Most Favored Nation: The Fate of Apple’s eBooks Antitrust Suit

(image by Sabin Paul) 

While much of the country is focused on the next battle Apple, Inc. will take to the Supreme Court, in which it will assert its First Amendment rights against unlocking its phones, the Court also conferenced on February 19 to decide whether Apple’s last battle against the United States will proceed, one that could decide the fate of future innovation and whether Apple will pay a hefty fine for violating the federal antitrust laws.

In July 2013, Judge Denise Cote of the United States District Court for the Southern District of New York found that Apple had engaged in a per se violation of Section 1 of the Sherman Antitrust Act when it worked with five of the six major publishing houses to kick off its iBookstore for the launch of the first iPad in 2010. The facts appear to be a straightforward application of Section 1, which prohibits “[e]very contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce….” Apple SVP Eddy Cue began working with five of the six major publishers in 2009 with the suggestion that Apple would price most of its e-books between $9.99 and $14.99. More important for the publishers was that Cue recommended adopting the agency model, in which the publishers control the e-book price and Apple takes a 30% commission. This was all calculated to take a bite out of Amazon, which at that time virtually controlled the e-book industry, set prices for most books at $9.99, and earned the ire of the publishing houses for doing so, as they worried their hardcover books could never compete at that price. After Apple’s model, which included as a key point a “most favored nation” clause allowing for Apple to sell e-books at its competitors’ lowest price, all of the participating houses sought agency contracts from Amazon, taking back their control over their prices.

Cue essentially needed the five booksellers, in the government’s eyes, because if a single one of them had gone to Amazon, the retailer could have simply embargoed them. However, the prospect of losing 48 percent of its books by embargoing all five of them cowed Amazon into accepting the deals. The government sued Apple, contending that these meetings were a per se violation of Section 1. Courts analyze antitrust violations either according to the per se analysis or the rule of reason. If the court determines a violation is per se illegal under Section 1, all the government has to do is prove it occurred. And they could. Eddy Cue contracted or conspired with these competitors to restrain trade, as five agreeing publishers is a combination, not competition. Judge Cote summarily found that this is what occurred and found Apple in violation. Alternatively, if the combination is measured by law using the rule of reason, the court is to balance the efficiencies and positive market impacts of the arrangement against the negative ones.

Throughout their appeals, Apple and the government have spent much of their time arguing whether the conspiracy is per se illegal or whether it should be analyzed under the rule of reason. Much of this has taken the form of deciding whether the agreement was horizontal—among the publishers—or vertical—between individual publishers and their agent, Apple. Horizontal cooperation tends to be per se illegal, and vertical cooperation almost never is. However, as the Supreme Court considers whether to take the case after Apple lost at the United States Court of Appeals for the Second Circuit, a number of antitrust scholars have broadened the questions the court must consider.

An amicus curiae brief filed by the International Center for Law & Economics (ICLE) and joined by sixteen law and economics scholars argues that the rule of reason should apply in this case principally because the courts almost never apply per se analysis to a type of combination they have not seen before. The ICLE argues that the e-books agency model is one such novel combination. The ICLE links this agency model to a much broader contingent of companies and models—Uber and other internet companies included—where “a critical mass” of clients is needed to inject any new competition at all. These “multi-sided platforms” require the person in the middle to be the facilitator, while the customers on one side depend on the clients on the other side. Apple, in order to compete with Amazon at all, needed to gain a critical mass of publishers in order to be able to provide any sort of bookstore customers would want to browse on their new iPads, the last great hope against Amazon’s 90 percent market share at that time.

The ICLE brief, which may end up guiding the court’s thoughts more than the main parties’ briefs, appeals to a simple distinction—if Apple had not entered the market, Amazon would have continued to dominate it. Interestingly, there appears to be no violation of Section 2 of the Sherman Act, which prohibits monopolies, so Amazon could in theory have continued its dominance unabated. On the one hand, the ICLE is correct that the “era of inhospitality,” in which the courts were hostile to nonstandard contracts, has ended, and this arrangement might constitute an agreement with which they are sufficiently unfamiliar to justify rule of reason analysis. There are certainly practical difficulties, such as the question of whether it is believable that Apple gathered the book publishers to “build a better bookstore” versus its acknowledgement that Amazon could cow one of them, but not all of them. But this brief has the potential to overturn what on its face looks like a clear antitrust violation and determine the future actions businesses might take when bringing new “multi-sided platforms” to market. Can a third competitor to Uber and Lyft spend a year getting a “critical mass” of Uber drivers to leave the company en masse and face no liability? The next move is up to the Supreme Court.