Invading the Most Favored Ebook Nation

Reports are pouring in this morning that the Department of Justice is preparing antitrust action against the Big Five publishers (Simon & Schuster, Hachette, Penguin, Macmillan, and Harper Collins) and Apple for conspiring to raise ebooks prices. (It’s a little ironic that I read it in today’s print Wall Street Journal, which I generally read before turning this damned thing on.)

The problem is in part the agency model, which allows publishers to set a price for books, and give retailers like Apple and Amazon a cut. Publishers are afraid of ebooks eating their hardcover lines, of course, but were absolutely terrified that Amazon’s loss-leader pricing of bestsellers at $9.99 would train customers to think that ebooks were worth $10 and no more. Publishers have experimented with windowed release, which holds back the ebook edition until the hardcover has a chance to generate its bigger bucks, but as best I know that’s not widely done. Agency pricing, however, has stuck.

Here’s an agency example, of a hardcover I read recently: Steven Pinker’s The Better Angels of Our Nature has a cover price of $40. (Publishing seems to be responding to the recent shortage of ‘9’ digits by rolling prices up a penny, at least on hardcovers.) All of the ebook stores that I’ve checked are selling the ebook version for $19.99. In an agency arrangement, publishers set both prices. The sales agent (that is, the retailer) gets 30% of the set price. In this case, that would be $6. The publisher gets the rest, here $14.

Why 30%? It’s arbitrary, and simply the number that Apple gave publishers when it changed its bookstore from the wholesale model to the agency model. Apple’s retail contract had a twist, which is really what’s getting them into trouble today: The “most-favored-nation” (MFN) clause, which specifies that publishers may not give other retailers better terms than they gave Apple. Much byzantine legal reasoning online, but here’s a short summary.

TGIANAL, but this still puzzles me a little, and I think we’ll learn more in coming days. MFN clauses have been litigated and are not themselves illegal. The sense is that, if anything, they tend to drive prices down. The current legal action from Justice seems to turn on whether the Big Five colluded on agency pricing (with Apple’s help) to force Amazon to accept the same terms that Apple got. The idea is that the parties named in the suit intended their actions to raise prices, a use of MFN that is in fact illegal. If that sounds like a hard thing to prove (rather than just allege) well, duhh.

As I’ve said earlier, I favor agency pricing, because it allows small, very small, and microscopic publishers to undercut the Big Five in a major way and maybe eke out a marginal living. You can bet that you won’t see 99c ebooks from Macmillan. Much of my puzzlement arises in wondering to what extent ebook publishing will be affected by things like the Robinson-Patman Act, which was created to prevent predatory pricing, though is not widely enforced these days. When the retailer’s role in selling ebooks is basically database management (or when the retailer becomes the publisher or even the author) predatory pricing is not an issue–but odder things have happened in the legal world before.

As always with complex legal issues involving enormous players with cavernous pockets, almost anything could happen. I think the case will either be settled before going to court, or else will be decided narrowly. Publishers may be stripped of their ability to demand that retailers accept the agency model, or any given given agency percentage. I think Amazon would love to retain agency pricing, and just negotiate a lower number.

As I’ve said many times: We’re still in the Cambian era of ebooks (the Pre-Cambrian Era ended with the arrival of the Kindle) and there’s still a whole mess of evolving to do.