Unites States of America v. Apple, Inc. et al

Filing 97

MEMORANDUM OF LAW in Support re: 96 MOTION to File Amicus Brief.. Document filed by Bob Kohn. (Attachments: # 1 Exhibit Proposed Amicus Brief)(Brower, Steven)

IN THE UNITED STATES DISTRICT COURT
FOR THE SOUTHERN DISTRICT OF NEW YORK

____________________________________

UNITED STATES OF AMERICA
Plaintiff
v.
APPLE, INC., ET. AL.
Defendants.

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Civil Action No.12-CV-2826 (DLC)

BRIEF OF BOB KOHN * AS AMICUS CURIAE

*

Bob Kohn is an individual consumer of e-books who, on May 30, 2012, submitted to the Department of Justice
(“DOJ”) a comment letter (ATC-0143, “Comments of Bob Kohn”) explaining at some length why the proposed Final
Judgment is not in the public interest. This brief responds to the DOJ’s response to those comments (“DOJ
Response”) and other public comments submitted during the 60-day comment period. Amicus is also co-author of
Kohn On Music Licensing (Wolters Kluwer, 4th Edition 2002), cited by the U.S. Supreme Court in Eldred v. Ashcroft,
57 U.S. 186 at fn 21 (2003), and other courts, including Fred Ahlert Music Corp. v. Warner/Chappell Music, 958
F.Supp. 170 (S.D.N.Y. 1997), Woods v. Bourne, 60 F.3d 978 (2d Cir. 1995), Boosey & Hawkes v. Buena Vista Home
Video, 145 F.3d 481 (2d Cir. 1988), and Bridgeport Music v. Dimension Films, 410 F.3d 792 at fn 18 (6th Cir. 2005).
He has testified before the District Court in United States v. ASCAP, 559 F.Supp.2d 332 (S.D.N.Y. 2008), regarding
the digital transmissions of music over the Internet and before both the FTC (1995) and the DOJ/FTC (2002)
regarding the intersections between copyright and antitrust law as they relate to the public interest in promoting
innovation and competition. A more complete resume and disclosure of Kohn’s background, qualifications and
affiliations is contained in the Comments of Bob Kohn.

i

T ABLE OF C ONTENTS
I.

INTRODUCTION ................................................................................................................................ 1

II.

STANDARD OF REVIEW .................................................................................................................. 2

III. THE RELIEF SOUGHT IS AN INSTRUMENT OF WRONG TO THE PUBLIC ............................ 4
A.

Impact of the Proposed Final Judgment on the Relevant Market or Markets ............................... 4
1. Court is Not Bound by the Relevant Market Plead in the Complaint .................................... 4
2. Characteristics of the Products At Issue................................................................................. 5
a.

E-Books Are Public Goods .......................................................................................... 6

b.

E-Books Are Systems Goods ....................................................................................... 8

c.

DOJ Failed to Take into Account the Impact of the Economic Characteristics of
E-Books in Reaching Its Decision................................................................................ 9

3. The Markets In Which E-book Transactions Occur............................................................. 10
4. DOJ Reached an Unreasonable Conclusion About the Remedy By Failing to Consider
the Pro-Competitive Effects of Defendants’ Alleged Conduct ............................................ 11
5. U.S. Supreme Court & Second Circuit has Justified Horizontal Price Fixing When It is
“Pro-Competitive” or When It Otherwise Contributes to “Efficiencies in the Operation
of a Market” ......................................................................................................................... 12
6. Countervailing Pro-competitive Contributions to Efficiency in the Operation in the EBook Market Justified Defendants’ Conduct ....................................................................... 15
a.
b.
B.

