updated 02:20 am EDT, Fri June 7, 2013
Revelation raises issues of equal treatment, conflict of interest
Under cross-examination from Apple's lawyers, a key government witness -- Amazon Vice President for Kindle Content Russell Grandinetti -- undermined a key element of the Department of Justice's case against the Cupertino giant by admitting that once it decided to move to the "agency model" under pressure from publishers, it demanded exactly the same terms from the publishers as Apple had required. The deal even included a 30 percent cut and a "most favored nation" (MFN) clause that is the crux of the DOJ's complaint against Apple.
Grandinetti may have further hurt the government's case by refusing to answer a direct question about a meeting he attended in January 2010 -- a week prior to the introduction of the original iPad -- in Amazon CEO Jeff Bezos' Seattle boathouse. He was asked by Apple attorneys to reveal what was said at the meeting, where Amazon executives knew that Apple was planning a big announcement and suspected it would be a tablet that could handle e-books -- thus threatening the reseller's existing Kindle e-reader and e-book business, on which it had a near-total monopoly.
"I'm not comfortable discussing the contents of that meeting," Grandinetti said, dodging the question by revealing that Amazon attorneys were present as well as thus the discussions could be protected under attorney-client privilege. As Fortune reporter John Paczkowski points out, outside observers would "be amazed at how much evidence in this case has been redacted because it contained trade secrets, business data, privileged conversations with attorneys, etc." Grandinetti was not required to answer the question.
Evidence entered into the record, however, showed that one day after the meeting, Amazon began developing its own terms for an "agency model" pricing contract for e-books. Prior to Apple's entry into the market, publishers -- unhappy with Amazon's loss-leader discounting of new e-books, which they felt were cannibalizing printed hardcover sales -- had met with Amazon a few months earlier and threatened to hold back e-book titles for "seven months" (as Grandinetti recalled) to give the hardback versions a chance to sell at their normal price, which was usually in the $26 range. Amazon was selling e-book versions of the same books simultaneously for $10, below the cost it paid for the e-books from publishers under its existing "wholesale" model (in which the reseller sets the price).
When Apple did unveil the iBookstore alongside the iPad, it was the result of weeks of negotiations with publishers that included a move to an "agency model" pricing option -- where publishers set the retail price, while the reseller collects a percentage as a distribution fee -- and an MFN clause that required publishers not to sell the same e-book for less to other retailers than it did to Apple, a move characterized in court as a preventative measure to ensure competitive viability. The MFN clause is at the core of what the DOJ charges was illegal price-fixing by Apple, intended to set the average price of e-books higher to the detriment of consumers.
In fact, the average price of e-books has fallen since the widespread implementation of the "agency model," which Amazon has since adopted. New releases, however, did increase in price from Amazon's previous cut-rate pricing -- leading the DOJ to charge Apple with causing consumers to pay "hundreds of millions of dollars more" but which Apple counters was the only way to keep the publishers solvent and the market stable, which allowed for competitors (not just Apple) to enter.
The terms of Amazon's own "agency" agreement are essentially identical to Apple's terms, including the 30 percent commission, an MFN clause, and -- most importantly to Amazon -- a guarantee that it would get access to e-books on the same day that the print versions were released. In an email shown in court, Amazon CEO Jeff Bezos called the threat that publishers might withhold e-book titles for a period to bolster print sales -- again, before Apple had even entered the market -- "an absolute declaration of war." Amazon was already known and feared by publishers for bullying retaliation and threats when publishers balked at its terms, but in fact when Apple introduced the iPad four of the (then) big six publishers were already "windowing" their latest releases.
The fact that Apple's iBookstore had no such threat against it -- since publishers themselves were setting the prices under Apple's model -- forced Amazon to abandon the "wholesale" model and use the agency model. Just a day after the iPad was announced, it began negotiating with publishers for an "agency" agreement.
The revelation has raised the question: if the "most favored nation" clause in Apple's contract was the root that moved the entire e-book industry to "agency" pricing and raised e-book prices unfairly -- as the DOJ argues -- why was it legal for Amazon to ask for the exactly the same terms, particularly when the threat came not from Apple, but from the publishers, before Apple entered the market?
During cross examination, Grandinetti admitted that Amazon designed its agency terms to be identical to Apple's in order to protect its business. He said Amazon wanted the "level playing field" with other e-book retailers -- the exact same wording that Apple has used to defend why it pursued the "agency" pricing model in the first place, and the same wording publishers used as to why they were unhappy with Amazon's discounting of the suggested retail price of new e-books. Amazon's practice not only devalued the worth of the e-book versions, the publishers felt, but also undercut what was at the time their main source of income: printed book sales.
Amazon agreed to the agency model to prevent "windowing" e-book releases from publishers who were retaliating for Amazon's abusive and monopolistic behavior, Apple attorneys told the court. Like Apple, Amazon -- which at the time had 90 percent share of the e-book market -- didn't want to be competitively disadvantaged going forward, and agreed to new terms in order to end what Grandinetti called "discrimination" by the publishers.