Dissent in Apple eBook Case Points to the Supreme Court

Apple haters cheered last Tuesday’s Second Circuit Court ruling denying Apple’s appeal in the ebook conspiracy case. But the celebration seems a little more muted than when Apple was first found guilty in 2012 and eventually forced into a $450 million dollar settlement. That’s because Apple still has the option of appealing the case to the Supreme Court, and the dissenting judge in this split decision pointed the way there like a bright spotlight revealing a path through the darkness.

When I’m not blogging about Apple and technology, I moonlight as a self-publisher, so this particular case has always been of interest to me, since it circles around areas that will likely directly affect my future. The final outcome of this has huge implications for technology, business, Apple and publishing, as well as self-publishing.

Apple haters have tried to make this out as if it was a clear cut issue of Apple being caught doing something wrong and refusing to fess up. Typical of Apple bashing in general, anyone who disagreed was labeled as being irrational, unwilling to look at the facts, and supporting Apple against logic and reason. In fact, a widely repeated meme in much of the reporting has been that “everyone” who knows anything about legal matters agrees that Apple was in the wrong.

Nothing could be further from the truth. Many very respected lawyers and legal commentators have pointed out that Apple has an excellent argument that they did nothing illegal, and a very good chance to prevail if they take the matter all the way up to the current pro-business Supreme Court. The “everyone agrees Apple was wrong” meme seemed to come from a desperate effort to convince Apple to give up and not pursue this to the top. Fat chance of that. Yet even now, some of the reporting tries to imply Apple is sure to lose with the Supreme Court, or that the Supreme Court will refuse to hear the case. Fat chance of that too.

Demolishing the argument that “everyone” agrees Apple did something illegal is the brilliant dissent written by Judge Dennis Jacobs. When it really counted, three highly experienced judges couldn’t agree that Apple did anything wrong. (And, in fact, the two judges that did reject Apple’s appeal, disagreed on key issues. So this was hardly a slam dunk legal decision.) Jacobs also strongly indicates that the Supreme Court would rule in Apple’s favor. He points out that a different circuit court of appeal came to a different conclusion (one that would favor Apple) in a similar case. He states:

“The majority’s holding in this case creates a circuit split, and puts us on the wrong side of it.”

That is the spotlight through the dark. And it points to the white columns of the Supreme Court. A circuit split is one of the main things the Supreme Court is supposed to resolve. If one circuit is saying X is illegal and another says X is legal, the Supreme Court almost has to intervene to decide which circuit is right. Moreover, I would argue that given the importance of this issue, Apple has a moral obligation to pursue it to the Supreme Court to resolve it once and for all. Apple has stated clearly in the past that they do see this as a serious matter.  And after this recent split decision an Apple spokesman said:

“Apple did not conspire to fix e-book pricing and this ruling does nothing to change the facts… while we want to put this behind us, the case is about principles and values. We know we did nothing wrong back in 2010 and are assessing the next steps.”

The next step should be the Supreme Court steps.

Tim Cook has been quoted as saying the ebook case was “bizarre” and he’s quite right.   Judge Jacobs dissent states that it is a "novel" application of anti-trust law:

"As the government conceded at oral argument, no court has previously considered a restraint of this kind."

What Apple did upon entering the ebook market is almost identical to what it did when it first introduced iTunes. With iTunes, Apple went to all the major record labels and demanded that they agree on set pricing and other terms so that customers could have a consistent experience when they purchased songs. No one accused Apple of violating anti-trust laws when they did that, certainly not the Department of Justice. Likewise, no one is accusing Apple of violating anti-trust laws in their most recent musical deal, where they basically did the same thing for music streaming.

The "bizarre" thing that Tim Cook referred to is that for some reason, what Apple legally did with music, was somehow illegal when Apple did it with ebooks. Anti-trust laws are generally supposed to kick in when a company dominates a market (particularly if they have a share of over 80%). Apple had 0% of the ebook market, so anti-trust laws shouldn’t have applied to it in any way at all. (Even the big publishers Apple was negotiating with didn’t control 80% of the market, it was closer to 50%.) More importantly, there hasn't been any prior case where anti-trust laws were imposed on a company before it entered a new market. The case against Apple is breaking new, novel, and bizarre, legal ground. All the more so, because at the time Apple made these new ebook deals, Amazon had 90% of the ebook trade. As many, including Judge Jacobs, have pointed out, if there were any anti-trust issues in 2012 related to ebooks, the focus should have been on Amazon’s market share, not trying to prevent a new competitor from entering the market.