Countervailing Amazon’s Monopsony Power ........................................................... 15
Countervailing Amazon’s Monopoly Power & Specifically Its Predatory Pricing
Practices ..................................................................................................................... 16

Impact of the Proposed Final Judgment Upon the Public Generally .......................................... 23

IV. CONCLUSION................................................................................................................................... 24

ii

TABLE OF AUTHORITIES
Cases
Associated Gen. Contractors of Cal., Inc. v. Carpenters, 459 U.S. 519 (1983) ............................................21
Barry Wright Corp. v. ITT Grinnell Corp., 724 F.2d 227 (1st Cir. 1983) ......................................................19
Broadcast Music v. CBS, 441 U.S. 1 (1979) ..................................................................................................12
Broadcast Music, Inc. v. Moor-Law, Inc., 527 F.Supp. 758 (D. Del. 1981) ....................................................6
Business Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717 (1988) ..............................................11
CBS v. ASCAP, 337 F.Supp. 394 (S.D.N.Y. 1972) ........................................................................................12
CBS v. ASCAP, 400 F.Supp. 737 (1975)........................................................................................................14
CBS v. ASCAP, 620 F.2d 930 (2d Cir. 1980), cert. denied 450 U.S. 970 (1981) ..........................................12
Fashion Organizers’ Guild of Am. v. FTC, 312 U.S. 457 (1941) ..................................................................13
FTC v. Indiana Fed’n of Dentists, 476 U.S. 457 (1986)................................................................................12
In Re Electronic Books Antitrust Litigation, 11 MD 2293 (DLC) ...................................................................9
In Re Wireless Telephone Services Antitrust Litigation, 385 F.Supp. 2d 392 (S.D.N.Y. 2003) ......................5
Leegin Creative Leather Products, Inc. v. PSKS, Inc., 551 U.S.877 (2007) .................................................11
Northeastern Telephone Co. v. American Telephone and Telegraph Co., 651 F.2d 76, (2d. Cir. 1981), cert.
denied, 455 U.S. 943 (1982) ......................................................................................................................18
Ortho Diagnostic Systems v. Abbott Laboratories, 920 F.Supp. 455 (S.D.N.Y. 1996) .................................18
Re-Alco v. National Center for Health Educ., 812 F.Supp. 387 (S.D.N.Y. 1993)...........................................5
Todd v. Exxon Corp., 275 F.3d 191 (2nd Cir. 2001) .......................................................................................16
United States v. BNS, Inc., 858 F.2d 456 (9th Cir. 1988) .................................................................................3
United States v. Grinnell Corp., 384 U.S. 563 (1966) ...................................................................................15
United States v. Keyspan Corp., 783 F. Supp.2d 633 (S.D.N.Y. 2011)...........................................................1
United States v. Microsoft Corp., 56 F.3d 1448 (D.C. Cir. 1995) ...................................................................2
United States v. SBC Commc’ns, Inc., 489 F.Supp. 2d 1 (D.D.C. 2007) .........................................................1
United States v. Swift & Co., 286 U.S. 106, 115 (1932) ..................................................................................3

Statutes
Copyright Act, 17 U.S.C. §501(a) ....................................................................................................................7
Sherman Act, 15 U.S.C. §2 ............................................................................................................................18
Tunney Act, 15 U.S.C.§16(f) ............................................................................................................................3

Rules
Antitrust Guidelines for the Licensing of Intellectual Property (DOJ/FTC 1995) ..........................................5
Horizontal Merger Guidelines (DOJ/FTC 2010) ..........................................................................................10

Articles & Treatises
Al Kohn & Bob Kohn, KOHN ON MUSIC LICENSING (4th Edition 2010, Wolters Kluwer) ...........................14
Carl Shapiro, The Role of Innovation in Competitive Analysis, THE ANTITRUST SOURCE (July, 2005) .........8
Christopher R. Leshe, Achieving Efficiency Through Collusion: A Market Failure Defense to Horizontal
Price Fixing, 81 CALIFORNIA LAW REV. 243 ............................................................................................24

