Breaking Down the Apple-DoJ-Agency Five Saga and Its Ramifications

Expert publishing blog opinions are solely those of the blogger and not necessarily endorsed by DBW.

What could the actions of the Department of Justice mean for e-books? Here’s a breakdown with some scenarios as I understand the situation.

 

Apple’s Agency Model

Publishers selling through Apple can only do so through an agency agreement (a uniform 70%/30% revenue split across all categories and digital products). That is true for all assets – games, music, video, movies, etc. – sold through Apple.

Based on the recent news reporting, the DoJ might accept agency as a valid business model. In an interview with the Wall Street Journal, Sharis Pozen, the top antitrust official at the Department of Justice states “we don’t pick the business model”, and is focusing its efforts on a settlement under which Apple drops the “most favored nation” clause form contracts according to a report by Reuters.

This means Apple’s business model for iTunes – including iBooks – may remain largely untouched. Apple does not have to worry about price-matching, does not need buyers or merchandisers to come up with the right price, and does not need to change its technical or e-commerce infrastructure.

 

Most Favored Nation

To be competitive under its retail model, Apple originally insisted on a Most Favored Nation (MFN) clause to make sure its goods (and its processes for pricing these, where the publisher set the retail price) were competitive (i.e. Apple would not be undercut on the same goods in the marketplace).

Being forced by the DoJ to drop the Most Favored Nation (MFN) clause means that Apple could no longer insist that the retail price agreed between Apple and publisher is the lowest in the market at all times.

 

Agency and the Big Six (Penguin, Macmillan, Hachette, Simon & Schuster, Random House and HarperCollins)

The big-six publishers (except Random House, which followed the “agency five” to this business model one year later) had agency agreements in place with Apple when iBooks launched and more importantly were able to force these agency agreements (RH included) on Amazon, too. Due to their market position and the popularity of their books (and authors), the big-six publishers prevailed in negotiations with Amazon (remember the outcry by authors and customers when Macmillan books disappeared from Amazon? Amazon caved inside of 3 days.)

It is likely that nothing will change for the big six if Apple is forced to drop MFN. It will be agency terms as normal with all retailers be they Apple, Amazon, BN, Google, Kobo or others. This is probably a very happy outcome for the big six.

However, at the same time, the big six are less constrained when doing short-terms promotions and will only be able to do these promotions selectively, i.e. only in certain channels and on certain titles. Regardless, I think the big six would be very happy with this outcome.

 

Agency and the Second Tier

Many publishers in the “2nd tier” (all those outside big six – this in no way refers to quality of the output, it is just a reflection of size and market-share) have agency agreements with Apple, but wholesale agreements with Amazon, because Amazon had the upper hand in negotiations along the lines of “you are not willing to sell on wholesale terms? O.K. we will not sell your books” and swoosh these publishers would have lost the potential of selling to 60% to 70% of the now very large e-book market (as much as 50% of the total market for many titles).

These publishers were in a very precarious situation under MFN. When Amazon dropped prices below retail price or even below wholesale price, then Apple was entitled under MFN to drop the “agency” retail price, too. This led to the absurd situation where Amazon sold titles at zero cost , but still paying wholesale price to publishers, and Apple matching the retail price of $0 and paying publishers 70% of $0, i.e. nil. This was not a pleasant situation for 2nd tier publishers to be in.

Thus the news that MFN might be dead would be great news for 2nd tier publishers. In the short term, they might be the biggest winners in this game. Strengthening 2nd tier publishers increases competition in the market and the DOJ might view this as one of its successes.

 

What Does It Mean for Consumers?

Henceforth titles in iBooks might be more expensive than at Amazon. That is not exactly news. This has happened many times on titles that were not in the best seller list (Apple seems to manually price match the best sellers and pay no attention to other titles, but that is based on circumstantial evidence). Will e-book prices drop? Probably not, at least not for any big-six titles and that is the majority of the best sellers, but it all depends on what Amazon does next.

 

DoJ

Killing MFN would still be a major coup for the DoJ and would in some ways level the playing field, because while Apple got MFN status, most 2nd tier retailers never got MFN. They had to trust the publisher that is would be a uniform price everywhere, but often there was that Amazon loophole, wherein the leading e-book e-tailer would drop prices to $0, a loophole the size of a barn door. Thus, this is also good news for 2nd tier retailers.

Is Amazon the big looser? Not really, it is now free to refuse agency terms without publishers pointing to MFN. Its poker hand just got a little bit stronger, but not much I would say.

 

What Does It Mean for Apple?

Well it is now clear to Apple, that e-books and iBooks are NOT key to success to how well the iPad sells and thus we have witnessed a benign neglect of iBooks.

Winning the battle on agency means that Apple does not have to change its technical infrastructure, which must sure be a big relief. It also means that no new battle fronts are opened in music, video, games or elsewhere. The agency model is not in “safe harbor” at least until another earthquake happens (Supreme Court case?).

That some of its titles in iBooks are uncompetitive probably doesn’t worry Apple much. It cares a hell of a lot more about upholding agency terms and MFN with magazine and newspaper publishers, where the market structure is totally different.

Apple is thus the big loser, but it lost on points that were not materially important to its business.

To quote the Red Queen in ‘Alice in Wonderland’: “All shall have prices” well at least in this round.

I might be wrong on some of my assumptions and conclusions above, but this is my analysis of where we are today based on the available information. I disagree with the Reuters assumption that a settlement on the MFN clause would automatically imply the death of agency. That is rather unlikely, but the world is full of surprises.

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