Apple’s mistake was hooking up with the book-publishing cartel

June 30, 2015, 7:59 PM UTC

Apple may be trying to keep the spotlight on its latest foray into the streaming-music business, but it is also still trying to clean up the mess caused by its ham-handed entry into an earlier market: book publishing. A federal court on Tuesday rejected the company’s appeal of an earlier ruling that found it guilty of orchestrating a conspiracy with the major book publishers, in what the court said was a successful attempt to artificially inflate the price of e-books.

As Fortune‘s Jeff Roberts reports, the court found Apple (AAPL) engaged in collusion with what amounted to an oligopoly—namely, Harper Collins, Penguin, Simon & Schuster, Hachette and Macmillan—and that its actions were a clear breach of antitrust law. Apple argued that the deal it cut with the publishers was necessary to blunt Amazon’s dominance in the e-book market, but the appeals court didn’t buy that argument. Judge Debra Ann Livingston wrote:

“Competition is not served by permitting a market entrant to eliminate price competition as a condition of entry, and it is cold comfort to consumers that they gained a new ebook retailer at the expense of passing control over all ebook prices to a cartel of book publishers.”

One reason the court failed to buy this argument is that the major publishers clearly had zero interest in actually competing on price—in fact, they wanted to do exactly the opposite. Their interest in doing a deal with Apple stemmed from a desire to maintain the existing favorable price structure for books, which allowed them to milk the market for high-priced hardcover versions of new novels before eventually releasing cheaper versions. Amazon’s (AMZN) low-priced e-books were a threat.

“These members of the Big Six thought that Amazon’s lower‐priced ebooks would make it more difficult for them to sell hardcover copies of new releases, which were often priced, as the district court noted, at thirty dollars or more. Further down the road, the publishers feared that consumers would become accustomed to the uniform $9.99 price point for these ebooks, permanently driving down the price they could charge for print versions.”

The fact that the book industry was a cozy cartel is reinforced by the court’s description of how the publishers behaved even before Apple came along: They “operated in a close‐knit industry and had no qualms communicating about the need to act together,” the ruling says, quoting from the lower-court decision: “On a fairly regular basis… the CEOs of the [Big Six] held dinners in the private dining rooms of New York restaurants, without counsel or assistants present, in order to discuss the common challenges they faced.”

Since the publishers didn’t compete with each other on the basis of price, the appeals court decision says, “publishers felt no hesitation in freely discussing Amazon’s prices with each other and their joint strategies for raising those prices.” And then into their laps fell Apple, which was looking for a way into the market, and the publishers realized they had a crowbar they could use to pry open their deals with Amazon and force the e-book retailer to give them better terms.

After strong-arming Amazon into accepting the new “agency pricing” model—in which the publishers got to set the price for their books, rather than allowing the retailer to do so—the book industry got exactly what it wanted. According to research by the Justice Department, the price of newly released books rose by an average of 24% and bestsellers climbed by 40%.

It says a lot about the book-publishing business that doing this actually caused book sales to drop fairly dramatically across the board: research done by another expert using data from Random House showed that publishers who switched to the agency model sold close to 15% fewer books than they would have otherwise. So the industry was effectively willing to trade a short-term decline in sales for the increase in power that they got over pricing as a result of the deal with Apple.

Much of Apple’s appeal was based on the idea that, while the book publishers (all of whom have already settled the case against them) may have colluded to fix prices, Apple was just an innocent business partner, and the fact that it signed identical deals with all of the publishers was effectively a coincidence. It also argued that it used what it called an “aikido move” to leverage market conditions in its favor. But the appeals court disagreed:

“Aikido move or not, the attractiveness of Apple’s offer to the Publisher Defendants hinged on whether it could successfully help organize them to force Amazon to an agency model and then to use their newfound collective control to raise ebook prices. The Supreme Court has defined an agreement for Sherman Act Section 1 purposes as ‘a conscious commitment to a common scheme designed to achieve an unlawful objective.’ Plainly, this use of the promise of higher prices as a bargaining chip to induce the Publisher Defendants to participate in the iBookstore constituted a conscious commitment to the goal of raising ebook prices.”

In other words, instead of being able to piggy-back on the market position of its publishing partners in order to gain entry into this new market, Apple hitched its e-book wagon to an industry that was already actively engaged in collusion over prices—and desperately trying to resist the future. And ultimately it was the giant electronics company that got crushed under the wheels of that wagon.

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