Friday, July 12, 2013

Competition and the Most-Favored-Nation Clause

In a blog post three weeks ago, I wrote about the e-books antitrust trial. I had some confusion about antitrust law (the standards for horizontal and vertical collusion) and I felt that the DOJ had seriously overreached in their case against Apple (alleging that Apple was the mastermind of the conspiracy and not just a participant). Well, Judge Denise Cote has handed down her decision and she has ruled that "without Apple’s orchestration of this conspiracy, it would not have succeeded as it did in the spring of 2010." The smoking gun cited by Judge Cote is this exchange between Steve Jobs and Walt Mossberg where Mossberg asks Jobs why a customer would buy an e-book from Apple for $14.99 when she can buy the same e-book from Amazon for $9.99:

Jobs: Well, that won’t be the case.

Mossberg: Meaning you won’t be $14.99, or they won’t be $9.99?

Jobs (smiling): The prices will be the same.

Judge Cote writes: "Jobs's purchase of an e-book for $14.99 at the Launch, and his explanation to a reporter that day that Amazon’s $9.99 price for the same book would be irrelevant because soon all prices will 'be the same' is further evidence that Apple understood and intended that Amazon’s ability to set retail prices would soon be eliminated."

The problem with this so-called smoking gun is that it doesn't prove anything. It is accepted fact that Apple negotiated most-favored-nation (MFN) clauses in its contracts with the publishers. Apple doesn't deny it because MFN clauses are perfectly legal. Amazon has one in its contracts as well. I've been looking for a more detailed explanation of how the MFN clause works and found one in this column by Adam Engst. Adam explains that if Amazon did not switch over to the agency model and continued to sell e-books below cost at $9.99, then Apple would be able to match their price. Apple would only get 30% of the $9.99 price, but they would make up for it by selling more e-books at that price than at $14.99. And if Amazon did switch over to the agency model, then both Amazon and Apple would be selling the same e-book for $14.99.

The MFN clause ensures that Amazon and Apple would be selling their e-books at the same price. So how does Jobs' statements to Mossberg indicate that he knew that the publishers were going to force Amazon to accept the agency model (never mind the DOJ's contention and Judge Cote's decision that Apple was the one forcing the agency model on the entire industry when all of the evidence suggests that it was the publishers who wanted the agency model and that they were just using Apple as a stick against Amazon)?

I don't like these MFN clauses; I think they are anti-competitive, especially for the smaller players in a market. The MFN clause does restrict a competitor's ability to set retail prices. One effect of the MFN clauses used by Apple and Amazon is that it makes it difficult for either company to offer a special sale price on an item. A similar technique, which I also think is anti-competitive, is the whole price-matching thing. When a huge retailer says that they will offer price-matching if you bring in a competitor's ad with a lower price, it reduces the incentive for a small retailer to offer a discount. Why offer a discount when you know that people are just going to take your price to the big box store nearby? Price-matching may sound like a good deal for the consumer, but ultimately it isn't. Unfortunately, MFN clauses and price-matching are both legal, and smoking guns are now apparently evidence of nothing. Go figure.

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