Case Study: Managers at Major Publishers Read the e-Writing on the e-Wall In 2010, executives at publishing companies faced a problem: Amazon.com was selling their newly released and popular e-books for $9.99. Amazon's managers wanted to keep the price of e-books low so that they could sell more of its e-reader, the Kindle. The managers of five major publishers, including Simon & Schuster, HarperCollins, and Macmillan, worried that Amazon's pricing strategy would cap the price they could charge for their e-books in other retail markets, such as that for Barnes & Noble's e-reader, the Nook. The managers of each publishing company knew that if they tried to renegotiate the price independently, Amazon could refuse to sell their e-books. That threat was real because Amazon's share of the e-book market was large, estimated at 66 percent. In order to raise the price of their books, all five publishing companies needed to cooperate, but such open collaboration is illegal. The managers were in quite a predicament. Apple then arrived on the scene. Apple's managers wanted to sell e-books in its iBookstore for its iPad and iPhone, but they wanted more profit than the company would make if the price was $9.99. What type of deal could Apple's managers suggest that would appeal to the managers of all five book publishers? This chapter will help you understand the structure of Apple's proposal and why the managers of all five major publishers agreed to it. This chapter will also provide insight into government opposition to the proposal. At the end of the chapter, you will learn how Apple structured its contacts with the publishers and how the government responded. Revisiting How Managers at Major Publishers Read the e-Writing on the e-Wall You saw at the beginning of this chapter that publishing company executives wanted to raise the $9.99 price Amazon.com was charging for their newly published e-books. The executives knew that they could not individually force Amazon to raise the price and that any explicit joint action, such as forming a cartel, is illegal. The managers were therefore eager to listen as Apple's managers presented their ideas for selling e-books in Apple's iBookstore. The most appealing aspect of the arrangement with Apple was "agency pricing," in which the publishers, not the retailers, set the price of the books. Importantly, Apple's contracts also included one of the precommitment strategies that was described in this chapter-a most-favored-customer clause. If any other retailer sold an e-book at a lower price, the publisher would be required to match the price in Apple's iBookstore. Apple was willing to list the e-books for a higher price in its iBookstore-say, $15.99- but if the publishing company allowed Amazon to set a lower price, the publisher was then obligated to set the same lower price in Apple's iBookstore. When publishing executives signed Apple's contracts with its most favored-customer clause, they forced themselves to lower their price in the iBookstore if they allowed Amazon to sell their e-books at $9.99. In terms of lost profit, this clause raised the cost to those publishers who agreed to Amazon's price. Because all five publishers signed similar contracts they were able to present a united front when threatening to cease wholesaling e-books to Amazon. The contract with Apple effectively allowed the publishers to establish a cartel and boost the price set by Amazon. The U.S. Department of Justice entered the fray, alleging that Apple's contract violated U.S. antitrust laws. The Justice Department took Apple and the five publishing companies to court, seeking to overturn the contracts. The executives of all five publishing companies settled before the case was heard. Apple refused to settle but lost in court. The publishing executives agreed to let Amazon and other retailers set whatever price they wanted for e-books for two years and to forego any most-favored-customer clauses in their contracts for five years. Explain your answers to the following questions. 1. Why were the five major publishers, before they had a deal with Apple, unable to compel Amazon to raise the prices of their e-books? 2. What is the most favored-customer clause included in Apple's contract with the publishers? How does the strategy benefit Apple and the publishers? 3. In what ways did Apple's contract with the publishers violate antitrust law? Case Study: Managers at Major Publishers Read the e-Writing on the e-Wall In 2010, executives at publishing companies faced a problem: Amazon.com was selling their newly released and popular e-books for $9.99. Amazon's managers wanted to keep the price of e-books low so that they could sell more of its e-reader, the Kindle. The managers of five major publishers, including Simon & Schuster, HarperCollins, and Macmillan, worried that Amazon's pricing strategy would cap the price they could charge for their e-books in other retail markets, such as that for Barnes & Noble's e-reader, the Nook. The managers of each publishing company knew that if they tried to renegotiate the price independently, Amazon could refuse to sell their e-books. That threat was real because Amazon's share of the e-book market was large, estimated at 66 percent. In order to raise the price of their books, all five publishing companies needed to cooperate, but such open collaboration is illegal. The managers were in quite a predicament. Apple then arrived on the scene. Apple's managers wanted to sell e-books in its iBookstore for its iPad and iPhone, but they wanted more profit than the company would make if the price was $9.99. What type of deal could Apple's managers suggest that would appeal to the managers of all five book publishers? This chapter will help you understand the structure of Apple's proposal and why the managers of all five major publishers agreed to it. This chapter will also provide insight into government opposition to the proposal. At the end of the chapter, you will learn how Apple structured its contacts with the publishers and how the government responded. Revisiting How Managers at Major Publishers Read the e-Writing on the e-Wall You saw at the beginning of this chapter that publishing company executives wanted to raise the $9.99 price Amazon.com was charging for their newly published e-books. The executives knew that they could not individually force Amazon to raise the price and that any explicit joint action, such as forming a cartel, is illegal. The managers were therefore eager to listen as Apple's managers presented their ideas for selling e-books in Apple's iBookstore. The most appealing aspect of the arrangement with Apple was "agency pricing," in which the publishers, not the retailers, set the price of the books. Importantly, Apple's contracts also included one of the precommitment strategies that was described in this chapter-a most-favored-customer clause. If any other retailer sold an e-book at a lower price, the publisher would be required to match the price in Apple's iBookstore. Apple was willing to list the e-books for a higher price in its iBookstore-say, $15.99- but if the publishing company allowed Amazon to set a lower price, the publisher was then obligated to set the same lower price in Apple's iBookstore. When publishing executives signed Apple's contracts with its most favored-customer clause, they forced themselves to lower their price in the iBookstore if they allowed Amazon to sell their e-books at $9.99. In terms of lost profit, this clause raised the cost to those publishers who agreed to Amazon's price. Because all five publishers signed similar contracts they were able to present a united front when threatening to cease wholesaling e-books to Amazon. The contract with Apple effectively allowed the publishers to establish a cartel and boost the price set by Amazon. The U.S. Department of Justice entered the fray, alleging that Apple's contract violated U.S. antitrust laws. The Justice Department took Apple and the five publishing companies to court, seeking to overturn the contracts. The executives of all five publishing companies settled before the case was heard. Apple refused to settle but lost in court. The publishing executives agreed to let Amazon and other retailers set whatever price they wanted for e-books for two years and to forego any most-favored-customer clauses in their contracts for five years. Explain your answers to the following questions. 1. Why were the five major publishers, before they had a deal with Apple, unable to compel Amazon to raise the prices of their e-books? 2. What is the most favored-customer clause included in Apple's contract with the publishers? How does the strategy benefit Apple and the publishers? 3. In what ways did Apple's contract with the publishers violate antitrust law