'I don't think you understand. We can't treat newspapers or magazines any differently than we treat FarmVille."
With those words, senior Apple executive Eddy Cue stuck to his take-it-or-leave-it business model of a 30% revenue share payable for transactions through the iTunes service. Despite my arguments to Mr. Cue in Apple's Cupertino, Calif., offices last year on behalf of news publishers seeking different terms, to him there was no difference between a newspaper and an online game.
It was a sobering reminder that traditional media brands have no preferred place in the new digital world. It also should be the defense's Exhibit A in the Justice Department's antitrust case against Apple and book publishers: The 30% revenue-share model is Apple's standard practice, not, as alleged by the government, the product of a conspiracy.
Whether it's news, games, apps or books, Apple's position is the same. The market determines the price, and Apple gets 30%. The Justice Department fails to acknowledge anywhere in its 36-page complaint against Apple and book publishers that this is the standard approach. (Indeed, the government complaint inaccurately refers to "30% margins" for Apple. Operating margins are very different from sales commissions.) The government says this "agency model" is inherently wrong ("per se" wrong, in legalese) and "would not have occurred without the conspiracy among the defendants."
The problem for the government is that there's nothing wrong with the agency model, which has been upheld by federal courts and is common across many industries. This approach by Apple and the publishers (including HarperCollins, a unit of News Corp., which also owns The Wall Street Journal) replaced the "wholesale model" that market leader Amazon preferred, which had allowed it to sell e-books at whatever price it wanted, including as loss leaders to protect its Kindle against competition from other e-readers.
Contrary to the Justice Department's complaint, "this model happens to look exactly like Apple's arrangement for apps and music as well, right down to the same percentage Apple takes from sales," wrote Geoffrey Manne, head of the International Center for Law and Economics, on the Technology Liberation Front blog. "This makes things easier for Apple, gives publishers more control over pricing, and offers Apple content and a good return sufficient to induce it to market and sell its platform." Or as Apple put it last week in refusing to settle with the Justice Department, "Just as we've allowed developers to set prices on the App Store, publishers set prices on the iBookstore."
The complaint discloses dinners the book publishers ate in posh New York restaurants to support the claim that they conspired to fix prices. The more accurate way to describe the goal of the dinners is that publishers conspired to repair an anticompetitive business model. They thought it made no sense for Amazon's Kindle to have a 90% market share and a single loss-leader price of $9.95 for consumers. They were right. Over the past couple of years, thanks to the agency model, the Kindle's market share has fallen to 60% thanks to competition from iPads and Barnes & Noble Nooks, and there is more variation in consumer prices, typically ranging from $5.95 to $14.95.
Pricing flexibility for publishers is necessary to allow innovation. Why shouldn't some e-books cost 99 cents and others that come with video and hardcover editions be $49.95? Why not give people the option to pay 10% more to access an e-book on all e-readers? Consumers should decide, not Amazon or the Antitrust Division.
This lawsuit is already reducing competition and causing investors to flee Barnes & Noble, whose Nook is the distant No. 2 e-reader. "By allowing Amazon to resume selling most titles at a loss, the Department of Justice will basically prevent traditional bookstores from trying to enter the e-book market, at the same time it drives trade out of those stores and into the proprietary world of the Kindle," novelist Scott Turow wrote on the website of the Authors Guild, where he is president. "It is hard to believe that the Justice Department has somehow persuaded itself that this solution fosters competition or is good for readers in the long run."
Allegations of price fixing are hard enough to prove in mature industries such as steel or railroads, where arguably executives could control prices by dining together in posh restaurants. The highly dynamic digital economy is different. A more humble, more technology-savvy Justice Department would have exercised restraint by letting the e-book market evolve instead of ordering it to freeze into a single model with a single provider at a single price point for consumers.
"Whenever an antitrust court is called on to balance efficiency against monopoly, there is trouble," Judge Richard Posner warned a decade ago in a paper called "Antitrust in the New Economy." He concluded: "Legal uncertainty, and the likelihood of error, soar."
