Incumbents don't like change. When a disruptor comes along and starts poking around, sparks are bound to fly. Especially if the incumbent and disruptor are heavyweight tech titans Amazon.com (Nasdaq: AMZN) and Apple (Nasdaq: AAPL).
Apple is trying to revolutionize the e-book industry in similar ways to how it changed the music industry with the iTunes store, although there is one key difference in its approach.
Prologue
With iTunes, Steve Jobs was adamant that songs be sold for $0.99, and he successfully fought to take pricing power away from the record labels. With iBooks, Jobs did the opposite: He allowed publishers like News Corp.'s (Nasdaq: NWSA) HarperCollins, CBS' (NYSE: CBS) Simon & Schuster, and Pearson's (NYSE: PSO) Penguin Group, among others, to set the prices while Apple got its 30% cut, adopting an agency model instead of a wholesale model.
Chapter 1: Salvation
Prior to Apple's entry, Amazon fought to price Kindle e-books at $9.99, even if that meant occasionally taking a loss after buying an e-book at $13 wholesale. Publishers weren't happy with the arrangement, as it reduced a book's perceived value in consumers' minds while taking away pricing power. David Young -- CEO of Hachette Book Group USA, one of the big six publishers -- had said, "If it's allowed to take hold in the consumer's mind that a book is worth ten bucks, to my mind it's game over for this business."
Source: Apple.com.
The problem was that none of the publishers could single-handedly force Amazon to change its ways, and if they all actively teamed up on the e-tailer, they could be charged with price-fixing and collusion. Enter Apple. When Cupertino offered salvation in the form of agency model pricing, they all jumped, and Amazon was forced to follow suit ahead of the iPad launch or risk losing e-book content.
Chapter 2: Prosecution
Well, the charges of price-fixing and collusion haven't been avoided, as the European Commission has opened an antitrust investigation. There are also a number of class action lawsuits, and Connecticut's attorney general has also launched an investigation. Never one to be left out, the U.S. Department of Justice recently followed suit with its own probe.
It's hardly a shocker, since the net result was for prices throughout the e-book market to move higher as publishers rejoiced their regained freedom.
The real question is whether Apple broke the law. Apple relies primarily on hardware sales: Less than 6% of last year's $108.2 billion revenue was attributed to content sales through iTunes, the App Store, and the iBookstore. It's a tough sell that Apple's revenue hinged on its ability to lure away the publishers.
Chapter 3: Decimation
The angle that the class action suits are taking is that Apple tried to stifle tablet competition with the deals. While Apple naturally wants to decimate iPad rivals -- and it's not like Research In Motion's (Nasdaq: RIMM) PlayBook or Motorola Mobility's (NYSE: MMI) Xoom are holding their own -- it needs to do so on a fair battleground.
If Apple's agency model deals were part of a longer-term strategy to keep Amazon out of the tablet market and were intended to hinder competition, the allegations may have a leg to stand on. Or in the legalese of the lawsuits, if Apple made its move "in order to cut into Amazon's substantial share of the markets for eBooks and to prevent Amazon from emerging as a serious competitor to its mobile platforms for the distribution, storage and access of digital media."
While Apple couldn't have known with certainty that Amazon would soon launch the Kindle Fire, it also wasn't a stretch of the imagination.
Chapter 4: Consolidation
It's not as clear-cut as simply Amazon vs. Apple. There are a total of at least 25 different class action suits throughout, and they are in the process of being consolidated. Some of the suits even target Amazon and Barnes & Noble (NYSE: BKS), which also uses the agency model, as co-conspirators, making it the consumer against publishers and retailers.
Even though Amazon had fought for lower prices, by begrudgingly going along with the agency model, it's now targeted as a potential accomplice. We'll have to wait and see which side of the suit Amazon lands on.
Chapter 5: Resolution
If the retailers and publishers are found to be in violation of antitrust laws, they would probably end up settling the issue by offering a small reimbursement to those who bought an e-book at higher prices. Naturally, the lawyers would likely end up being the biggest winners, with the "conspirators" footing the bill.
Anyone who has ever received a mysterious letter in the mail telling them they're included in a class action settlement and are eligible for a negligible payment in the neighborhood of $10 will tell you it might not even be worth the time spent to complete the paperwork and wait six to eight weeks to get a check in the mail.
Epilogue
Apple will have a good defense arguing that its agency model is just business as usual, as opposed to the allegations that it help hatch a grand plan to gouge e-book buyers. It has long used the agency model in the App Store, keeping 30% of sales and passing along 70% to developers. Disrupting the wholesale pricing model that Amazon had imposed, as the only viable large-scale e-book platform at the time, was just a side effect.
I don't think Apple is guilty, but then again, I'm not the U.S. Department of Justice.
Add Apple to your watchlist to see the final verdict. E-books are just part of the mobile revolution. Get access to this free report on another stock positioned to bank on the mobile revolution.
