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William Petrocelli

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The Justice Department Jumps Into Amazon's Pocket

Posted: 04/24/2012 2:31 pm

The record of the Anti-trust Division of the U.S. Department of Justice over the last 40 years has been a sorry one. Sometimes it goes after companies that have done nothing wrong, but more often it lets big-time antitrust violators get away with murder. In a recent case -- one that has roiled the publishing industry -- the DOJ has managed to do both. The Justice Department is hounding MacMillan and Penguin Publishers, even though those companies and other publishers have done nothing more than try to protect their business from the unfair tactics of Amazon.com. In the meantime, the DOJ has given Amazon a green light to continue on its path towards monopolization of the book business.

News coverage of the DOJ's case has been almost uniformly critical. (The Atlantic Monthly's April 12 article was entitled "The Justice Department Just Made Jeff Bezos Dictator-for-Life"). When large publishers, small publishers, independent booksellers, Barnes & Noble, Apple Corporation, the American Booksellers Association, and the Authors Guild all agree that this case is terribly wrong, it's time for the Justice Department take a step back and re-assess what's doing. Most people in the book business think the Justice Department has gone from being an anti-trust enforcer to an anti-trust enabler.

Any basketball fan will recognize this situation. We've all seen games where a referee fails to see a player being beaten, punched, and gouged under the net. And when he finally tries to fend off his tormentor, the referee wakes up just in time to see the last shove and call a foul against the victim. That's what's happening here. The DOJ has stepped into a business it doesn't understand at all, and it is tilting the outcome against those who are trying to play by the rules.

What did the publishers do to bring down the wrath of the Justice Department? They did nothing other than what any rational business person would do in the face of unfair pressure from an over-bearing, dominant retailer. Faced with e-book pricing demands from Amazon.com that his company couldn't meet, MacMillan president John Sargent instituted what was called an "agency plan" under which the publishers would sell e-books directly to readers and give the retailer that arranged the sale -- whether it be Amazon or some other bookseller -- an agency fee.

There's nothing illegal or even unusual about such an arrangement. Many companies -- including Amazon -- sell directly to customers and give the originator of the sale a commission or affiliate fee. In this particular case, the Agency Plan was a creative solution to a difficult marketing situation. The DOJ claims there was collusion between the publishers, but the evidence of that is very slim. Sargent is adamant that he made the decision on his own:

"After days of thought and worry, I made the decision on January 22nd, 2010, a little after 4:00 AM, on an exercise bike in my basement. It remains the loneliest decision I have ever made, and I see no reason to go back on it now."

When the MacMillan plan was announced at a national meeting of booksellers a few weeks later, it got a standing ovation. Other publishers adopted the plan on their own after that. The immediate result of the Agency Plan was a dramatic increase in competition in e-books. Amazon, which had a 90% share of the market, saw its share drop to 60%. New competitors started asserting themselves in the market, including Apple, Google, Barnes & Noble, and a host of independent stores.

But none of that was good enough for the lawyers at the Department of Justice. The DOJ refs saw only the hint of a shove under the basket and called the foul on the wrong player.

Where Did the Justice Department Go Wrong?

If you read the Justice Department's complaint, you'd get the impression that the publishers adopted the Agency Plan as a means of maximizing their profits at the expense of the consumer. Nothing could be further from the truth. All the evidence shows that the Agency Plan was adopted as a defensive measure against a very real threat by Amazon to monopolize both the e-book market and the larger print-book market. The Justice Department lawyers closed their eyes to all that, as they were seemingly swept up by the Amazon mystique.

The kindest way to describe the Justice Department's analysis is to say that it was superficial. The DOJ latched on to the idea that Amazon would no longer be able to sell e-books from those publishers at $9.99 -- the price at which it had been selling them before the Agency Plan went into effect. They viewed that development as price-fixing, and as far they were concerned that ended the argument.

