Anti-Trust Laws, Agency Pricing, and You: A Primer

For those of you who don't know, the United States Department of Justice recently sued six companies -- namely, Apple, and the publishing houses Hachette, HarperCollins, Simon & Schuster, Macmillan, and Penguin -- for violating anti-trust laws for establishing a pricing model for e-books known in the industry as agency pricing.

Yeah, I know, you're probably looking at that sentence and thinking that it sounds like a foreign language. Which is why I've decided to write a small guide on the issue at hand and define some terms -- because this is going to be a battle that will be vitally important for writers as we move further and further into the digital age.

Disclaimer: Economics and legal studies are not my strong suits, so if I'm getting anything wrong here, or you have anything to add that might make these issues even clearer, please give me a nudge in the comments!

What is agency pricing, and why did publishing houses start using this model?
Agency pricing is one way of setting the price on merchandise. Basically, in this model, the producer of a good (in this case, the publisher) sets the price of that good (an e-book), and retailers (bookstores, including Amazon) are not allowed to change that price. These terms would be laid out in contracts that publishers have with bookstores to negotiate the terms of selling and distribution. For example, if Scholastic wanted to sell Harry Potter e-books for $6 apiece, Barnes & Noble could not put that e-book on sale for $4 -- it would have to remain $6, or Barnes & Noble would be in violation of its contract with Scholastic.

Publishing houses began using this model principally to undercut Amazon; they knew that if Amazon had the ability to continuously slash prices, popular e-books could be sold for pennies, to the detriment of the publishers' profits. Amazon, as a company, could probably still turn a profit even if their e-books department didn't break even, because Amazon also sells other things -- appliances, video games, clothes, you name it. Publishers, however, don't sell anything but books, and would have no recourse if their prices fell. By using agency pricing, publishing houses could set their own prices and ensure that they could still turn a profit from e-books.

What's wrong with the agency model?
Nothing, really, except for one little issue: the publishing houses who used the agency pricing model have been charged with violating anti-trust laws, because there is evidence that they colluded with one another in order to enforce agency pricing.

What does that mean? Sort of what it sounds like: Hachette, HarperCollins, Simon & Schuster, Macmillion, Penguin, and the Apple iBookstore plotted behind the scenes to have all of their e-book prices set in precisely the same way; that is, e-books with hardcover equivalents that are published by any of these companies might sell for $20, while e-books with paperback equivalents might sell for $10. The Department of Justice sees this backdoor-dealing as illegal, because under United States Anti-trust Laws, companies are not allowed to combine into an entity so powerful that it will essentially undercut all competition; the economic forces of supply and demand are supposed to dictate market price. Agency pricing, however, does not allow for fluctuations in price in the market. For example, if no one wants to read A Million Little Pieces, a bookstore might either want raise the price to turn a profit on the few books they do sell, or put it on sale so that more people will be enticed to buy it. Agency pricing obviously allows for neither.

So now what?
The Department of Justice, after an investigation, has sued all six companies. So far, HarperCollins, Hachette, and Simon & Schuster have agreed to settle with the government rather than go to court and spend what will probably be hundreds of thousands of dollars in legal fees. Apple, Penguin, and Macmillan are going to fight the charges in court.

The companies who are settling must void their any contracts involving agency pricing with retailers (although they can draw up new ones), and cannot fix prices on e-books for the next two years.

But what does this have to do with me?
If you're a writer, an awful lot. Although I personally have no doubt that Apple and the two other publishers will be found guilty of violating anti-trust laws, the trust is that these laws do have a benefit for more than just publishing houses -- they ensure that writers will get higher royalties.

Royalties are the payments that writers get every time they sell a book; authors are usually guaranteed a certain percent of the sales in their contracts. If profits fall, writers will be paid less, and therefore aren't guaranteed a large profit on any book they publish. Although the market might figure out a way for authors to still make good money off their royalties even without agency pricing, it's probably going to take a while -- and writers probably can't afford to wait that long.

With Amazon already moving to slash e-book prices and these companies preparing to battle it out with the United States government, the water can only get hotter.

Further reading
Publishing guru Mike Shatzkin has a much more literate explanation of agency pricing, as well as a number of other pricing models, at this blog.

How the Department of Justice got involved.

Attorney General Eric Holder's comments on the issue.