United States: The Second Circuit's Apple Ebooks Opinion

The Second Circuit affirmed the district court and held, 2 to 1, that defendant Apple Inc. had violated Section 1 by masterminding the creation, organization and implementation of a conspiracy by five publishers of ebooks that benefited Apple, as Apple intended, by eliminating retail price competition from Apple's rival, Amazon, in the sale of ebooks. United States v. Apple Inc., No.13-3741 (2d Cir. June 30, 2015).1

Amazon, as described by the court, was viewed as the common enemy by Apple and publishers of printed trade books and ebooks (the five publishers settled out before trial for the imposition of equitable relief). Apple was about to introduce the iPad with great fanfare, and wanted to open its iBookstore at the same time. Apple viewed Amazon's across the board $9.99 pricing for ebooks as too low for Apple to make a profit as a retailer, and Apple would not enter into retailing ebooks unless it was profitable. Apple wanted to eliminate Amazon's price competition at the retail level (slip op. p. 24).

The publisher defendants, five of the industry's "Big 6" publishers (p. 14), decried Amazon's $9.99 prices for ebooks as destructive to their traditional way of doing business. They believed that Amazon's prices were making it harder to sell hardcover versions of new releases and New York Times bestsellers; that Amazon would permanently depress prices for printed trade books and gain the power to demand lower wholesale prices; and that authors would go directly to Amazon to get published and cut out the publishers altogether (pp. 14, 85). They were at a loss as to how they could force Amazon to raise ebook prices. Apple knew of and used the publishers' willingness to combine and conspire to force Amazon to raise retail prices (p. 19).

The Court of Appeals affirmed the district court's findings that Apple implemented its plan through its contracts with the publishers to sell their books at retail; by regularly informing them of what the other publishers were doing and what they should do; and by directing them to act in unison so that Amazon would surrender when the publishers made their demands that Amazon enter into contracts with them using Apple's "agency model." It worked. Amazon gave in to the combined strength of the publishers (pp. 38-40), giving the publishers the power to set Amazon's retail prices for their ebooks. That led to higher retail prices by rival Amazon that Apple considered "reasonable."

Apple's contracts for its sale of the five publishers' ebooks constituted the centerpiece of the accused combination. The contracts had three major terms. The first term was designed to eliminate Amazon's power to set its own retail prices. The publishers had been selling to retailers for decades using the "wholesale model," whereby they sold to retailers like Amazon for wholesale prices and Amazon set its retail prices. Apple's ebook contracts with the five publishers instead employed an "agency model" in which the publishers set the retail price and split the revenue with the retailer, 70 percent to the publisher and 30 percent to the retailer (p. 23). Apple initially wanted to have the publishers agree in writing to make all retailers, including Amazon, move to the agency model (p. 24). An in-house counsel for Apple then came up with a "better way" to accomplish the same thing (pp. 28-29).

This became the second major contract term, the Most Favored Nation clause ("MFN") (p. 26). The "MFN would require the publisher to offer any book in Apple's iBookstore for no more than what the same ebook was offered for elsewhere, such as from Amazon" (id.). The MFN was intended to make it imperative for the publishers to move Amazon to the agency model. It would have caused the five publishers to suffer losses if they permitted Amazon's $9.99 pricing to persist and only made 70 percent of that price when selling through Apple's iBookstore. The MFN therefore "stiffen[ed] the spines" of the publishers to present a unified front to demand new terms from Amazon (p. 29).

The third major term was the placement of price caps in Apple's contracts with the five publishers (pp. 29-30). Apple did not want the publishers to use their control over retail prices to raise prices too high. Ebook prices were classified by the prices of the printed trade versions of the ebooks. For example, a New York Times ebook bestseller would cost $14.99 if the hardcover version of the book was over $30.00, and $12.99 if the hardcover was listed below the $30.00 price (p. 30). The publishers negotiated Apple upward on the corresponding ebook prices, and sometimes raised prices of hardcovers so that books would qualify for higher ebook prices (p. 41).

