Ebook pricing presents a new dilemma

It was a script publishers would have had to fight to print. A 36-page lawsuit from the US Department of Justice this week told a conspiracy story, concocted by top industry executives over dinner at expensive New York restaurants such as Picholine and Alto.

Government lawyers told a compelling story of a battle between anxious suppliers and a powerful retailer over who should control what the consumer pays. Even better, the late Steve Jobs, co-founder of the world’s most valuable company, had a starring role.

But book rights were the last thing publishers were concerned about. Five of the industry’s “big six” – Hachette, HarperCollins, Macmillan, Penguin and Simon & Schuster – were cited in the defense, as was Apple, which launched the iPad in early 2010 with an iBookstore offering titles from the five publishers . The lawsuit had been brewing for months, alongside investigations by the European Commission and several US states, but still surprised analysts.

It also divided the industry, with Hachette, HarperCollins and Simon & Schuster admitting no guilt, but immediately arranging to avoid what Hachette called “prolonged and costly litigation with government plaintiffs with virtually unlimited resources”.

Macmillan and Penguin – a subsidiary of Pearson, like the Financial Times – opted to dispute the case instead. “The costs of prosecution – in time, distraction and expense – are truly daunting. But the conditions demanded by the DoJ were too onerous, said John Sargent, chief executive of Macmillan.

Apple will also fight. “The DoJ’s accusation of collusion against Apple is simply not true,” he said. “The launch of the iBookstore in 2010 spurred innovation and competition, breaking Amazon’s monopoly hold on the publishing industry.”

Mr Sargent said he did not conspire with anyone when he agreed to Macmillan’s groundbreaking deal with Apple’s iBookstore. “After days of thinking and worrying, I made the decision on January 22, 2010, a little after 4 a.m., on an exercise bike in my basement,” he recalled. “It remains the loneliest decision I have ever made, and I see no reason to go back on it now.”

Behind the DoJ’s collusion allegations lie thorny economic theories that are unlikely to find their way into a novel. At issue is whether Apple and publishers inflated the price of ebooks by agreeing to change the way they are sold.

In the DoJ’s account, publishers were alarmed that Amazon, which quickly gained 90% of the U.S. e-book market after launching its Kindle e-readers, was slashing top titles to $9.99, “eroding the perception of value of their products in the minds of customers”, in Words of Mr. Jobs. Amazon’s prices were also squeezing the margins of rival retailers who felt pressured to match them.

The e-books had been sold under a “wholesale” model, in which publishers charged retailers, such as Amazon, a wholesale price, but retailers could decide on a higher or lower retail price. For three days in January 2010, on the eve of the iPad’s launch, the five publishers signed “agency” agreements with Apple, which allowed them to set the retail price – usually $12.99 or $14.99 – and guaranteed Apple a 30% discount.

They also agreed to a “most favored nation” clause which promised Apple that they would not sell their books for less outside the iBookstore. Other retailers — including Amazon — quickly aligned themselves with the agency’s model. Random House, the largest publisher, followed suit a year later — enough time to exclude it from the DoJ lawsuit. The effect on e-book prices remains a matter of debate. According to the DoJ, the change cost consumers tens of millions of dollars. But behind the bestseller list, publishers say prices have come down. Hachette said 82% of its e-books cost $9.99 or less, while Smashwords, an independent e-book publisher, produced data showing the average price of its titles fell from $4.16 to $2. $.97 since October 2010.

The DoJ settlement has raised the prospect of three major publishers continuing their agency deals while the three that have settled must make a series of changes that effectively kill the model in the eyes of some analysts.

The level of detail in the regulations also infuriated some publishers, who argued privately that the DoJ shouldn’t determine business models.

Despite protests from publishers, analysts consider the e-book sector to be relatively healthy. “It’s the only digital media company that’s been able to make a relatively cost-effective transition from analog to digital,” says James McQuivey of Forrester Research. “The agency model pricing was intended to delay fundamental changes in the business, such as the erosion of hardback book sales, and it saved them a few years.”

According to figures from the Pew Research Center, 21% of Americans read an ebook in the year through February, and ebook buyers were avid readers, consuming two titles a month.

Veronis Suhler Stevenson, a private equity firm, estimates that e-book sales jumped 150% in 2010 to $913 million and expects the total consumer book market to grow at a modest compound annual rate of 0 .3% between 2010 and 2015, fueled by the double digital growth of digital platforms.

Publishers fear their share of that revenue will suffer if the DoJ gives more power to Amazon, whose market share in e-books has risen from 90% since the advent of the agency model but remains well below above any rival at 60%.

Amazon, now competing with publishers through its own brand of e-books, is perhaps the only member of the industry willing to take on the script from the DoJ. But it will take a long court battle to determine whether the story is ultimately classified as true crime or pulp fiction.

With additional reporting by David Gelles