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New iPads at an Apple Store in Germany.

Inside US lawsuit: How Apple, publishers allegedly brought Amazon to heel

US antitrust lawyers filed a lawsuit against Apple Inc. and two publishers, alleging they conspired to inflate the price of e-books, at an estimated cost to readers of $100 million.

Antitrust lawyers at the Department of Justice filed a civil lawsuit Wednesday charging Apple Inc., and two of the nation’s largest book publishers with conspiring to artificially inflate the price of e-books.

The antitrust suit was filed in federal court in New York, where three other publishers agreed to settle the same charges.

In an alleged plot that could easily rival best-selling tales published by the defendant companies, prosecutors say the five book publishers conspired over a four-year period with Apple in an attempt to force online retail giant Amazon to stop charging a deeply discounted $9.99 for new e-books.

Estimates are that the alleged plot cost readers $100 million in inflated e-book prices.

“During regular, near-quarterly meetings, we allege that publishing company executives discussed confidential business and competitive matters – including Amazon’s e-book retailing practices – as part of a conspiracy to raise, fix, and stabilize retail prices,” Attorney General Eric Holder told reporters in Washington.

“With today’s lawsuit, we are sending a clear message that competitors, even in rapidly evolving technology industries, cannot conspire to raise prices,” added Sharis Pozen, acting assistant attorney general in charge of the Justice Department’s antitrust division.

“We want to undo the harm caused by the companies’ anticompetitive conduct and restore retail price competition so that consumers can pay lower prices for their e-books,” she said.

The lawsuit is the result of cooperation between the Justice Department’s Antitrust Division and the European Commission. The attorneys general of Connecticut, Texas, and 13 other states also played a role in the investigation.

In addition to Apple, the publishers named in the pending suit are Macmillan and Penguin Group, both based in New York City.

Hachette Book Group, HarperCollins, and Simon & Schuster, all New York-based, have agreed to settle the lawsuit and end anticompetitive practices alleged by the government.

The alleged conspiracy revolved around the emerging market for e-books and a perceived threat to the future of the book publishing business as it presently exists.

Publishing executives were worried that Amazon’s deep-discount pricing of e-books might significantly undercut their ability to continue to sell hardcover books for $25 or more.

In addition, they worried that if e-books became too popular, upstart digital publishers – including Amazon itself – might enter the e-book industry and push the long-dominant publishers aside, according to court documents.

“Amazon’s move threatened the publisher defendants’ traditional positions as the gate-keepers of the publishing world,” the suit says.

To rein Amazon in, the suit says, executives from the five book publishers decided to change the way they sold their books to book retailers.

Under the old rules, retailers purchased the books at a wholesale discount off the publisher’s list price. The retailers were then free to set their own bookstore prices after that.

In a series of meetings in private dining rooms at exclusive Manhattan restaurants (without corporate counsel present), the publishing executives agreed to simultaneously end their use of the “wholesale” business  model and shift instead to an “agency” model, according to court files.

Under the agency model, the publisher would set the price and the retailer would be required to maintain that price. Thus, the publishers could end Amazon’s $9.99 e-book discount sales by simply setting the price higher.

No single book publisher acting alone would have the market clout to make such an arrangement stick. But, according to the suit, all five publishers agreed to impose identical terms on Amazon and all other e-book retailers.

In 2010, e-book revenues to the five publishers exceeded $300 million, the suit says.

To provide extra pressure on Amazon, the five publishers also cut a special deal with Apple’s Steve Jobs, who was preparing to launch the company’s latest product, the iPad. Jobs was anxious to obtain a competitive advantage over Amazon’s Kindle book reader, the suit says.

The publishers offered Jobs an advantage. Under the deal, Apple would sell e-books for between $12.99 and $14.99 for use on the iPad. Apple was guaranteed a 30 percent commission on every e-book sold, and received a further guarantee that it would not face price competition from Amazon or any other retailer, according to court documents.

Jobs is quoted in the complaint as having said at one point during the negotiations: “We’ll go to [an] agency model, where you set the price, and we get our 30 percent, and yes, the customer pays a little more, but that’s what you want anyway.”

 The complaint assessed the impact of the deal: “Millions of e-books that would have sold at retail for $9.99 or for other low prices instead sold for the prices indicated by the price schedules included in the Apple Agency Agreements – generally $12.99 or $14.99.”

The suit notes: “Apple saw a way to turn the agency scheme into a highly profitable model for itself. Apple determined to give the publisher defendants what they wanted while shielding itself from retail price competition and realizing margins far in excess of what e-book retailers then averaged on each newly released or bestselling e-book sold.”

Within four months of entering the agreement with Apple, the five publishers had transitioned from the wholesale model to the new agency model with e-book retailers.

According to the suit, during the transition, Macmillan delivered an ultimatum to Amazon – adopt the agency model or lose the ability to sell e-book versions of new hardcover titles for the first seven months of their release.

Amazon refused, and in protest stopped selling Macmillan products – both hardback books and e-books, the suit says.

In a competitive market, the other publishers might seek to take advantage of the disagreement to undercut Macmillan. They did not.

The lawsuit quotes an unnamed publishing chief executive as saying: “Macmillan [executives] have been brave, but they are small. We need to move the lines. And I am thrilled to know how [Amazon] will react against 3 or 4 of the big guys.”

Once the other publishers made their positions known, Amazon backed down and agreed to resume sale of Macmillan books and e-books.

“We allege that these executives knew full well what they were doing. That is, taking steps to make sure the prices consumers paid for e-books were higher,” Ms. Pozen said.

She added: “Let me be clear, when companies get together and conspire to enter into agreements that eliminate price competition, it crosses the line. This kind of agreement is illegal and anticompetitive.”

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