Watkins LLP in San Francisco, said Apple can argue it was providing an alternative to the near monopoly Amazon won with low margins and deep discounts. Amazon had 90 percent e-books market before the pricing model changed, according to Harding.

‘Another Business Option'

“Apple offered a new model, another business option,” said Wall, who represents Apple on other matters but isn't involved in the e-books case. “I don't think there's anything wrong with Apple saying ‘If you don't like Amazon's model, sign up for mine.' That's competition.”

E-books is the fastest growing category within the $27 billion book-publishing business, according to a Bloomberg Industry report. Revenue from e-books doubled last year to $1.9 billion, according to preliminary estimates from the Association of American Publishers.

The publishers' distribution contracts with Apple guaranteed they would lower the retail price of any e-book in Apple's iBook store to match the lowest price offered by any other retailer, according to the Justice Department lawsuit.

These price guarantees, which ensure a company can't be undersold by its rivals, are known as most-favored-nation clauses and can signal uncompetitive behavior, according to Steve Salop, professor of economics and law at Georgetown University Law Center.

Successful Challenges

Such clauses have been successfully challenged by the U.S. in cases against companies including General Electric Co. and Westinghouse Electric Co., and Delta Dental Insurance Co., an insurer and service provider, Salop said. In 2010, the Justice Department sued Blue Cross Blue Shield of Michigan for allegedly entering most-favored-nation agreements that raised hospital prices. The case is pending.

The publishers' legal ground may be shakier Apple's because, almost simultaneously, they entered into similar contracts with the iPad maker that allowed them to raise prices, said University of Iowa's Hovenkamp. Under a 1939 U.S. Supreme Court decision involving movie tickets, now known as the Interstate Circuit Doctrine, collusion can be proven by circumstantial evidence when it's clear that without the agreement of the group, each firm would be acting against its own interest, he said.

Joint Action

The Justice Department, citing internal e-mails and conversations, claimed the publishers forged the new pricing agreements with Apple only when they were confident they could act jointly.

The publishers may argue that Amazon's low prices would have cut the number of printed books and bookstores, hurting consumers with a loss of variety and output, Georgetown Law Center's Salop said.

Lande, of the American Antitrust Institute, said even so, price-fixing conspiracies can't be used to solve an industry's problems. Even if Amazon engaged in so-called predatory pricing by selling below cost, the solution is to go to court or appeal to Congress, Lande said.

“You are not allowed to break the antitrust laws,” he said.

The Supreme Court has held in a landmark case involving the Addyston Pipe & Steel Co., that “ruinous competition” doesn't justify price fixing, Hovenkamp said.

‘Less Money'

“The publishers were worried about making less money on hard copy books,” said Howard University's Gavil. “But there are no rules of competition that say they were entitled to continue making the same profits on their hard copy books as they had in the past.”

The suit was filed in Manhattan, where U.S. District Judge Denise Cote is supervising pretrial proceedings in a group of at least 27 antitrust suits by private parties against Apple and the publishers.

The case is U.S. v. Apple, 12-cv-2826, U.S. District Court, Southern District of New York (Manhattan).