May 292012

One of the lynchpins of the Department of Justice’s assertion that Apple was responsible for colluding with publishers to drive up the price of ebooks is that there was a competitive market prior to Apple’s entry defined by Amazon’s $9.99 price point for new releases and bestsellers. From paragraph 92 of the DoJ complaint:

Prior to the Defendants’ conspiracy, consumers benefited from price competition that led to $9.99 prices for newly released and bestselling e-books.

Apple pretty capably demolishes this myth in their response:

Apple denies that the $9.99 price level referenced in paragraph 92 was the result of “price competition.” Rather it reflected a strategic pricing decision made by Amazon, with a 90% share of eBook sales, made almost exclusively to consumers who had purchased Amazon’s Kindle eReader.

There’s been a lot written about Amazon’s business model recently. Most of it focuses on how little money they make and how a company with a P/E of 174 could be valued so high. The prescient former Apple CEO Jean-Louis Gassée has a theory that he lays out in his Monday Note:

After having cleared the field, Amazon will take advantage of what is delicately called “pricing power”. As the Last Man Standing, they will raise prices at will and regain profitability. This isn’t Amazon’s only game. The breadth of their offering, their superior customer service and awesome logistics, make life difficult for poorly managed competitors such as Best Buy, or the undead Circuit City, to name but a few companies whose weaknesses where exposed by Amazon’s superbly efficient machine.

But traders recognize the wink and the nod behind today’s numbers, they are willing to pay a high price for a share of Amazon’s future dominant position.

The point about Amazon’s “future dominance” is underscored by their profitability, which is illustrated in the Monday Note piece by a chart taken from Seeking Alpha:

Amazon's margins - prior to the other shoe dropping

So you have a market juggernaut artificially keeping prices down while reaping an unsustainable margin, ostensibly to drive out competition before using this leverage to raise prices in the future. Part of this strategy was selling select e-books at a loss for $9.99 until Apple entered the market. If you look at the grain of one particular tree’s bark, like the DoJ does, this is “bad” for the consumer. If you pull your camera back a couple of feet, you can see what Amazon is doing – and what the DoJ should be addressing. Even for the government, this degree of myopia would be funny if it wasn’t so damaging. But by all means, waste taxpayers’ money going after the wrong party.

 Posted by at 10:46 am

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