That’s why Apple must take the case all the way to the Supreme Court. This is a very dangerous precedent, particularly in a modern world where giant international corporations are able to quickly seize huge amounts of market share. Anti-trust laws in the United States are already too rarely enforced (abuse by cable companies is a good example of that). They should be used against true monopolies. If they are now twisted so they are used to punish companies trying to compete against monopolies, then they have no positive purpose.

It is true there is long history of collusion between the big New York publishers Apple negotiated with on what is called a "horizontal plane" between direct competitors. It would be nice if the Justice Department had sued those publishers for forcing writers to take “standard” writing contracts that dramatically underpay them. For, example, all the big publishers have secretly agreed not to do print only deals where writers to keep their ebook rights. Exposing that, and other abuses, would have been a good use of the Justice Department's time. But instead, the DOJ filed suit to protect a huge company, Amazon, that already had a huge monopoly on ebooks and more than enough leverage to negotiate tough deals with the big publishers.

The original judge in the matter, Denise Cotes, wrote an extremely long decision trying to explain why Apple did something illegal, focusing ultimately on the issue of prices for ebooks going up. As many have pointed out, if you have a solid argument, you don’t need to over explain it. Her decision comes across as being very defensive of its shaky legal ground, and there’s are huge problems with her arguments about pricing. As Judge Jacobs says:

"The district court opinion and the plaintiffs’ briefs fixate on the idea that Apple ended Amazon’s $9.99 price for most new releases and bestsellers, and that consumers would have preferred a lower price. But the consumer’s near- term preference for low prices is not an object of antitrust law… The rule of reason promotes competition; it can be safely assumed that if competition sharpens, prices will take care of themselves."

Exactly. Anti-trust law is not simply a vehicle for creating low prices. It's purpose is to encourage and protect competition. Competition may or may not lead to lower prices (it might lead to better service, better quality or more choices). Moreover, Apple was not in competition with the big publishers, it was a distributor looking to make the best deal possible on what is called a vertical plane. On top of that, none of the specific contractual terms between Apple and the big publishers related to pricing were illegal. For example, agency pricing and a most favored nations clause. Even Judge Cote conceded that publishers have a right to set their own prices though agency pricing. She specifically stated:

 “… this Court has not found, that the agency model for distribution of content, or any one of the clauses included in the Agreements, or any of the identified negotiation tactics is inherently illegal. Indeed, entirely lawful contracts may include an MFN, price caps, or pricing tiers.”

Despite admitting the deals were legal, she still bizarrely ruled against Apple and forced it into $450 million dollar settlement. The irony is that since the deals were legal, the publishers simply waited a few years and negotiated almost exactly the same agency pricing deal with Amazon that was supposedly wrong when Apple originally negotiated it. Prices for best selling ebooks have gone up recently from $9.99, because that’s what publishers always wanted. And they were legally entitled to demand it. Apple can now sell those books for the same price as Amazon, as their original favored nations agreement required. Whether higher ebook prices for some best sellers is ultimately a good thing for readers and publishers isn’t a matter for the government to decide. The free market will decide it.

However, thanks to the DOJ lawsuit, Amazon has had extra years to try to solidify its hold on ebook sales before prices were (legally) raised anyway. Particularly, readers (including Apple's iPad customers) now have three more years of ebooks collected in Amazon’s proprietary format, encouraging them to stick within Amazon’s ecosystem. It’s hard to see how customers have benefited from all of this government interference in Apple’s ability to compete with its own iBooks store.

So if none of what Apple or the big publishers did was illegal, (and all of it is happening now anyway), why was Apple forced into a settlement to pay $450 million dollars? That is a rather difficult question, and since the specifics of Apple's actions (wanting to sell ebooks) didn't sound bad enough during the trial, the DOJ needed to compare Apple's actions to driving the car during a bank robbery or facilitating a illegal drug deal. But as Judge Jacob says in his dissent:

"Application of the rule of reason easily absolves Apple of antitrust liability. That is why at oral argument the government analogized this case to a drug conspiracy, in which every player is a criminal--at every level, on every axis, whether big or small, whether new entrant or recidivist. The government found the analogy useful--and necessary--because in an all-criminal industry there is no justification or harbor under a rule of reason."