But it should have been just the beginning of the analysis. It is clear even in paragraph 30 of the DOJ's own complaint that Amazon was engaging in predatory pricing -- i.e. by selling e-books at $9.99, Amazon was selling them below cost. Predatory pricing is illegal under federal law and under most state laws. Selling below cost is one of the principal tactics used by would-be monopolists to force smaller companies into a ruinous price war that will eventually put them out of business. With their competitors gone, monopolists can then raise their prices to any level they want. Even if the Justice Department was reluctant to stop Amazon from engaging in predatory pricing, it is truly shocking that it would use its power, as it has here, to force others to accept it.

If the DOJ had been doing its job, Amazon's predatory pricing should have been the tip-off to some far deeper problems. Those tactics didn't just begin recently. Amazon has been selling print-books below cost for a number of years. It continues to pressure publishers relentlessly for special deals that aren't available to its competitors, using as one of its favorite tactics the abrupt, unannounced de-listing of the publisher's book s from its website. According to many experts, Amazon has priced its Kindle Reader below cost, and it has magnified the impact of that tactic by allowing only books sold by Amazon to be read on the Kindle. Even Amazon's fanatical opposition to collecting sales tax fits into this picture as part of an effort to drive a deep wedge between its prices and those of its competitors. There is plenty of evidence that Amazon is using these tactics to attempt to monopolize both the e-book and the print-book markets, but the Justice Department apparently ignored all of it.

Amazon's E-book Strategy

This dispute originated with Amazon's arbitrary decision to sell all e-books at $9.99, which was lower than the price at which it was purchasing those books. Book-industry analysts looking at this decision concluded that Amazon was trying to force the price of e-books so low that buyers would abandon print books altogether. If that happened, Amazon -- with its 90% share of the e-book market and a Kindle device that played only Amazon-purchased product -- would be sitting pretty.

But it was stage two of Amazon's strategy that precipitated this crisis. This occurred when Amazon began pushing the publishers to drop the wholesale price of e-books substantially below $9.99. From Amazon's point of view, that would have two beneficial effects. One, they would stop losing money on each e-book sale. And two, the publishers would probably be forced to shift most of their fixed costs to print books. That would cause an increase in the price of print books, thus creating a further, artificially-induced disparity between the price of e-books and print books.

From the point of view of publishers, this would be disastrous. While it is true the cost of producing e-books is somewhat lower than print books, there are large development, marketing, and other costs that publishers simply couldn't recover if they were forced to drop their wholesale price significantly below $9.99. For booksellers the situation would be even worse: the net effect of Amazon's power-play would be to drive up the cost of print books in the bookstores. The Justice Department simply ignored all of this in its decision.

Did Anyone Think About the Authors?

To really see the disastrous effects of the DOJ's action, we should probably listen to authors. They are the ones who create the books. A low e-book price won't do the reading public any good if that pricing structure causes authors to get discouraged from writing the books that people want to read.

Scott Turow, president of the Author's Guild, reacted to the Justice Department action with this statement:

"The irony of this bites hard: our government may be on the verge of killing real competition in order to save the appearance of competition. This would be tragic for all of us who value books and the culture they support."

It is easy to see why Turow and other authors are alarmed. Their potential book royalties are severely threatened. With a new hardcover book, an author will typically get around $3.00 to $4.00 per copy in royalties -- hardly an extravagant amount, when you consider the effort that goes in to writing a book. But if the print book fades away and the $9.99-priced e-book becomes the new norm, authors' royalties would be reduced to a pittance. At that price, there is almost nothing left for the authors after covering the publisher's costs and Amazon's mark-up. In that scenario, future authors will probably be looking at royalties of only a few pennies on every e-book sold.

The Justice Department lawyers have some soul-searching to do on this. And if they won't take a more thorough look at what they are doing, maybe Congress should do it for them. Right now, they have aligned themselves with the forces that threaten to destroy the book business, and that's a shameful place to be.

 
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