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Is Amazon’s low pricing competitive or a real monopoly?
By ASHER MEIR
20/04/2012
A competitive market for e-books will be present when each publisher makes its own agreement with each retailer.
 
The US Justice Department filed an antitrust suit against Apple and five of America’s largest publishing companies last week, charging them with price fixing. Even as these companies are being charged with monopolistic behavior, many observers view their agreement as the bulwark against monopoly, fearing that no company alone can stop Amazon from sole domination of the book market.

The elephant in the room is of course Amazon. In 1995 the company started selling books online and rapidly became a major competitor to bookstores.

No trip to the store was needed, and the selection was far larger than that found in even the largest bookstores. By 2007, it was estimated that Amazon was selling about 15 percent of all books in the United States. This slow trend of dominating the US book market became a rapid trend in 2007. Amazon began selling electronic books that caught on rapidly due to their convenience, immediate access and low price, and it expects to have the majority of the US market within a year.

Perceiving a “chicken and egg” situation where people wouldn’t buy electronic readers without an adequate selection of titles and wouldn’t buy e-books without readers (even though it is possible on a PC), Amazon began cutting prices on both devices and titles in what is widely perceived as a “loss-leader” strategy in which losses on one product are meant to bring profits, or future profits, on another. Amazon also demanded price cuts from publishers.

The publishers did not stand idly by. They conceived an ingenious plan that would enable them to maintain control of e-book prices. In the traditional model, publishers sell their inventory to retailers, who resell them. But there is an alternative.

Retailers can act as agents of the publishers. In this case, the publishers retain ownership of the book and pay retailers a fee for displaying and selling.

In the wake of Amazon, its Kindle reader and its $9.99 price for a digital version of $25 hardcover books, the publishers adopted an agency strategy for electronic books. Thus, they and not Amazon would be in charge of prices.

An agency deal was cut with Apple and subsequently presented as an ultimatum to Amazon.

The result: an end to Amazon’s loss-leader strategy and higher prices for publishers.

But the Justice Department found many aspects of this process problematic. The first issue was the agency model itself.

The distinction between reselling and agency is meaningful in the “bricks and mortar” world. For example, if there is a fire, the retailer takes the hit under the traditional model and the publisher under the agency model.

But digital books seldom go up in flames, so the Justice Department concluded that this was no more than a fiction to create de facto collusion among sellers.

Beyond the agency model per se, the alleged anticompetitive actions included giving Apple “most-favored nation” status; that is, the publishers guaranteed that no Apple competitor would undercut Apple. Promising a customer that he is getting the lowest price is not that uncommon in the business world, but the practice has not been tested in court and Apple was not a customer, given that the agency model made it merely an agent.

Another problem is that the five publishers named in the suit seemed to have acted in coordination, meaning that the publishers not only created effective collusion in retailing but also engaged in collusion among the publishers themselves. (An alternative charge is that Apple acted as a “hub” to create de facto collusion among the “spokes.”) Three of the publishers agreed to a settlement with the Justice Department. But as of this writing, two publishers and Apple are sticking it out and defending themselves in court.

So who is the monopolist: Amazon or Apple and its allies? Amazon’s conduct could be considered monopolistic if it fit the category of “predatory pricing.” In predatory pricing, a monopolist dominates an industry and offers high prices. But it defends its monopoly by sharply reducing prices just long enough to drive competitors out of business.

One problem with this diagnosis is that this model does not seem to suit the book industry.

Predatory pricing, or the threat of predatory pricing, is plausible in industries where huge investments are necessary to go in. If airlines are charging high prices, I may see an opportunity for profit by starting my own airline and charging slightly less. But the investment needed to break into the airline industry is enormous; the prospect that existing firms could ride on their existing capital and the cash cushion from their monopoly profits to drive prices rock bottom for a few months could be enough to deter me. This model doesn’t suit the book business. Selling books online requires a very modest investment.

Another problem is that it doesn’t take into account that the threat of competition is also competition. Amazon could have 90% of the market but still not be a monopolist if they have to keep prices competitive to keep others from entering the market.

If $10 is the price a competitive market would fix, it doesn’t matter if I pay $10 to Amazon if Amazon is the only game in town; they may be changing me only $10 because they know that if they charge $11 someone else will set up shop across town.

Again, if there are few barriers to entry, even potential competition can keep sellers in line.

The anticompetitive aspects of the agency agreement are fact. In their wake, e-book prices rose sharply. The pro-competitive aspects of keeping Amazon from domination are speculative and unpersuasive. A competitive market for e-books will be present when each publisher makes its own agreement with each retailer.

That doesn’t preclude agency agreements, but it does preclude that audacious coordination that accompanied the current model, the one the Justice Department has begun to dismantle.

ethics-at-work@besr.org Asher Meir is research director at the Business Ethics Center of Jerusalem, an independent institute in the Jerusalem College of Technology (Machon Lev).
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