While Apple claimed it had "unwittingly" organized the publishers' conspiracy (p. 63), the lengthy fact section of the Second Circuit's opinion describes numerous deliberate acts by Apple to further the combination (e.g., pp. 31, 32, 35, 39, 58, 64). For example, "Apple kept the Publisher Defendants apprised about who was in and how many were on board. . . The Publisher Defendants also kept in close communication" (p. 35, quoting the district court opinion). Apple reportedly told the publishers that it would not enter ebook retailing unless at least five of the Big 6 agreed to the price fixing agreement (p. 31).

Apple's stronger argument was to concede what it had done but to assert that it was procompetitive because it made it possible for Apple to enter ebook retailing, a market that Amazon controlled with a massive 90 percent share. Apple's entry reduced Amazon's share to 60 percent. This was the argument accepted by the dissenting opinion here in Apple, which would have exonerated Apple. The dissent held that the liability issues pertaining to Apple should be analyzed exclusively under the Rule of Reason as vertical restraints.

The dissent agreed with Apple's positions that the only way for it to enter ebook retailing was to use price fixing to raise Amazon's prices, and that Amazon's low $9.99 pricing had succeeded in preventing entry at the retail level. Apple asserted that Amazon engaged in loss leader pricing of new releases and New York Times bestsellers. The dissent stated that Apple had achieved "the pro-competitive result of deconcentrating a market that had been dominated by a monopolist and insulated from competition through below-cost pricing" (Dissent slip op. p. 26).

The majority held that Apple had not shown that price fixing was necessary for Apple to be able to enter (pp. 99, 103), and that Apple had not shown that it would have lost money if it had entered a market that had price competition (p. 100). The majority recognized that a market with artificially high prices caused by price fixing is more attractive to potential new entrants, but "it would seem to follow that the more successful an agreement is in raising the price level, the safer it is from antitrust attack. Nothing could be more inconsistent with our cases" (p. 94, quoting Catalano, Inc. v. Target Sales, 446 U.S. 643, 649 (1980)).

The majority stated that "the Sherman Act does not authorize . . . marketplace vigilantism to eliminate perceived 'ruinous competition' or other 'competitive evils'" (p. 98, quoting Arizona v. Maricopa County Med. Soc'y, 457 U.S. 332, 346 (1982)). The antitrust laws encouraged vigorous price competition by Amazon (p. 97, citing Brooke Group Ltd. v. Brown & Williamson Tobacco Corp., 509 U.S. 209 (1993); cf. Cargill, Inc. v. Monfort of Colorado, Inc., 479 U.S.104, 116 (1986) ("[I]t is in the interest of competition to permit dominant firms to engage in vigorous competition, including price competition." [Citation omitted]). Apple had not shown that the price fixing it had arranged improved competition (pp. 104-105). Collusion, the method used to raise prices here, is "the supreme evil of antitrust" (p. 98, quoting Verizon Communications Inc. v. Law Offices of Curtis V. Trinko, 540 U.S. 398, 408 (2004)). In short, the majority held that "Apple had no entitlement to enter the market on its preferred terms" (p. 97).

The majority believed that the combination as described in its opinion impaired consumer welfare and nullified any potential benefit of reduced concentration. Retail prices of the five publishers' ebooks rose a weighted average 23.9 percent (p. 42) and the volume of ebooks they sold diminished by 12.9 percent (p. 87).

The majority held that this case did not present the same type of pristine vertical restraints found in Leegin Creative Leather Prods., Inc. v. PSKS, Inc., 551 U.S. 877 (2007). Defendant Leegin's vertical restraints only applied to retailers carrying Leegin's leather goods. Leegin did not eliminate price competition, or any other type of competition at its horizontal level, that it faced as a manufacturer from other manufacturers of leather goods. Here, the court found that Apple's primary objective, which it achieved, was an anticompetitive effect on a horizontal rival (p. 77).2

Footnotes

[1] The lead opinion found that Apple had committed a per se violation of Section 1 and, alternatively, had restrained trade unlawfully under the Rule of Reason; the concurring opinion joined the per se holding only and stated that no Rule of Reason analysis was needed; and the dissent held Apple's conduct was lawful under the Rule of Reason.

[2] The opinion also dealt at length with the proper scope of injunctive relief against Apple and the publishers. That issue is beyond the scope of this article. No damages were sought.

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