iii

Doreen Carvajal, Small Publishers Feel Power of Amazon’s Buy Button, NEW YORK TIMES (June 16, 2008)
...................................................................................................................................................................15
Douglas D. Leeds, Raising the Standard: Antitrust Scrutiny of Standard-Setting Consortia in High
Technology Industries, FORDHAM INTELL. PROP. MEDIA & ENT. L.J. 641 (1997) ...................................17
Gellhorn, Kovacic & Calkins, ANTITRUST LAW AND ECONOMICS (Thomson West 2004) ............................7
Herbert Hovenkamp, FEDERAL ANTITRUST POLICY (2d ed. 1999) ...............................................................14
Jay Himes, Judicial Review of Justice Department Consent Decrees: Is the Tunney Act Glass Half-Empty
or Half-Full? (February 28, 2007) ...............................................................................................................3
John Cirace, CBS v. ASCAP: An Economic Analysis of a Political Problem, 47 FORDHAM L. REV. 277,
293-94 (1978-79) .......................................................................................................................................14
Joseph Farrell & Carl Shapiro, Dynamic Competition with Switching Costs, ECONOMICS WORKING PAPERS
8865, University of California, Berkeley (1988) .........................................................................................9
M. Gallaugher & Yu-Ming Wang,Network Effects and the Impact of Free Goods: An Analysis of the Web
Server Market, INTERNATIONAL JOURNAL OF ELECTRONIC COMMERCE, Vol.3, No. 4, Summer, pp. 6788 (1999) ....................................................................................................................................................17
Michael L. Katz & Carl Shapiro, Network Externalities Competition and Compatibility, AMERICAN
ECONOMIC REVIEW, Vol. 75, No. 3 (June, 1985) ......................................................................................17
Michael L. Katz & Carl Shapiro, Systems Competition and Network Effects , JOURNAL OF ECONOMIC
PERSPECTIVES, Vol. 8, Issue 2 (Spring 1994)............................................................................................17
Philip E. Areeda & Donald F. Turner, Predatory Pricing and Related Practices Under Section 2 of the
Sherman Act, 88 HARV. L. REV. 697 (1975)..............................................................................................18
R.G. Lipesy & Kevin Lancaster, The General Theory of Second Best, 24 REV. ECON. STUD. 11 (1956-57)
...................................................................................................................................................................24
Richard S. Wirtz, Rethinking Price-Fixing, 20 INDIANA L. REV. 531 (1987) ...............................................14
Roger D. Blair & Jeffrey L. Harrison, Monopsony, ANTITRUST LAW AND ECONOMICS (1993) ...................14
Tunney Act, 15 U.S.C. §16(e) ..........................................................................................................................1
Yabing Jiang, e-Book Platform Competition in the Presence of Two-Sided Network Externalities, 2012 45th
Hawaii International Conference on Systems Sciences, IEEE Computer Society 4777 (2012) ................11

Constitutional Provisions
U.S. Constitution, Article I, §8 ......................................................................................................................23

Public Comments
Comments of Author’s Guild (ATC-0214, June 25, 2012) ...........................................................................15
Comments of Bob Kohn (ATC-0143, May 30, 2012) .....................................................................................1

iv

I.

INTRODUCTION

Many of the public comments spoke to a truth that seems obvious to everyone, including the
government: that Defendants’ conduct made the e-book market more competitive, evidenced by
Amazon’s market share in e-books declining from 90% to 60% during the year following the
industry’s adoption of the agency model. This brief takes the obvious and establishes its legal
underpinnings, challenging the government’s conclusion on the reasonableness of the proposed
remedy by showing how the DOJ failed to consider the countervailing pro-competitive virtues of
Defendants’ conduct—something which the government’s own U.S. Supreme Court authority cited
in the DOJ Response requires. The brief also challenges the government’s factual foundation for its
decision that Amazon did not engage in predatory pricing. The DOJ Response invented (citing no
authority) a bizarre standard for predatory pricing that is entirely inconsistent with that followed by
the Second Circuit. By applying the wrong law to their facts, the DOJ’s conclusions cannot be
reasonable. To test the reasonableness of its conclusions, the Court must see those facts.
In determining whether the proposed Final Judgment is in the public interest, the Court will
be considering certain factors enumerated in the Tunney Act 1 to evaluate whether “there is a factual
foundation for the government’s decisions such that its conclusions regarding the proposed
settlements are reasonable.” 2 The Comments of Bob Kohn showed how the factual foundation
proffered by the government in its Complaint and CIS point to a conclusion about the proposed
settlement that is unreasonable. This brief is focused on showing how the DOJ Response has
actually helped demonstrate the unreasonableness of the government’s conclusions.
The Court’s public interest determination in this case is like few others: it hinges not upon
whether the government has vigorously and faithfully represented the public interest by seeking a

