On October 31, 2022, Judge Florence Pan, now on the D.C. Circuit but sitting by designation in the District Court of the District of Columbia, delivered a "treat" to the Department of Justice (DOJ) and a "trick" to Penguin Random House by blocking its $2.18 billion purchase of rival publisher Simon & Schuster. The opinion, which was released on November 7, 2022, represents a comprehensive endorsement of the DOJ's monopsony theory of the case and a complete rejection of the defendants' counterarguments. After a string of defeats, the case marks the first win for the DOJ under the Biden administration in a litigated merger challenge.
Background
Penguin Random House and Simon & Schuster are two of the "Big Five" largest book publishers in the United States. In November 2020, after a bidding process, Penguin agreed to buy Simon & Schuster for $2.18 billion in a deal that would cement Penguin as the number one publisher in the United States with a market share nearly three times that of its closest competitor.
In November 2021, the DOJ sued to block the merger under Section 7 of the Clayton Act. Rather than argue that the deal would substantially lessen competition or tend to create a monopoly that would result in increased prices for consumers, the DOJ argued that the combined entity would tend to create monopsony power that would result in lower advance payments to authors. Advances are the upfront money paid to an author before a work is completed and published; in exchange for an advance, the author receives no royalties until the advance is offset. Because most books do not recover the cost of their advance, this is often the only money an author will receive. An author's agent will often shop a book to multiple publishers to achieve the greatest advance for their client. The DOJ argued that by reducing the number of publishers, the deal would decrease the dollar amount of advances to authors, harming their ability to write books and reducing output.
In bringing its complaint, the DOJ focused on a subset of the overall publishing landscape: "anticipated top-selling books," which it defined as books with advances of at least $250,000. As the court noted, the Big Five publishers collectively held 91% of this market. After a trial featuring testimony from literary luminaries such as Stephen King, the court agreed with the DOJ and permanently enjoined the merger.
Implications and Takeaways
The opinion is notable for a number of reasons. First, Judge Pan rejected the defendants' attacks against the DOJ's use of a $250,000 threshold for defining the relevant market, which argued that the threshold was arbitrary, that price alone should not be part of the definition as books are valued along a continuum, and that the transaction would have no anticompetitive effects if the market were defined at various other dollar thresholds. In rejecting these arguments, Judge Pan noted that the Clayton Act prohibits mergers that may substantially lessen competition "in any line of commerce or in any activity affecting commerce." Thus, the court adopted the view that all market definition requires some degree of artificial line-drawing that cannot be measured "by metes and bounds" and, accordingly, should not stand in the way of an examination of the competitive effects of a transaction. Indeed, she noted that there was precedent for focusing on the "high end" of a market as it would likely be distinct from the other potential submarkets.
Second, Judge Pan noted that the industry has been the subject of increasing concentration over the past four decades but had reached a stability in the past three years, which this merger threatened to upend. She noted that none of the non-Big Five publishers had increased their market share and the aggregate share for them was "essentially flat." This counseled for assigning more weight to the market shares, which reflected the dominance the combined entity would possess. Moreover, she found the stability of market shares over the past three years to be evidence of the difficulty for new entrants to enter the market due to the need for big back lists, extensive marketing, sales, and distribution teams, and scale. As a result, the stability of the market shares demonstrated that the major publishers were already benefitting from diminished competition. She noted that new entrants like Amazon and Disney had not yet successfully entered and had no short-term plans to make a competitive entry, with Disney focusing on a five-year entry plan and Amazon actually losing share in the market for top-selling books.
Judge Pan also found significant the competitive harms that would result from the merger. For instance, Penguin and Simon & Schuster were often each other's most significant competitor and their separate presence in auctions could drive advances higher. Additionally, if Penguin were to acquire Simon & Schuster, it would have less incentive to expand its market share by buying more books as it would be naturally acquiring more books through Simon & Schuster. Judge Pan also found it noteworthy that there was a history of collusion in the book industry, from the Apple case where the major book publishers colluded to increase e-book prices to parallel conduct to demand audiobook rights as part of negotiations. Judge Pan noted that, given the backdrop of the Apple case, it was apparent that there was already "tacit collusion or parallel accommodating conduct when acquiring books." For instance, terms for payment structures, which had previously been paid in two installments, were uniformly moved to three and then four payments. Publishers also uniformly shifted e-book royalty rates from 50% to 25% in the early days of e-books. She found this parallel behavior to be telling as publishers could theoretically compete with each other by offering better contract terms but had appeared to tacitly agree to only compete on advances, as the other terms were better for them.
The focus on authors as labor and a monopsony theory of harm is not the DOJ's typical focus on monopolization and consumer harm, but does reflect Assistant Attorney General Jonathan Kanter's growing focus on labor markets, as reflected in the DOJ's recent civil lawsuit against poultry processors which allegedly conspired to suppress the wages of plant workers, or its criminal case prosecution against a dialysis provider for a conspiracy to suppress competition for senior-level employees. President Biden's Executive Order on Competition urged the DOJ to focus on the antitrust risks with labor markets and Kanter has responded to that call by describing competition in labor markets as a "moral issue" and promising a focus on antitrust risks that would harm wages. With regard to injury to consumers, Judge Pan did mention a few times that the reduced advances for authors would have the knock-on effect of decreasing the output of books, to the detriment of the reading public. As reflected in the recent focus by the federal enforcement agencies on merger effects on labor, the opinion is a reminder for merging companies to take a comprehensive view of the potential anticompetitive claims that their merger may face both upstream and downstream.
Finally, the court seemed skeptical of the defendants in general, as they made several arguments that she found "incredible," "unsupportable," "unreliable," or even a "sleight of hand." For example, the court's rejection of the criticism of DOJ's GUPPI models was based in part on the fact that defendants' economists had used GUPPI models during the pre-complaint investigation. The court criticized the defense efforts to present the independent publishers as a bulk 9% of the market, rather than broken out individually by publisher. Judge Pan rejected as unenforceable and suggestive of a "consciousness of guilt" the unilateral promise by Penguin's CEO to allow Simon & Schuster legacy imprints to compete with Penguin when there is no external bidder. And, as in most merger trials, the court was able to cite to defendants' documents presented by DOJ that contradicted defense claims.
The decision marks the first victory for the Biden DOJ in a merger challenge litigated to a decision. The DOJ had suffered multiple setbacks of late, including failed challenges to Booz Allen's acquisition of EverWatch, UnitedHealth Care's acquisition of Change Healthcare, and U.S. Sugar's purchase of Imperial Sugar. Although one victory does not indicate a trend, it does provide support for the Antitrust Division's aggressive-merger enforcement agenda and its continued focus on labor markets. In light of the enhanced risk of trial, it is incumbent upon companies considering a merger in a concentrated industry to begin to prepare for the possibility of trial from the beginning of the consideration of the deal, and to weigh fix-it-first options before making an HSR filing.
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