“Pearson notes recent media coverage regarding Penguin, its consumer publishing division, and Random House (part of Bertelsmann). Pearson confirms that it is discussing with Bertelsmann a possible combination of Penguin and Random House. The two companies have not reached agreement and there is no certainty that the discussions will lead to a transaction. A further announcement will be made if and when appropriate.”

Random House is the world’s largest book publisher, publishing around 10,000 books a year. Its 2011 revenues (PDF) were €1.75 billion (USD $2.27 billion). Penguin publishes over 4,000 books a year and had 2011 revenues (PDF) of £1.05 billion (USD $1.7 billion). A merger would create a global book publishing powerhouse with a presence in the fast-developing digital markets China, India and Brazil.

Many in the industry have long wondered when two of the big-six publishers would merge, but I don’t think anyone expected Penguin or Random House to go first. It has seemed much more likely that HarperCollins or Simon & Schuster would be sold (which is of course still a possibility), since neither News Corp nor CBS places a high priority on book publishing and News Corp is spinning off its publishing and educational assets.

The FT, citing “three people familiar with the negotiations,” reported that the companies were discussing “a merger in which Bertelsmann would have a stake of more than 50 percent” but offered few other details other than that, if a merger went through, “both Markus Dohle, chief executive of Random House, and John Makinson, chief executive of Penguin, are expected to take senior leadership roles.” As the FT notes, a merger could face difficulty gaining regulatory approval.

Rumors of a merger had previously surfaced in Germany’s Manager magazine in an August article about the various ways in which Bertelsmann CEO Thomas Rabe is trying to expand its influence. At the time, a Bertelsmann spokesman told UK trade publication The Bookseller, “It is speculation in the media that we do not comment on.”

Photo courtesy of Shutterstock user Thomas Bethge.

What is agency pricing, anyway?

Agency pricing is at the heart of the lawsuits but the legality of the model itself does not appear to be in question. Agency pricing allows book publishers to set the prices of their e-books, while the retailer (the “agent”) takes a commission. Under the agency model, the publisher is the only party that can discount e-books, and an e-book’s price must be the same across all retailers (i.e., an e-book can’t go on sale at just one retailer). The agency model is different from the wholesale model, in which publishers set a book’s suggested retail price and retailers can discount the books to any price they want.

In early 2010, Apple negotiated with the big-six publishers — Penguin, Macmillan, Hachette, Simon & Schuster, HarperCollins and Random House — to make their e-books available on its then-forthcoming tablet, the iPad, through the then-forthcoming iBookstore. All of those publishers except Random House adopted the agency model at around the time of those negotiations.

Amazon turned off Macmillan’s “buy” button in protest over Macmillan’s switch to the agency model, but the retailer eventually capitulated and restored Macmillan’s books.

About a year later, Random House became the last big-six publisher to adopt the agency pricing model.

Background reading: “Price-fixing makes comeback after Supreme Court ruling” by Joseph Pereira (WSJ, 8/18/08) | “Big six negotiate with Apple, ready new business model for e-books” by Michael Cader (1/19/10) | “Most dramatic publishing event of 2010? Introducing agency pricing!” by Mike Shatzkin (11/30/10)

Who is suing over publishers’ adoption of agency pricing?

Apple and the first five of the “big-six” publishers to adopt agency pricing — all of them except Random House, I’ll call them the “big five” here — are the defendants in a number of lawsuits.

The largest is the suit from the U.S. Department of Justice, filed today after weeks of investigations and buildup. In addition, 16 states sued Apple and the big-five today, claiming that agency pricing cost consumers $100 million. These lawsuits come on top of over a dozen class-action lawsuits, the first of which was filed last August, and a formal antitrust investigation by the European Commission.

Why are they suing?

The lawsuits accuse Apple and the big-five of colluding to raise e-book prices. The suits do not allege that agency pricing itself is illegal; rather, they allege that the big-five and Apple illegally conspired to adopt the model all at once in order to retaliate against Amazon’s discounting. Our legal reporter Jeff John Roberts explored the logic behind the suits here, here and here.

Publishers Marketplace took a deep dive into today’s DOJ filing and notes it revolves around two separate alleged conspiracies — one regarding a possible joint venture to sell e-books together (in conversations starting in 2008) and one to replace the wholesale model with the agency model. The DOJ charges that the publishers and Apple “shared their business information, plans, and strategies in order to formulate ways to raise retail e-book prices.”

Background reading: “Bigger than agency, bigger than e-books: The case against Apple and publishers” by Tim Carmody (Wired, 3/28/12)

Why do book publishers support agency pricing?