1
2

United States v. SBC Commc’ns, Inc., 489 F.Supp. 2d 1, 13 (D.D.C. 2007). Factors are listed in 15 U.S.C. §16(e).
United States v. Keyspan Corp., 783 F. Supp.2d 633, 637 (S.D.N.Y. 2011).

1

remedy that “does not go far enough”; rather, it concerns whether the proposed remedy will harm
consumers rather than benefit us. 3 This brief will show that, based upon the DOJ’s own facts,
arguments, and authority, the government’s conclusions are unreasonable. Using the DOJ’s own
factual allegations (stripped of their conclusions, which is really the subject of this proceeding), this
brief shows how Defendants’ conduct benefited consumer welfare, and why those benefits should
not be reversed by the proposed Final Judgment. While the Court should be “deferential to the
government’s predictions as to the effect of the proposed remedies,” 4 it should not do so when the
government’s conclusions supporting those predictions are unreasonable. Keyspan at 637.
The proposed Final Judgment, which unwinds these pro-competitive benefits, is antithetical
to both consumer welfare and to the copyright rights of authors, a right founded through the U.S.
Constitution by the public and for the public to promote Writings. Regardless of how one may view
Defendants’ conduct as alleged, a Final Judgment that is an “instrument of wrong” to consumers and
the public generally cannot be in the public interest.
II.

STANDARD OF REVIEW

Without rehashing the litany of the DOJ’s citations that would appear to strip this Court of a
sentient role in this proceeding, this brief proceeds on the basis of the standard of review set forth in
Keyspan. 5 Accordingly, this Court need not engage in a “full-blown, lengthy and expensive trial”
(DOJ Response at 44) to determine if the government’s conclusions about the settlement are
3

Unlike other Tunney Act proceedings, the question here is not whether the proposed remedy is “reasonably
adequate.” It concerns whether consumers are harmed by the proposed “remedy” such that the DOJ’s conclusions
about the settlement are unreasonable.
4
United States v. Microsoft Corp., 56 F.3d 1448, 1461 (D.C. Cir. 1995) (“Microsoft I”).
5
Keyspan at 637 (The “relevant inquiry is whether there is a factual foundation for the government’s decisions such
that its conclusions regarding the proposed settlement are reasonable”). See also, SBC Commc’ns, Inc., 489 F.Supp. 2d
1, 16 (D.D.C. 2007). Compare the two alternative formulations of the standard in SBC Commc’ns: (1) “The “relevant
inquiry is whether there is a factual foundation for the government’s decisions such that its conclusions regarding the
proposed settlement are reasonable”—SBC Commc’ns at 16, and (2) “The government need not prove that the
settlements will perfectly remedy the alleged antitrust harms; it need only provide a factual basis for concluding that
the settlements are reasonably adequate remedies for the alleged harms”—SBC Commc’ns, at 17. As to why
formulation (1) from SBC Commc’ns, the one followed by Keyspan, should be the one used in this proceeding, see
accompanying Memorandum Supporting Motion for Leave to Participate as Amicus Curiae at 2.

