How this settlement is different

According to documents filed with the court Friday (PDF, and see links below), Macmillan agreed to many of the same settlement terms that HarperCollins, Simon & Schuster, Hachette and Penguin already agreed to — but there are also significant differences. Retailers will immediately be allowed to discount Macmillan’s ebooks, in order to “provide for more prompt relief to consumers.” In the cases of the three original settling publishers (HarperCollins, Simon & Schuster and Hachette) and Penguin (which settled in December), “several months passed before consumers saw the benefits of the settlements through lower retail prices on many of the settling publishers’ ebooks.” In Macmillan’s case, however, according to the competitive impact statement:

That “two-year cooling-off period” means that, for two years, settling publishers can’t restrict retailers like Amazon from setting, changing, or lowering ebook prices. The settlement means Macmillan gets a back-dated head start on this period, so it will again be able to restrict discounting in December 2014. Most-favored nations clauses are prohibited for five years, but Macmillan had already removed those from its contracts.

Unlike the other big-six publishers, Macmillan also publishes digital textbooks. Those are exempt from the settlement because the DOJ antitrust case focused only on trade books.

Finally, there are provisions to make it clear that Macmillan’s parent company, Holtzbrinck, would be in trouble if it “worked in concert with Macmillan to evade Macmillan’s obligations under the settlement.”

“Our company is not large enough to risk a worst case judgment”

In his letter, Sargent describes massive legal bills that Macmillan — the smallest of the big-six publishers, and the only one that is entirely privately owned — would have had to pay in “a worst case judgment”:

As each publisher settled, the remaining defendants became responsible not only for their own treble damages, but also possibly for the treble damages of the settling publishers (minus what they settled for).  A few weeks ago I got an estimate of the maximum possible damage figure. I cannot share the breathtaking amount with you, but it was much more than the entire equity of our company.

Court docs

Macmillan’s proposed final judgment (PDF)

Competitive impact statement (PDF)

The pilot is limited to 1,200 older titles from the Minotaur Books mystery and crime fiction imprint (part of Macmillan’s St. Martins division). Libraries will be able to lend out the ebooks for two years or 52 times, whichever comes first, before having to buy a new copy. According to Library Journal, each ebook will cost $25. The ebooks will be available through three different digital library distributors at launch: OverDrive, 3M Cloud Library and Baker & Taylor’s Axis 360.

Macmillan CEO John Sargent said in a statement, “Among the many titles we publish, mystery and crime fiction makes up one of the largest categories and Minotaur Books is the primary source. And, as the library market has always been one of Minotaur’s largest customers, we think that this pilot will provide books especially desired by library patrons.” Alison Lazarus, president of Macmillan’s sales division, told Library Journal that the company “will make assessments along the way as to whether to expand the title selection and whether to continue the program as launched beyond the two-year term.”

Publishers have been reluctant to offer ebooks to libraries in part because they fear that it will cut into sales. Sargent said “ we do not expect [the pilot] will heavily impact our retail sales over time.”

With Macmillan’s new offering, all the big-six publishers except for Simon & Schuster are making ebooks available to libraries in at least a limited way. Penguin is testing its own pilot with libraries in New York, Los Angeles and Cleveland (after previously pulling all its ebooks and digital audiobooks from libraries). Random House makes all of its ebooks available to libraries but sharply increased the prices last year. HarperCollins allows ebooks to be checked out 26 times before the library has to buy a new copy. Hachette does not make ebooks published after April 2010 available to libraries, and increased the prices of those that are available last year.

Photo courtesy of Flickr / Eric Mueller 

Macmillan is the smallest of the big-six publishers, and the only one that is wholly privately owned. Sargent says there are two reasons Macmillan is not settling: “First, it is hard to settle when you have done nothing wrong. Much as the lawyers explain to me that settling is completely standard business procedure, it still seems fundamentally flawed to me somehow.” More importantly, he writes:

Since the very beginning, the government’s demands have never wavered in all our discussions. They still insist on the two year discounting regime that forms the heart of the agreement signed by the three settling publishers. It was our belief that Amazon would use that entire discount for the two years. That would mean that retailers who felt they needed to match prices with Amazon would have no revenue from ebooks from five of the big publishers (and possibly the sixth) for two years. Not no profit, no revenue. For two years. We felt that few retailers could survive this or would choose to survive this.