In refusing Apple's appeal, Judge Debra Ann Livingston also adopted melodramatic language and attacked Apple's actions as "vigilantism." Sure, vigilantes are terrible, but what on Earth does that have to do with Apple wanting to compete with Amazon by selling ebooks? What does it even mean? In her decision, she appears to object to Apple being a clever negotiator and demanding tough terms. Judge Jacob's states:

“A further and pervasive error (by the district court and by my colleagues on this appeal) is the implicit assumption that competition should be genteel, lawyer-designed, and fair under sporting rules, and that antitrust law is offended by gloves-off competition.”

It's it true Apple was gloves-off, or not fair under sporting rules? Were they business "vigilantes?" Or perhaps they did something basically legal, but they didn’t dot the “i” and cross the “t’s” in a way to satisfy every legal nicety. Were they driving under the normal speed limit, but forgetting that the speed limit is lower on school days? Should they have handled the matter of entering the ebook market in a more "genteel" way? Were they needlessly ruthless in their relentless pursuit of cold hearted business? Is it fair on any level to compare their actions, at least metaphorically, to drug dealers and vigilantes?

Judge Jacob addresses this head on. He states that Apple had no choice but to do exactly what they did if they wanted to enter the ebook market and compete against Amazon. His thoughtful dissent is much shorter and more to the point than Judge Cotes, because he doesn’t have to twist the law around, or use melodramatic language, to make his point that Apple did nothing illegal. Yet he takes the time to very specifically address what Apple’s options were, and why they took the most responsible and legal approach to entering the ebook market and bringing much needed competition.

For starters, even if there was a conspiracy between the big publishers to try to fix prices, that does not mean Apple was doing anything illegal by negotiating with them. As Judge Jacobs says:

“Collusion among competitors does not describe Apple’s conduct or account for its motive. Apple’s conduct had no element of collusion with a horizontal rival. Its own rival in competition was (and presumably is) Amazon; and that competition takes place on a horizontal plane distinct from the plane of the horizontal conspiracy among the publishers. All Apple’s energy--all it did that has been condemned in this case--was directed to weakening its competitive rival, and pushing it aside to make room for Apple’s entry. On the only horizontal plane that matters to Apple’s e-book business, Apple was in competition and never in collusion. So it does not do to deem Apple’s conduct anti-competitive just because the publishers’ horizontal conspiracy was found to be illegal per se.”

At the time, Amazon had achieved it’s 90% share of the ebook trade by heavily discounting many best selling ebooks to $9.99, taking a loss on their sales. The big publishers wanted their best selling books to retail at a higher price, and feared Amazon’s dominance of the ebook market, and huge discounting of their best sellers, would create the customer expectation that all ebooks should sell for $9.99 or less.  Amazon would then lock them into that price for the forceable future.

Now, I’m a huge fan of Amazon, and I think overall what they have been doing in the ebook market is smart and good for readers, writers and publishers. Their efforts to push the price of ebooks to $9.99 is based on a desire to grow the ebook market. They’ve consistently made an argument, which I agree is probably true, that pricing ebooks at $9.99 will mean more are sold and more profits for everyone, publishers included.

I am also not a fan of the big traditional publishers Apple made deals with. They have colluded to screw writers and pay lousy royalties on ebooks. The reason they hated Amazon’s $9.99 ebook price is that they didn’t want the ebook market to grow too fast. They wanted ebooks expensive to protect their print sales. Never-the-less, they have a legal right to charge what they want for their books and to pursue whatever legal business strategy they like, even if that means they favor their print market over Amazon’s ebook market. Even Judge Cote acknowledged their desire higher prices, to protect print, was completely legal.

In 2012, Apple wanted to sell their new iPads and knew the iPad was a great reading device for ebooks. They needed a deal with the big publishers to provide content. The big publishers needed someone to give them leverage against Amazon’s 90% market share and predatory pricing. So what was Apple to do if it wanted to enter the ebook market? Judge Jacob steps through Apple’s options:

“In the course of this litigation, three theories have been offered for how Apple could have entered the e-book market on less restrictive terms. Each theory misapprehends the market or the law, or both. The absence of alternative means bespeaks the reasonableness of the measures Apple took.”

As the Judge says, Apple's actions were not just legal, they were completely reasonable.  But didn't it have at least some other opinions?