2

reasonable. On the contrary, the Courts may inquire into the reasonableness of the DOJ’s
conclusions assuming all of the factual allegations regarding Defendants’ conduct in the Complaint,
stripped of their conclusory tint, are true, drawing all reasonable inferences in the government’s
favor. (The Court, of course, is not so constrained. Congress has provided the Court with the tools
for a more complete examination of the factual foundation and reasonableness of the government’s
conclusions. 15 U.S.C. §16(f)). To defer to both the DOJ’s alleged facts as well as their conclusions,
as the DOJ appears to be urging, would indeed make “a mockery of judicial power.”
In addition, we will not ask the Court to “reach beyond the complaint to evaluate claims the
government did not make.” 6 Nor will we ask that Court “construct [its] own hypothetical case and
then evaluate the decree against the case,” 7 or “redraft the complaint to inquire into other matters
that the United States did not pursue” 8 or “engage in an unrestricted evaluation of what relief would
best serve the public.” 9 We are asking the Court to rule that the proposed Final Judgment is not in
the public interest. By so doing, the Court need not engage in any of the foregoing parade of
horribles that are beyond the standard of review; it would simply be telling the DOJ to go back to
the drawing board. If the Court eventually finds the Defendants’ engaged in wrongdoing, so be it,
but a consent decree that is harmful to the public should not be approved by a court.
A consent decree “is not merely a contract between the parties. The decree’s approval is a
judicial act by a branch of our government. It is, therefore, imperative that the court avoid
allowing the decree to become “an instrument of wrong” to the public.” 10

6

Microsoft, 56 F.3d at 1459. From that, however, it does not follow that the Court should not reach out to facts to
evaluate claims that the government did, in fact, make. Otherwise, Congress would not have given the Court the
extensive fact-finding tools it clearly has under 15 U.S.C. §16(f), including the examination of witnesses and
documentary materials. And there would be no independent means by which the court could evaluate whether the
factual foundation of the governments decisions actually support its conclusions regarding the proposed remedy.
7
CIS §VII (quoting Microsoft, 56 F.3d at 1459 and Keyspan, 783 F.Supp.2d at 638).
8
CIS §VII (quoting Microsoft, 56 F.3d at 1459-60).
9
See, United States v. BNS, Inc., 858 F.2d 456, 462 (9th Cir. 1988); see also, Microsoft, 56 F.3d at 1460-62.
10
Former Chief of the Antitrust Bureau of the State of New York, Jay Himes, Judicial Review of Justice Department
Consent Decrees: Is the Tunney Act Glass Half-Empty or Half-Full? at 6 (February 28, 2007) (quoting United States
v. Swift & Co., 286 U.S. 106, 115 (1932) (Opinion of the U.S. Supreme Court delivered by Justice Cardozo),
http://www.comptel.org/files/tunney-act_himes.pdf.

3

III.

THE RELIEF SOUGHT IS AN INSTRUMENT OF WRONG TO THE PUBLIC
The government’s conclusions regarding the proposed Final Judgment are contrary to

consumer experience, common sense, U.S. Supreme Court and Second Circuit precedent, and nearly
20 years of U.S. government antitrust policy. Consistent with the Keyspan standard of review, this
brief will enquire whether the government’s conclusions regarding the settlement are reasonable
considering the enumerated factors in 15 U.S.C 16(e). These factors include the impact of the
proposed remedy: (a) upon the relevant market or markets 11 and (b) upon the public generally. Id.
Because of its elementary error in formulating the proposed remedy, the DOJ’s factual foundation
actually supports the conclusion that the proposed Final Judgment is not in the public interest.
A.

Impact of the Proposed Final Judgment on the Relevant Market or Markets

The 2004 Tunney Reform Act, for the first time, made it a requirement that Court consider
the impact of entry of the judgment “upon competition in the relevant market or markets.” This is
so, even if the Court believes or finds that the alleged activity was illegal per se. In its Response, the
DOJ repeatedly waives the per se flag, but that has nothing to do with the statutory requirement
compelling the Court to consider the impact of the proposed settlement upon competition in the
relevant market or markets. As one of the enumerated factors, such impact must be considered in
relation to evaluating whether the government’s conclusions are reasonable.
1.