Book publishers’ general argument for agency pricing is that it ensures a more competitive marketplace because no one retailer — i.e., Amazon — is able to deeply discount e-books and thus gain a monopolistic position. Publishers argue that in the time since agency pricing was adopted, the e-book market has become more vibrant because smaller retailers are able to sell e-books at the same price as Amazon.

Background reading: I support agency pricing and debated the model with my colleague Mathew Ingram here – in that post you’ll see both pro- and anti-agency pricing arguments. | See also Mathew’s post today, “The e-book wars: Who is less evil, Amazon or book publishers?“

How have the publishers and Apple responded?

Three of the big-five — HarperCollins, Simon & Schuster and Hachette — agreed to settle the case with the DOJ. In statements released today, Hachette and HarperCollins admitted to no wrongdoing and said they settled reluctantly, in order to avoid protracted legal battles and high court costs that, in the words of Hachette, would be “too disruptive to our business.” Simon & Schuster did not release a statement. (Here’s more on how the proposed settlement would work.)

Meanwhile, Macmillan CEO John Sargent announced that Macmillan will fight the lawsuit. The company “felt the settlement the DOJ wanted to impose would have a very negative and long term impact on those who sell books for a living, from the largest chain stores to the smallest independents,” Sargent wrote in an open letter to the publishing community.

Penguin CEO John Makinson announced Penguin, too, will fight the suit. “We understood that the shift to agency would be very costly to Penguin and its shareholders in the short term, but we reasoned that the prevention of a monopoly in the supply of e-books had to be in the best interests, not just of Penguin, but of consumers, authors and booksellers as well,” Makinson said in a statement. The DOJ’s filing “contains a number of material misstatements and omissions, which we look forward to having the opportunity to correct in court.”

Apple released a statement saying, “The DOJ’s accusation of collusion against Apple is simply not true. The launch of the iBookstore in 2010 fostered innovation and competition, breaking Amazon’s monopolistic grip on the publishing industry. Since then customers have benefited from eBooks that are more interactive and engaging. Just as we’ve allowed developers to set prices on the App Store, publishers set prices on the iBookstore.”

How have retailers responded?

Amazon is happy. If agency pricing goes away, the company will be able to discount e-books the way it discounts print books and can likely return to its pre-agency pricing tactic of pricing New York Times bestsellers at $9.99. The company released the following statement on the three publishers’ settlement: “This is a big win for Kindle owners, and we look forward to being allowed to lower prices on more Kindle books.” Amazon stock went up the afternoon of the DOJ filing.

Barnes & Noble had no comment, but the DOJ lawsuit and following publisher settlements are not good news for the nation’s largest bookstore chain. Agency pricing prevents Amazon from undercutting B&N on big-six publishers’ e-book prices and B&N has said that agency pricing “expands [its] gross margins.” Barnes & Noble stock went down the afternoon of the DOJ filing.

What happens with the investigations abroad?

The European Commission received proposals from Apple, Simon & Schuster, HarperCollins, Hachette and Holtzbrinck (Macmillan’s parent company) to bring the antitrust investigations to a close. (Penguin, the fifth company under investigation in the EU, did not send such a proposal.)

Will readers notice any changes right away?

Readers should not expect changes in e-book pricing until June at the earliest. Here’s more on what the lawsuit means for readers.

What happens next?

If the settlement is approved, the three publishers who settled — HarperCollins, Hachette and Simon & Schuster — are required to end their current publishing contracts with Apple but may enter into new ones. Here’s more on the terms of the settlement.

Macmillan and Penguin are headed to court to fight the DOJ’s allegations.

Sixteen states also filed suit on April 11 seek “consumer restitution.” Hachette and HarperCollins reached settlements with the states and agreed to pay $52 million in damages. Simon & Schuster is close to settling with the states. Damages are calculated based on “based on the number of states participating and the number of e-books sold in each state.” Eventually all fifty states may join the e-book settlement.

The class-action lawsuit led by Seattle-based firm Hagens-Berman continue and also seek financial restitution. “While Attorney General Holder’s actions, if successful, will put an end to the anticompetitive actions, our class-action is designed to pry the ill-gotten profits from Apple and the publishers and return them to consumers,” lead counsel Steve Berman said. He added, “We are eager to move forward with our civil action against Apple and the publishers, and to show the court and the public the depth and breadth of the conspiracy they concocted at the expense of consumers.” However, as our legal reporter Jeff John Roberts explains, a settlement with the states would effectively trump the private class-action lawsuit.

Agency pricing does not go away. Random House is not involved in any of the investigations and is free to continue selling e-books under the agency model, as are any other publishers who adopted the model later. Macmillan and Penguin will continue to sell their e-books under the agency model.

This post is a work in progress. Do you have other questions, thoughts or concerns? Let me know in the comments.

We’ll be talking about e-books at paidContent 2012, May 23 in New York City.