Nevertheless, Macmillan has entered new contracts with most ebook retailers “except one whose term was not up yet” (he does not specify which one). Sargent explains the new terms: “All the new contracts are compliant with the government’s requests in their complaint. They contain no most-favored nations clauses and no price limits. They also allow 10 percent discounting on individual books priced at $13.99 and above.” (This was partially reported by Publishers Weekly on Monday.) (Macmillan settled in the European Union “because of many differences in their system and because the discounting change will not materially affect the market there for us.”)

Despite these measures, the lawsuit continues. “The legal bills look like the unit sales numbers for 50 Shades of Grey,” Sargent writes. But though Macmillan is the smallest of the big-six publishers it has no plans to merge with another as Random House and Penguin are doing. Being small “has never hurt us in the past, and I expect it will not hurt us in the future,” Sargent writes. “Publishing trade books is, in the end, a human endeavor…You need a certain level of capital and infrastructure, but that does not require being a behemoth. We will be more than fine in the land of the giants. I expect we will continue to grow and prosper.”

Sargent also comments on Macmillan’s business overall. Twenty-six percent of the publisher’s sales were digital in 2012, and “our e-book business has been softer of late, particularly for the last few weeks, even as the number of reading devices continues to grow.”

Both publishers flatly deny that they engaged in a price-fixing conspiracy with other publishers. Macmillan’s response is shorter and more fiery; Penguin’s response is longer, with more colorful details and explainers.

Penguin’s response

Penguin “began to consider the agency model seriously when, and only when, Apple proposed it to Penguin as a method of doing business for Apple’s proposed iBookstore,” the complaint says, noting that it “proposed a wholesale/retail distribution agreement with Apple on January 4, 2010″ and Apple responded the next day with the agency model “as a take-it-or-leave-it deal term.”

Penguin “admits that it believed that Apple could not have a successful iBookstore without the participation of and supply of books from other publishers, because if the iBookstore’s inventory was limited to only a small percentage of available eBooks, the iBookstore would almost certainly fail.” And “Penguin sought assurances from Apple that Apple could deliver the breadth of participation Penguin felt was necessary for a successful eBook store.”

The company says that many of the publisher conversations cited in the DOJ suit had nothing to do with agency pricing but were actually related to Penguin’s participation in the U.S. and UK e-book joint ventures aNobii and Bookish. (aNobii has launched in the UK; Bookish is delayed.) ”The legality and propriety of these joint ventures, which Penguin was recruited to join before it made the decision to enter into an agency model with Apple, is not and has never been actually challenged,” Penguin notes.

The agency model hasn’t ended price competition, Penguin says, but rather moved it “from the retail level to the publisher level.” Among the types of competition that Penguin says have increased since the agency model:

There is more dynamic pricing of eBooks, which has resulted in lower consumer prices on many, many eBook titles, more robust competition at the device level in terms of both the cost and variety of eReading devices, handsome and imaginative enhanced, full-color eBooks, which did not even exist as a category before Apple introduced the iPad, and more vibrant and differentiated marketing of eBooks by Penguin’s agents, all to the benefit of consumers.

Throughout the filing, Penguin cites enhanced e-books as one of the reasons it wanted to enter into a relationship with Apple. Books like “Penguin’s enhanced version of A.A. Milne’s classic Winnie the Pooh, which is pre-loaded as a complementary eBook on every iPad,” weren’t possible before iPad because “the Amazon Kindle was not then capable of accommodating color or other enhancements.”

The much-cited publishing executive dinner at Picholine was actually intended to welcome Markus Dohle as the new CEO of Random House, Penguin says in its complaint; Macmillan says the same and notes in italics for emphasis that Random House was “a house not even alleged to be part of the alleged conspiracy.”

Penguin’s response as a PDF here

Macmillan’s response

“Macmillan did not participate in any illegal conspiracy,” Macmillan’s filing says, and “the lack of direct evidence of conspiracy cited in the Government’s Complaint is telling…[it is] necessarily based entirely on the little circumstantial evidence it was able to locate during its extensive investigation, on which it piles innuendo on top of innuendo, stretches facts and implies actions that did not occur and which Macmillan denies unequivocally.”