“Theory 1: Apple could have competed with Amazon on Amazon’s terms, using wholesale contracts and below-cost pricing. This was never an option. The district court found as fact that: a new entrant into the e-book retail market “would run the risk of losing money if it tried or was forced to match Amazon’s pricing to remain competitive,” … Apple was “not willing” to engage in below-cost pricing… and Apple could have avoided this money-losing price structure simply by forgoing entry to the market…. Even if Apple had been willing to adopt below-cost pricing, the result at best would have been duopoly, and the hardening of the existing barrier to entry. Antitrust law disfavors a durable duopoly nearly as much as monopoly itself.”

As the judge points out, the problem with Theory 1, is that if Apple simply matched Amazon’s predatory pricing they would have been forced to take a big loss on their ebook sales. Why should Apple enter a market simply to take a loss? This has never been the way Apple does business. While they are focused on their hardware sales, they try to make a profit on every product (including digital products). Moreover, why should the publishers have agreed to sell ebooks to Apple if it was simply going to discount them the same way Amazon was doing. It’s quite likely Apple couldn’t have been made a deal with them. Even more importantly, if Apple had entered the market on the basis of taking a loss on best selling books, it would have run the risk of violating anti-trust laws. (Like, the way anti-trust laws are supposed to be enforced, not the bizarre way Judge Cotes enforces them.) If theory 1 was Apple’s only option, Apple simply wouldn’t have gotten into the market.

“Theory 2: Apple could have entered the e-book retail market using the wholesale model and charged higher prices than Amazon’s. The district court foreclosed this theory as well; it found that Apple refused to impair its brand by charging “what it considered unrealistically high prices.” … even if Apple had been willing to tarnish its brand by offering bad value for money, the notion that customers would actually have bought e-books from Apple at the higher price defies the law of demand. Higher prices may stimulate sales of certain wines and perfumes--not e-books. … nor could Apple justify higher prices for the e-books by competing on the basis of its new hardware, the iPad, because there is inter-operability among platforms. And if Apple had attempted to pursue this hardware-based competition by programming its iPad to run the iBookstore but to reject Amazon’s Kindle application, Apple might have been exposed to an entirely different antitrust peril.”

Apple also had the option of pricing their ebooks higher, like the publishers wanted, without a most favored nations clause to compel Amazon to match the higher price. But if they had done that, they obviously would have hurt their reputation. If every ebook Apple offered was $14.99 compared to $9.99, not only would no one buy Apple’s ebooks, but Apple would look like it was trying to gouge it’s customers.

Moreover, if Apple tried to prevent Amazon ebooks from being read on the iPad, they would not only be perceived as gouging customers, but, as the judge points out, they would be opening themselves up for a different sort of anti-trust lawsuit. So once again, if theory 2 was Apple’s only option, it would have had to stay out of the ebook market.

“Theory 3: Apple could have asked the Department of Justice to act against Amazon’s monopoly. Counsel for the United States actually proposed this at oral argument. At the same time, however, he conceded that the Department of Justice had already “noticed” Amazon’s e-book pricing and had chosen not to challenge it because the government “regarded it as good for consumers.” Any request from Apple would therefore have been futile. … More fundamentally, litigation is not a market alternative.”

This theory, proposed by the DOJ, is the most laughable of Apple’s non-options. The DOJ, admitting they would have ignored Apple, suggests that Apple should have gone to them and asked for them to investigate Amazon’s pricing. If Apple had pursued this option, how many years should they have waited for an answer from the DOJ? Would they have even gotten a definitive answer? Even if they had eventually gotten one, since the DOJ felt Amazon’s pricing was fine, they would have simply wasted a huge amount of time and effort. Not much of an option.

Judge Jacobs concludes his examination of Apple’s options with this statement:

“Apple took steps to compete with a monopolist and open the market to more entrants, generating only minor competitive restraints in the process. Its conduct was eminently reasonable; no one has suggested a viable alternative.”

Actually, there was only one real alternative to the way Apple pursued this. To have simply not entered the ebook market. In fact, they could have made a deal with Amazon and embraced the Kindle App as the main ebook reader. They might have even been able to have gotten a cut from Amazon’s ebook sales. (Which they don’t get now, because Amazon ebooks can’t be purchased through the iPad.) In the long run, they might have even gotten more money, and certainly avoided a $450 million dollar fine, by simply allowing Amazon to continue to completely control the ebook market.

Supposedly the smoking gun against Apple was an email by Steve Jobs. In it he said:

“I can live with this, as long as they move Amazon to the agent model too for new releases for the first year. If they don’t, I’m not sure we can be competitive.”