Court is Not Bound by the Relevant Market Plead in the Complaint

It should be self-evident that the Court is not bound to consider the impact of the proposed
judgment solely upon those markets alleged in the Complaint. First, the Court inherently has the
power to dismiss the Complaint on a Rule 12(b)(6) motion for failing to plead an appropriate
relevant market sufficient to state a claim upon which relief may be granted (or for failing to provide

11

15 U.S.C.§16(e)(1)(B).

4

a plausible explanation for why the market should be limited as it has been in the Complaint). 12 To
suggest otherwise is to truly “make a mockery of judicial power.” To drive home the point, suppose
the DOJ, for whatever reason, did not, in fact, plead a relevant market. Then, what relevant markets
would the Court consider in making its public interest determination, keeping in mind the Court
must consider the impact of the proposed judgment upon competition relevant market or markets?
The only answer to that question can be that the Court must consider the market or markets that the
Court deems relevant. 13
Second, one of the other enumerated factors the Court must consider is the impact of the
proposed Final Judgment upon “the public generally.” If the proposed remedy had no impact (or
even a positive impact) upon the relevant market alleged in the Complaint, but destroyed
competition in related markets (such as those which the IP Guidelines 14 require the DOJ to
consider)—either upstream markets, such as the markets for e-book devices and platforms, or
downstream markets, such as the markets for e-book distribution rights and author manuscript
rights—to the detriment of consumers or the public generally, the Court should find that the
government’s conclusions regarding the proposed settlement are unreasonable.
2.

Characteristics of the Products At Issue

Before considering the impact of the settlement upon the relevant market or markets, one
must first answer the question: market for what? Of all of the government decisions relevant to
12

See, In Re Wireless Telephone Services Antitrust Litigation, 385 F.Supp. 2d 392 (S.D.N.Y. 2003) (citing Todd v.
Exxon Corp., 275 F.3d 191,198 (2d Cir. 2001)) See, also Re-Alco v. National Center for Health Educ., 812 F.Supp.
387 (S.D.N.Y. 1993).
13
In assessing the reasonableness of the government’s conclusions as to the relevant market, the Court is not being
asked to conduct “a wide-ranging inquiry” (Microsoft, 56 F.3d at 1459) into factual allegations that reaches beyond
the scope of the Complaint. It is an assessment the Court customarily conducts every time it rules on 12(b)(6) motion.
If Congress didn’t intend the Court to consider the impact upon the market or markets that the Court deems relevant, it
would not have required the Court to consider such impact nor would Congress have given the Court the tools with
which to independently determine the markets relevant to the public interest determination. 15 U.S.C. §§16(e), 16(f).
14
The antitrust policy of the U.S. with respect to copyrighted works is set forth in the Antitrust Guidelines for the
Licensing of Intellectual Property (DOJ/FTC 1995) (the “IP Guidelines”). The IP Guidelines, available today on the
DOJ website, are fresh and relevant today as they were when they were first promulgated nearly 18 years ago. See,
Carl Shapiro, The Role of Innovation in Competitive Analysis, THE ANTITRUST SOURCE (July, 2005).

5

determining whether its conclusions are reasonable, clearly the most important concerns the
definition and nature of the product at issue—e-books. This is where the DOJ got it fundamentally
wrong and why the government’s factual foundation collapses under the mere weight of consumer
experience and common sense.
The Complaint provides the following definition of e-books:
“—books sold to consumers in electronic form and read on a variety of devices, including
dedicated e-readers (such as the Kindle or Nook), multipurpose tablets, smartphones and
personal computers. Consumers reap a variety of benefits from e-books, including 24-hour
access to product with near-instant delivery, easier portability and storage, and adjustable
font size. E-books also are considerably cheaper to produce and distribute than physical (or
“print”) books.” Complaint at ¶ 1.
In its discussion of the relevant market, the Complaint adds this:
“There are no technological alternatives to e-books, thousands of which can be stored on a
single small device. E-books can be stored and read on electronic devices, while print books
cannot. E-books can be located, purchased and downloaded anywhere a customer has an
internet connection, while print books cannot.” Complaint at ¶ 99.
Being the lens through which the government formulated its case and the proposed remedy,
it is plain to see where it went wrong. The Complaint reads more like an advertisement for e-books
than a reflection of sound antitrust policy. The antitrust policy of the United States, as embodied in
the DOJ’s own IP Guidelines, direct that the characteristics that distinguish the intellectual property
at issue from other forms of property must be taken into account in evaluating the specific market
circumstances in which e-book transactions occur.
a.

