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Amazon Seen Gaining Advantage With Apple’s E-Book Defeat

July 11, 2013

Amazon Seen Gaining Advantage With Apple’s E-Book Defeat

The U.S. government and 33 state attorneys general sued Apple and five of the biggest publishers in April 2012, claiming the Cupertino, California-based company pushed publishers to sign agreements letting it sell e-books under a model that raised prices and harmed consumers. Photographer: Scott Eells/Bloomberg

In the retailing wars with Apple Inc. (AAPL:US), score one for Amazon.com Inc. (AMZN:US)

A judge’s ruling that Apple violated U.S. antitrust laws by colluding to increase e-book prices gives retailers such as Amazon added flexibility to sell digital books more cheaply and gain market share. The decision may also lead to greater government oversight of the iPhone maker’s ability to control pricing in other markets, such as music and movies.

“Amazon emerges as the winner from all of the activity related to e-book pricing,” said Tom Forte, an analyst at Telsey Advisory Group in New York. “The company seems to be free to price the way it wants to, which, by Amazon’s standards, is aggressively to gain market share.”

Apple used agreements with publishers to fix prices of e-books, a federal judge in Manhattan ruled yesterday. Those deals helped the company sell reading content that boosted the appeal of its smartphones and tablets, while forcing Amazon to raise prices on some books and abandon the one-size-fits-all pricing that lured users to its Kindle readers. The verdict stands to give Amazon more leverage in negotiations with publishers.

Amazon shares advanced 2.5 percent to $299.66 at the close in New York. Apple rose 1.6 percent to $427.29. Investors continue to trade the online retailer at a premium, giving it a valuation of 25.5 times Apple (AMZN:US) and a multiple of 26.7 against the Standard & Poor’s 500 Index (AMZN:US) on a price-earnings basis.

Agency Model

While sales of e-books have exploded in the U.S., they still make up only 20 percent of the market, and those gains are slowing. Last year, e-book sales rose 44 percent to $3.04 billion after more than doubling in 2011, according to the Association of American Publishers.

The U.S. government and 33 state attorneys general sued Apple and five of the biggest publishers in April 2012, claiming the Cupertino, California-based company pushed publishers to sign agreements letting it sell e-books under a model that raised prices and harmed consumers.

Apple fought the lawsuit, seeking to fend off greater oversight and continue the agency model of letting content owners rather than retailers set prices, while generating income by taking a commission.

“Apple is using that agency model in a number of contexts and they chose to use it in part for e-books because they were using it in other contexts,” said Scott Kessler, an analyst at S&P Capital IQ.

Price Points

Apple is the world’s largest seller of music, and established the pricing model where tracks typically sell for 99 cents and albums for $9.99. With movies and television shows, where there is more competition from cable companies and online services such as Netflix Inc. (NFLX:US) and Hulu LLC, Apple has a less rigid pricing model.

By adopting a new model with higher e-book prices, Apple sought to force Amazon to change its pricing, the plaintiffs argued. At the time, the online retailer was selling titles for $9.99, often below cost. E-books now have a wider price range. More than 650,000 e-books sold by Amazon cost $4.99 or less and more than 1.2 million are $9.99 or less, the company said in May. Currently, the digital version of Dan Brown’s “Inferno” sells for $12.99.

U.S. District Judge Denise Cote said Apple lost the case, in part, because of statements by its deceased founder, Steve Jobs, that government lawyers said showed Apple was targeting Amazon. States are seeking triple damages for overcharges, according to Connecticut Attorney General George Jepsen’s office. Another trial will be held to determine Apple’s penalty.

Amazon Sales

“Any financial penalty is pocket change for Apple, but this decision can have a long-term effect,” said David Balto, a former policy director for the U.S. Federal Trade Commission. “The government can extend this beyond books.”

The ruling gives Seattle-based Amazon leeway in an industry that already accounts for a significant portion of its revenue. Amazon began selling e-books in 2007, and four years later, books for Kindle readers surpassed print sales.

Media, which includes digital content such as books, music and movies, will make up 26 percent of Amazon’s total sales in 2014, according to Dan Kurnos, an analyst at Benchmark Co. E-books will account for about half of that, he said.

Amazon’s aggressive pricing means the online retailer’s massive scale ends up benefiting customers, Kurnos said. Amazon has aligned itself with antitrust laws that seek to protect consumers, making its model difficult to contest, he said.

Market Competition

“Competitive practices are for the benefit of the consumer,” Kurnos said in an interview. “When was the last time you saw someone get in significant trouble for cutting prices too severely?”

Drew Herdener, a spokesman for Amazon, declined to comment.

While this ruling doesn’t affect authors and consumers because the agency model had already been phased out by the publishers’ settlement with the government, the decision may pave the way for Amazon to become even more powerful in the book industry, according to Paul Aiken, executive director of the Authors Guild.

With Amazon able to discount e-books at will, that will make digital titles more appealing and could increase pressure on brick-and-mortar bookstores, Aiken said. Fewer bookstores will also only increase Amazon’s negotiating power with publishers. For those chains that do offer e-books, like Barnes & Noble Inc. (BKS:US), competing with Amazon will be even harder considering that in the past it’s sold best-selling digital titles at a loss.

“If one is concerned about competition in the book industry, a healthy retail sector is critical,” Aiken said. “That now seems to be very much in doubt.”

Monopolistic Grip

Apple argues that it wasn’t fixing prices and was trying to create more competition in a market dominated by one player.

“Apple did not conspire to fix e-book pricing and we will continue to fight against these false accusations,” said Tom Neumayr, an Apple spokesman. “When we introduced the iBookstore in 2010, we gave customers more choice, injecting much needed innovation and competition into the market, breaking Amazon’s monopolistic grip on the publishing industry. We’ve done nothing wrong and we will appeal the judge’s decision.”

The company’s appeal isn’t likely to prevail and a final penalty could be in place within a year, said Christopher Sagers, a law professor at Cleveland State University. The ruling may put Apple in a similar situation as Microsoft Corp. (MSFT:US), which faced increased oversight as part of its deal to resolve antitrust charges. The software maker was subject to periodic status reports to check whether it complied with its settlement with the government.

“We’re likely to see pretty broad, invasive government monitoring,” Sagers said. “This case could have a big effect in how they set up new businesses.”

To contact the reporters on this story: Adam Satariano in San Francisco at asatariano1@bloomberg.net; Danielle Kucera in San Francisco at dkucera6@bloomberg.net

To contact the editor responsible for this story: Pui-Wing Tam at ptam13@bloomberg.net


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