I see no smoking gun here. No drug deal, no vigilantism. Jobs is simply stating a fact. I also see no great evil in customers having to pay $14.99 rather than $9.99 if they want a particular best seller in the first year it comes out. Despite the years of bizarre litigation, Amazon has moved to the agency model, prices have gone up and the world hasn't ended. Apple couldn't compete with Amazon's 90% share of the ebook market without the support of publishers to level prices. Amazon now has to come up with other ways to compete, and so does Apple. That's a good thing. The bad thing would have been if Apple has simply avoided the market.

That is the real problem with this bizarre case. That is why Apple must continue to pursue this all the way to the Supreme Court. Because this case breaks new law, and the new law tells companies that they shouldn’t try to compete in these kinds of tough markets by making tough decisions. If they do, the government may step in and punish them. And that’s really bad for business, bad for America, and frankly, would be bad for me as a self-publisher and digital content creator.

I mentioned earlier that I’m a fan of Amazon and I think it has done a lot of good things for writers and readers in trying to build the ebook market. But they have not done this for humanitarian reasons. They have done it for business reasons. And most of the good they have done, like making self-publishing easy and profitable, as been because of competitive pressure. Amazon’s also done some bad things, like using non-standard ebook formats (for reasons that are good for their business interests, but not so much for customers). There is every reason to believe that if Amazon doesn’t have competition, they might do more bad things than good things. I believe in a free market, and a free, competitive market is the best way to make sure Amazon continues to do good things.

Specifically, if Apple, considering only the three bad options it had available, had decided not to enter the ebook market, I would be making considerably less money per ebook sold on Amazon than I’m doing now. Before Apple entered the ebook market, Amazon only paid writers 30% of the sale price on all ebooks. Apple historically paid content creators, in the App Store, 70%. Just before Apple entered the market, Amazon changed it’s policy and now pays self-publishers 70% on ebooks in a certain price range. They clearly did this because they feared self-publishers would immediately shift to Apple.

I think paying writers only 30% on most ebooks is wrong. It an unfair deal. And that’s what Amazon was doing for years before Apple entered the market. Self-publishers would have had no chance of getting Amazon to change the 30% policy if Apple had never stepped in to provide competition. So it’s a good thing that Apple got into the ebook market, and it’s a really bad thing Apple is being punished by the government for doing it in the only responsible way it could.

This is not just about the past. Amazon could still do more to improve the way it works with self-publishers, and frankly Apple could do more too. Content creators need these companies to compete freely, and aggressively, without bizarre government interference to protect one company over another.

I believe strongly that this entire DOJ lawsuit has hurt self-publishers, because Apple has taken a very low key approach to ebooks since being forced into the settlement. There is much more Apple could do to help grow the ebook market, and provide better tools for self-publishers, but I think they are reasonably holding off to see where this case finally rests.  Likewise, I think the years of litigation have given Amazon too much leverage in the market and discouraged other competitors from considering entry.

The legal issues raised in this case will also likely effect a whole range of tech companies in the future, particularly companies that deal with digital content. For the first time, the government is litigating against and punishing companies for trying to enter new markets. They are using anti-trust law, not to bust up companies that have monopolies, but to protect companies with monopolies.

For example, Google dominates digital video with You Tube. And they frankly pay digital content producers very little. Much less even than Amazon’s pre-Apple 30% of revenue. You Tube has a clear monopoly on short form video content (and are moving into long form). If Apple, or any other company, decides to take a huge risk by entering the market against You Tube, will they also have to look over their shoulder to make sure the DOJ doesn’t punish them for legal competitive behavior?

Under this new reading of anti-trust laws, will a competitor to You Tube be acting illegally if it joins with content creators to encourage higher payments for artists? What about comic books? Amazon currently controls most of that market too as well as audio books. Netflix also pays independent content providers very poorly, yet they have a huge market share. How will this decision effect potential competition in those areas?

One of the amazing things about the internet is how quickly companies can grow and capture market share, but a troubling aspect is how dominate certain companies are in specific markets. Google controls most of the search market, and video markets. Amazon controls most of the ebook market. Apple most of the music download market. Facebook most of the social networking market. We need more competition in all of these markets, not less. And this rewriting of anti-trust law is a big step in the wrong direction.

UPDATE: Yes, Apple is appealing to the Supreme Court.