E-Books Are Public Goods

E-books have the classic characteristics of what are known as, “public goods.” See,
Broadcast Music, Inc. v. Moor-Law, Inc., 527 F.Supp. 758 (D. Del. 1981), aff’d without published
opinion, 691 F.2d 490 (3d Cir. 1982). First, unlike private goods (e.g., apples or printed books),
which can be withheld from the market and released only in exchange for payment, an e-book can

6

be consumed without leaving any less for others to consume. 15 Second, the digital nature of e-books
facilitates the reproduction of perfect copies at virtually no cost, making it difficult for the copyright
owner to exclude persons who do not pay for consuming the e-book—a problem known as the free
rider problem, 16 misappropriation, 17 infringement, 18 illegal file sharing, 19 or piracy.
In economic terms, the supply curve operating in the market for public goods, such as ebooks, is completely different from the supply curve in the market for private goods, such as printed
books. For example, the supply curve of a printed book is typically the same as the book’s marginal
cost curve. 20 This is because the cost of acquiring a copy of and consuming an additional printed
book costs the consumer something. By contrast, because of the free rider or piracy problem, the
marginal cost of acquiring and consuming an additional e-book can be as low as zero. Moor-Law,
527 F.Supp. at 763. Accordingly, “the natural market forces of supply and demand do not operate
normally on pricing in this market.” Id.
Because of the public good characteristics of e-books, normal cost-based pricing is not
feasible. Id. For example, the price that a publisher can charge for an e-book is subject to a natural
constraint: illegal competitors charging zero for the same e-book. In Moor-Law, the District Court
found, as an observed fact, that “the free rider problem does provide a significant constraint on the
price BMI charges.” By the same token, the publisher’s cost of producing and marketing e-books are
increased by the high costs of enforcing their legal rights and preventing their copyrighted works
from being pirated (i.e., through technical and legal means). Id. “Since the free rider problem tends
to make BMI’s enforcement costs high and can, indeed, cause increased costs to more than consume
increased revenue from a higher price, BMI considers this problem when setting a price”. Id.
15

See, Moor-Law at 763.
Id.
17
IP Guidelines at §1.0.
18
Copyright Act, 17 U.S.C. §501(a).
19
A&M Records, Inc. v. Napster, Inc., 239 F.3d 1004, 1011 (9th Cir. 2001).
20
Gellhorn, Kovacic & Calkins, ANTITRUST LAW AND ECONOMICS at 71 (Thomson West 2004).
16

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b.

E-Books Are Systems Goods

Another defining characteristic of e-books that distinguish them from other forms of property
is their need to interoperate with other products to have value. 21 In this respect, e-books are
considered, “systems” goods 22—they have no use or value to a consumer in isolation. To have any
value at all, e-books need to operate within a system comprised of “intermediate” or “final” goods.
Id. at §3.2.1. Unlike a printed book, an e-book is only "one component among many in a production
process and derives value from its combination with complementary factors.” 23 Not just any factors:
complementary factors.
This is important, because it is rarely true that an e-book, once sold to a consumer, can be
read on “a variety of devices”; an e-book can only be read on the particular kind of device with
which it was designed to interoperate—i.e., a “complementary” component that is “compatible”
with the e-book’s particular format. Nor can it necessarily be read, as stated in the proposed Final
Judgment, on “other electronic devices capable of visually displaying E-books.” 24 For example, an
e-book designed to operate on a Kindle has no use or value to a consumer who owns only a Nook
device. To read the Kindle-formatted e-book, the consumer would have to purchase a Kindlecompatible device—which in itself should tell you something about the cost of that e-book to the
consumer: the price charged for the e-book is not the only factor in the consumer’s purchase
decision.
By contrast, consumers can read printed books right off the shelf, standing alone, without the
aid of any kind of device and no compatibility requirements (other than the language of the person