Like Penguin, Macmillan says the publisher conversations cited in the DOJ suit weren’t about agency pricing, but actually had to do with joint ventures Bookish and aNobii. Macmillan adds that “the government’s deafening silence about Bookish indicates its acceptance of the legitimacy of the joint venture itself and of its formative process.”

Macmillan says Apple proposed agency terms “to Macmillan on a ‘take it or leave it’ basis. Macmillan’s unilateral decision to accept Apple’s take it or leave it’ offer to adopt the agency model was made by [CEO John] Sargent alone.”

Macmillan’s response as a PDF here

See also…

Everything you need to know about the e-book lawsuit in one post

What the DOJ e-book lawsuit means for readers now

The states’ class action suit, which was filed the same day as the Department of Justice’s lawsuit, alleges that Apple and book publishers conspired to set e-book prices. Unlike the DOJ, the states seek monetary restitution for consumers. (They have already reached a settlement with Hachette, Simon & Schuster and HarperCollins.)

The states’ amended complaint makes public information that was redacted from the version filed in April. (It’s not clear why the information was originally redacted.) Much of the now-public information is duplicated in the Department of Justice filing against Apple and publishers, but some of it is new, including an e-mail from Steve Jobs. Among the content previously redacted and now public:

–Negotiating on Apple’s take: Macmillan CEO John Sargent attempted to negotiate with Apple’s Eddy Cue on a way to make agency pricing less painful for publishers (publishers actually make more money under the wholesale model, where they are paid based on a book’s retail list price, than from the agency model). On January 11, 2010, Sargent wrote to Apple in an e-mail, “Am thinking a possible way to ease the financial pain for the publishers and authors of moving to the agency model. Could you take a reduced cut on hardcover first releases (where we are presently making 14.00 in revenue and would make 9.00 under your assumptions)?” Apple did not agree to take less than its customary 30 percent cut.

–Publisher e-mail: A “Conspiring Publisher executive” e-mailed his or her parent company’s CEO on January 21, 2010:

[Eddy Cue] … was eloquent on why they would be a great partner, that price could and would be experimented with as Apple want [sic] to drive high revenues; that this would be for a one year term; that one major publisher (clearly RH) was out and that ne [sic] need the five majors in but maybe four. He said that he was sure he would close on two today and two tomorrow. Amazon is in town being provocative and with, as Jeff Trachtenberg said to me this morning, ‘a swagger in their step’. I’m off to the AAP so will try and discover what is going on.”

Trachtenberg is the book publishing reporter at the Wall Street Journal. Amazon had just announced it would raise its royalty rate to 70 percent on many self-published titles.

–Steve Jobs e-mail: In late January 2010, Steve Jobs became directly involved in the agency pricing negotiations “after Eddy Cue could not secure one of the Conspiring Publisher’s commitment directly from an executive.” Jobs “wrote to an executive at the parent company, in part”:

As I see it, [Conspiring Publisher] has the following choices:

1. Throw in with Apple and see if we can all make a go of this to create a real mainstream ebooks market at $12.99 and $14.99.

2. Keep going with Amazon at $9.99. You will make a bit more money in the short term, but in the medium term Amazon will tell you they will be paying you 70% of $9.99. They have shareholders too.

3. Hold back your books from Amazon. Without a way for customers to buy your ebooks, they will steal them. This will be the start of piracy and once started, there will be no stopping it. Trust me, I’ve seen this happen with my own eyes.

Maybe I’m missing something, but I don’t see any other alternatives. Do you?

Note that Jobs predicts that in the absence of credible competitors, Amazon would begin offering publishers less favorable terms.

–Pricing tiers: Here’s how Apple calculated its e-book prices in publisher contracts:

–E-mails to Barnes & Noble: Once five publishers and Apple had enacted agency pricing, the complaint says the five publishers “worked together to force” Random House to adopt it as well. On March 4, 2010, in an exchange also identified in the DOJ’s filing, Penguin CEO David Shanks sent Barnes & Noble’s then-CEO Steve Riggio an e-mail reading in part, “Random House has chosen to stay on their current model and will allow retailers to sell at whatever price they wish…I would hope that [Barnes & Noble] would be equally brutal to Publishers who have thrown in with your competition with obvious disdain for your welfare…I hope you make Random House hurt like Amazon is doing to people who are looking out for the overall welfare of the publishing industry.”

