Economists on Apple Ebook Antitrust Case: Judge Cote got it Wrong

U.S. Federal Court Judge Denise Cote ruled that Apple was the ring leader in a conspiracy with publishers to artificially raise the price of books, but two economists are saying she got it wrong -- completely wrong. Bradford Cornell from CalTech and Janusz Ordover from NYU felt her ruling was so far off base that they filed a 30-page amici curiae brief with the court in defense of Apple and explaining just how wrong Judge Cote's ruling is.

Economists say Judge Cote blew it on Apple antitrust rulingEconomists say Judge Cote blew it on Apple antitrust ruling

The Department of Justice filed a lawsuit against Apple and several publishers alleging they colluded to take the book market away from Amazon and raise the prices consumers pay for what they read. Apple said it was negotiating independent deals with publishers to get titles on its iBookstore for the iPad, and was trying to compete against the near monopoly Amazon had created.

The publishers all settled with the DOJ out of court to avoid potentially crippling fines, but Apple stood its ground and went to trial. Despite the evidence Apple presented, Judge Cote ruled in favor of the DOJ, imposed an injunction restricting its business negotiations, and placed a monitor in the company as part of her remedy.

In essence, the Court backed Amazon's practice of selling books below cost, which in turn pushes other retailers out of the market because they can't compete by losing money.

Mr. Cornell and Mr. Ordover summed up the issues with Judge Cote's ruling saying,

Efficient markets depend on firms acting in their independent business interests. In this case, the District Court's failure to consider the economics of the vertical agreements between Apple and the Publisher Defendants led it to infer that Apple facilitated and participated in a horizontal price-fixing conspiracy. The District Court never considered evidence and economic reasoning that the vertical agreements were in Apple's independent business interest in entering e-book retailing, wholly apart from any horizontal conspiracy.

The provisions of the agreements at issue—agency, 'most-favored-nation' (MFN) clauses, and price caps—can be instrumental in facilitating new entry, particularly into markets with an entrenched, dominant firm. In this case, the District Court disregarded economic evidence and reasoning that these provisions served Apple's independent business interest in entering the e-book market, where Amazon was a near-monopolist. The District Court also ignored economic evidence and reasoning suggesting that Apple's entry into e-book retailing, and not the MFNs, allowed the Publisher Defendants to persuade Amazon to switch from a wholesale to an agency business model.

The District Court also erred in equating price increases for some e-books with harm to competition. Apple's entry into the e-book retail market dramatically increased competition by diminishing Amazon's power as a retail monopolist (and its ability to pursue a "loss-leader" strategy that inefficiently priced e-books below their acquisition cost).  That increased competition gave publishers more bargaining power, thereby bringing ebook pricing closer to competitive levels. These errors threaten to chill competition by discouraging the use of common vertical contracting techniques that are often essential to facilitating the expensive and risky investments needed for entry into highly concentrated markets.  Our antitrust laws should encourage, not penalize, vertical contracting arrangements that facilitate entry and enhance competition.

Apple is appealing Judge Cote's decision and has called her ruling a radical departure from modern antitrust law. The company has also said her ruling will be harmful to consumers and will have a negative impact on competition, which is inline with the sentiment in the amici curiae brief.

The DOJ will be filing its response to Apple's appeal some time in May, but hearing dates for the trial haven't been set yet.

[Thanks to Fortune for the heads up]