Apple Gets Another Legal Black Eye

Tech giant found guilty of conspiring to raise e-book prices

   
Apple Gets Another Legal Black Eye

When Amazon (AMZN) released its first Kindle in 2007 and e-book sales started to climb, consumers were lured in not just by the convenience of carrying a library in their pocket, but also by the prospect of cheaper books.

Then, when Apple (AAPL) joined the party with its iPad and iBookstore in 2010, the expectation was that real competition had finally arrived for digital books, meaning an era of even greater savings seemed on the horizon.

Instead, the opposite happened: E-books actually got more expensive. Why? Well, a judge just ruled that Apple conspired with major U.S. publishers to raise e-book prices.

When you consider all the variables, it makes sense that an e-book should cost less than its paper counterpart. Significant chunks of the cost equation are eliminated by going digital — there’s no paper, no printing, no shipping (books are heavy), no shelf space required and no returns of unsold copies. Instead, there is just the minimal cost involved in formatting the book for different e-book standards and the two-minute download for customers.

Apple’s iPad promised to be the first serious competition to Amazon’s Kindle e-readers. The iBookstore, in turn, should have provided the competition that smaller e-book retailers like Sony (SNE) hadn’t managed. Apple itself, as quoted by AllThingsD in reaction to losing the anti-trust trial, continues its posture of being a positive influence for consumers:

“When we introduced the iBookstore in 2010, we gave customers more choice, injecting much needed innovation and competition into the market, breaking Amazon’s monopolistic grip on the publishing industry.”

I was an early e-book adopter and have a personal collection of seven e-readers (not counting iPads). Writing for About.com in 2011 after Apple’s entry into the e-book market, I found a significant upward trend in bestseller e-book prices. With Apple in the game, Amazon’s $9.99 e-book bestseller price point rapidly escalated and when I compared the paper vs. digital copies of the the first 10 books on the New York Times bestseller list in 2011, the average savings per e-book had dropped to $5.63 per title from the $20 range in 2007.

The U.S. Department of Justice was watching developments in the e-book industry too and in 2012, it filed an antitrust suit against Apple and five publishers accusing them of colluding to raise e-book prices.

To understand what was going on, it’s important to note that Amazon’s practices — as well as other retailers like Barnes & Noble (BKS) — followed what is known as a wholesale pricing model. The retailer sets prices and can choose to use bestsellers as loss leaders if they so choose. Amazon did just that, buying books at a $12 to $14 wholesale price and discounting them at a loss in order to keep its position as the number one e-book retailer. Thus the Amazon $9.99 Kindle bestseller.

Some industry watchers were actually amazed that the DOJ didn’t step in and slap Amazon (which dominated the industry at the time with some 90% of digital book sales) for using predatory pricing to keep e-book selling competitors at bay.

Apple, while in negotiations with publishers as the iBookstore was preparing to launch, went with an agency pricing model — the same one it uses with its app store. Instead of Apple setting prices, the publishers set the book at any price they want and Apple keeps 30% of the proceeds.

Why is this problematic? Because there are so few publishers, the agreement with Apple gives them too much control over pricing and limits discounting. They leveraged that deal to force agency pricing on Amazon as well (threatening to cut off access to bestsellers until well after publication), and the days of the $9.99 Kindle bestseller were pretty much over.

The DOJ proved prices of e-book at all retailers increased after Apple adopted the agency pricing model. The Digital Reader reprinted charts from the DOJ’s case, showing one week after Apple’s agency agreement with publishers came into effect, the average price of e-books increased by 19% at Amazon and by 20% and Barnes & Noble. In addition, a clause in Apple’s contract with the publishers ensured Apple would never have to compete against Amazon on price.

While the publishers had already caved and settled, Apple insisted on fighting the suit and despite losing, has indicated it intends to appeal.

So what happens now? Not much for the moment. Damages have yet to be decided upon and, since publishers already having settled, e-book prices had been dropping. Publishers are letting retailers apply discounts to e-books once again.

For Apple, though, it’s another legal black eye after losing in court to Samsung last month and facing an upcoming import ban on older iPhones and iPads. This one’s potentially more damaging to its reputation, too — portraying the company as a price-fixer that conspired to raise prices paid by consumers, costing them millions of dollars.

The good news: Investors aren’t too worried about this aspect of things, though, as AAPL didn’t moved much at all after the ruling.

As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.


Article printed from InvestorPlace Media, http://investorplace.com/2013/07/apple-gets-another-legal-black-eye/.

©2014 InvestorPlace Media, LLC

Comments are currently unavailable. Please check back soon.