In early December, the Justice Department confirmed that it was investigating the pricing of e-books and the related activities of major publishers and online retailers, such as Amazon.com and Apple. As a print and digital author, participant in the publishing industry, and graduate of the Yale Law School, this naturally caught my eye. It also led me to start thinking about the assumptions that underlie existing antitrust laws.
Democracy is the basis of our form of government. Capitalism is the basis of our economic system. They are distinct systems, and (at least in theory) it's possible to have one without the other. But will the antitrust rules developed to foster capitalism in the previous century inadvertently weaken our democracy in this century? In addition, do pre-digital era antitrust doctrines hinder the development of a fair, robust capitalism in our age? The current Justice Department investigation is a case study for examining these issues.
Lengthy, reasoned arguments (i.e. books) have historically played a central role in the marketplace of ideas. Important books have changed the way we look at our society, altered our political beliefs, changed foreign policy, and moved the nation in myriad ways. In the digital era, we benefit from many new forms of disseminating information, such as blogs and online news sources, all of which add to the marketplace of ideas. Nonetheless, none of these new sources of information has replaced the essential nature of a book (in physical or digital form): a lengthy effort, researched and written over a long period of time, which reflects the author's most thoughtful analysis and reflections on the subject in question.
The research and creation of many significant, important works are funded by advances from book companies. The book company grants the money up front on the basis of a proposal, which allows the author to pursue the project while earning a living. Hypothetically, if publishers stopped offering advances, many important works would never be created. Authors (who are not always academics or paid foundation researchers with a guaranteed salary) simply could not afford to undertake the work. This capitalist, for-profit motive plays an important role in funding important contributions to the marketplace of ideas.
Today, the book industry is struggling to adapt to the digital transformation. At its core, digital information has a tough time establishing value in the eyes of the consumer. If the book industry declines, some authors will undoubtedly self-publish, and it's possible new financing vehicles, for the equivalent of today's advances, will evolve. In essence, a weaker book industry means our society loses a source of funding for important, time-consuming, and extensive research and analysis.
The Justice Department has not revealed the precise nature of the investigation. But it's my understanding that when the Kindle was first released, Amazon.com priced e-books at less than the wholesale cost it was paying publishers. In effect, to boost Kindle sales and the idea of e-reading in general, Amazon was often taking a loss on sales.
A long-held tenant of antitrust law is that vertical price fixing (an agreement between the manufacturer and the retailer to sell a product at a specific price) is often illegal. These restrictions are why manufacturers offer products with a "manufacturer's suggested retail price" ("the MSRP"). The manufacturer is not permitted to formally agree with retailers on the prices consumers pay for products. The retailer is free to set the price offered to consumers, thereby enabling discounts from the MSRP. (Note: In recent years, the Supreme Court has adopted a more flexible approach to the issue or vertical price fixing, adopting a "rule of reason" test, but it remains a central area of antitrust policy.) In addition, competitors cannot work together to restrain price competition in some way (horizontal price fixing).
As the e-book business started to develop, publishers were concerned that Amazon's pricing approach was devaluing their products and (I assume) threatening to destroy hardcover sales at bookstores. In response, publishers developed what is known in the industry as "the agency model." Under this model, the publisher sets the price the consumer pays. In this model the digital retailer is not buying the product at a wholesale price, but acting as a sort of sales agent for the publisher. As the sales agent, the retailer receives a commission on each sale. In effect, digital book purchases become like insurance policy purchases, with Amazon and Apple as the brokers. From the perspective of antitrust law, the actual seller is the publisher, which sells through an agent and no agreement in restraint of trade exists. My assumption is that the Justice Department is investigating whether this agency pricing model violates restrictions on vertical price fixing and whether the way it was deployed by multiple publishers reflects some form of horizontal price fixing.
It's easy to have a knee-jerk negative reaction to the higher e-book prices that publishers have set under the agency model. But here's where this all gets interesting. As the (now barely existent) music industry and suffering newspaper industry have learned, it's incredibly hard to establish value for digital content. This reflects the competitive marketplace that may make content available for free, consumer perceptions of what they should pay for digital goods, the availability of other revenues streams (such as advertising), and a host of other factors.
One undeniable effect is that the Internet inherently drives the value of digital goods down. Instant price comparisons, easy access to lower-priced alternative options for digital information and entertainment, and illegal file sharing all contribute to this phenomenon. Traditional publishers also face challenges in making the digital transition. Importantly, a host of new competitors that help authors create digital books have arisen, and authors can also publish on their own. So the competitive dynamic for digital books, with far easier access to low-priced and free alternatives as well as all kinds of new types of publishers and distribution models, is very different than the dynamic that existed when vertical pricing restrictions were first developed.
There is a second, more fundamental issue at work here. The digital world makes the bundling (whether explicit or implicit) of intellectual property far easier than the physical world. Companies can make their profit in one place and break even or lose money on other products to support this activity. The problem is that this kind of activity destroys the perceived value among consumers of the bundled products. Amazon, for example, may be making money on the Kindle and not the e-books, but still profit in the long run.
The basic point here is that in the digital world it's possible to imagine instances where it's profitable for retailers to destroy the perceived consumer value of e-books and the associated hard copy titles.
Our society is best served by a robust e-book industry. As e-book prices declines, fewer and fewer authors are able to make a living expressing their ideas, whether they are political, socially insightful, or a form of entertainment.
With so much new competition emerging, and so many unknowns for the publishing industry itself, my strong bias is not to stretch interpretations of antitrust laws developed for a different era-and to allow the industry to do what it feels is best for its long-term survival. If the violations of the laws are clear-cut, then perhaps the Justice Department should seek to have the laws changed before beginning an enforcement action. If no violations are clear cut, then the Justice Department should have the wisdom to leave well enough alone. The worst possible outcome would be for the Department to attempt to extend the doctrines of the antitrust laws to cover the agency model, working from the mistaken belief that this would benefit our society.
Here are two takeaways:
First, the creation of information in our society has always been recognized as playing a central role in building a healthy democracy, with the attendant benefits of the best aspects of capitalism. This recognition is embodied in the first amendment. As we move to a digital era, there is increasingly less ability for information creators to profitably fund the creation of "expensive" information (i.e. books requiring extensive research and interviews, investigative journalism, and the like). Our democracy, and ultimately the operations of a robust, fair capitalist system -- based on the best possible information -- are poorer for this loss. To the extent that any of our existing laws inadvertently destroy the remaining infrastructure that profitably supports the creation of such information, they must be reexamined.
Second, the ability for retailers to make money on one product (such as the Kindle or the iPad), while cutting prices on digital products, is something new to our era. We need to stop and think about how the distribution of products that spread ideas may be affected by antitrust laws. We must ensure that our laws are not furthering the destruction of a robust marketplace for ideas.
Full Disclosure: I have published books with several publishing houses and worked as a paid consultant to several book and magazine companies.
Bruce Judson is Entrepreneur-in-Residence at the Yale Entrepreneurial Institute and a former Senior Faculty Fellow at the Yale School of Management.