The state complaint additionally says that Shanks was trying to get Barnes & Noble to “stop any promotion or advertising of Random House titles,” and when Barnes & Noble continued to do so, “Shanks went back to Barnes & Noble again. Following this contact, Barnes & Noble’s management decided not to feature Random House in any future advertising.” I asked Barnes & Noble for a statement and a spokeswoman told me the company has no comment. (This is interesting but does not prove the states’ claim that all five publishers acted against Random House, since only one publisher is mentioned.)

–“The Club”: In September 2009 as the publishers considered “windowing,” or staggering the print and digital releases of a book, they “referenced themselves in one email as ‘the Club!’” This was in reference to windowing discussions and not to agency pricing discussions with Apple.

The states’ amended complaint (5/11/12)
The states’ original complaint (4/11/12)
The Department of Justice’s complaint (4/11/12)

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.

“Let me start by saying that Macmillan did not act illegally. Macmillan did not collude,” Sargent writes. He acknowledges that the costs of fighting the DOJ’s suit — “in time, distraction, and expense” — are “truly daunting,” but “we have decided to fight this in court.”

Meanwhile, HarperCollins, Hachette and Simon & Schuster are settling with the DOJ. Penguin, the fifth publisher named in the suit, has not yet announced its plans but is presumed to be fighting the case in court.

“The government’s charge is that Macmillan’s CEO colluded with other CEO’s in changing to the agency model. I am Macmillan’s CEO and I made the decision to move Macmillan to the agency model,” Sargent writes. “After days of thought and worry, I made the decision on January 22nd, 2010 a little after 4:00 AM, on an exercise bike in my basement. It remains the loneliest decision I have ever made, and I see no reason to go back on it now.”

And, Sargent says, “When Macmillan changed to the agency model we did so knowing we would make less money on our e-book business. We made the change to support an open and competitive market for the future, and it worked. We still believe in that future and we still believe the agency model is the only way to get there.”

Macmillan, under Sargent’s leadership, has been at the front lines of fighting against Amazon — starting back in 2010, when Macmillan switched to the agency model and Amazon temporarily turned off the “buy” button on its books before capitulating. In today’s letter, Sargent notes that the DOJ’s proposed settlement terms “could have allowed Amazon to recover the monopoly position it had been building before our switch to the agency model. We also 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 wants consumers to understand one detail in particular: the majority of Macmillan’s books will still sell for under $10. He can say that because so far new releases — the category where the price is going up — only make up one third of Macmillan’s digital sales. Some of Sargent’s key points:

– At the end of March, Macmillan “will move from the ‘retail model’ of selling e-books (publishers sell to retailers, who then sell to readers at a price that the retailer determines) to the ‘agency model’ (publishers set the price, and retailers take a commission on the sale to readers).”

– Macmillan is slamming windows shut, promising to publish e-books (when it has the rights) at the same time as print first release, and is working to expand its number of digital titles. “Readers were clearly frustrated at the lack of availability of new titles, and the change to the agency model will solve this problem.”

– Forget what you’ve heard or read about the disappearance of $9.99 e-books, at least where Macmillan is concerned. Sargent promises a wide range of prices with most Macmillan e-books still priced below ten dollars. But it is the end of $10 digital versions of new hardback releases. “Generally e-book editions of hardcover new releases will be priced between $14.99 and $12.99; a few books will be priced higher and lower.” New York Times (NYSE: NYT) bestsellers will be priced at $12.99 or lower while they are on the list. And Sargent promises that e-books editions of new paper backs “generally” will run between $6.99 and $9.99.

– E-book pricing will reflect lower prices as paperback editions are released. “If we do issue a paperback, we will drop the digital price to $9.99 or lower at publication date (if not before). The price differential between the book and the e-book will become smaller at the lower price points.”

We’re looking forward to the next installment. Sargent promises to explain the long-term or author royalty consequences of the switch to agency.