21

IP Guidelines at §2.1.
The nature of “systems” products is discussed at length in Comments of Bob Kohn at pp. 24-27.
23
IP Guidelines at §2.3. The owner of intellectual property has to arrange for its combination with other necessary
factors to realize its commercial value. Id
24
The definition, as rephrased in the proposed Final Judgment, is the same in all material respects: “‘E-book’ means
an electronically formatted book designed to be read on a computer, a handheld device, or other electronic devices
capable of visually displaying E-books.”Proposed Final Judgment, §II (Definitions), D (“E-Book”).
22

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desiring to read the book) . The consumer need only consider the price of the printed book in
relation to its perceived value; he or she need not consider other factors, such as compatibility with
the consumer’s devices, the costs of switching to another device to read the book, and other factors
that have nothing to do with the price of the book itself. For example, an e-book could be given
away for free, but a consumer concerned with switching costs may still not acquire it. By the same
token, a consumer may be willing to pay twice as much (e.g., $18.98, rather than $9.99) for a copy
of an e-book that operates on several incompatible devices, because consumers place a value on
convenience and flexibility. 25
c.

DOJ Failed to Take into Account the Impact of the Economic
Characteristics of E-Books in Reaching Its Decision

These critical distinctions between e-books and printed books were part of the crucial
factual foundation underlying the DOJ’s decisions in this case. 26 For the reasons explained above,
the natural market forces of supply and demand that operate in the market for printed books do not
operate normally on pricing in the market for e-books. Accordingly, antitrust analysis must take
these differences into account in evaluating specific market circumstances in which transactions
occur. IP Guidelines §2.3. This is because a “number of different goods markets may be relevant to
evaluating the effects” of a restraint. Id. at §3.2.1. For example, a restraint of trade may have
“competitive effects in markets for final or intermediate goods made using the copyrighted work, or
it may have effects upstream, in markets for goods that are used as inputs, along with the
copyrighted work, to the production of other goods.” Id. In general, the delineation of relevant
market in the intellectual property area is approached as stated in the DOJ’s Horizontal Merger
Guidelines (2010). Id. Under the Merger Guidelines, the government “will normally identify one or
25

See generally, Joseph Farrell & Carl Shapiro, Dynamic Competition with Switching Costs, ECONOMICS WORKING
PAPERS 8865, University of California, Berkeley (1988).
26
Nor are e-books merely “electronic versions of books.” See, Opinion and Order In Re Electronic Books Antitrust
Litigation, 11 MD 2293 (DLC) (May, 15 2012). E-books are public goods; printed books are private goods. E-books
are systems goods; printed books are non-system, or stand-alone goods.

9

more relevant markets” (Merger Guidelines at§4) and will consider the “network effects” operating
in such markets. Id. at §2.2.3 (Example 2).
The CIS, the DOJ Response, and Motion for Entry are each devoid of any discussion
whatsoever of these crucial characteristics that distinguish e-books from other forms of property, the
impact of those distinctions in each of the markets affected by e-book transactions, and the network
effects operating in these markets. By failing to take these considerations into account, the factual
foundation of the government’s decisions are such that their conclusions about the proposed remedy
are unreasonable.
3.

The Markets In Which E-book Transactions Occur

Given the nature of products at issue, the market or markets in which e-book transactions
occur have at least the following characteristics (a) the need of e-books to interoperate with other
goods in order to give them value and (b) the need to compete in a market the marginal cost curve of
which is zero—that is, a market in which there is one quiet, but giant competitor: free riders who
can readily take advantage of their digital form to cheaply trade in pirated copies without payment.
But, in its approach this case and the proposed remedy, the DOJ treated the market for ebooks as it would a market for any private (as opposed to public) good and any stand-alone (as
opposed to system) good, such as apples or printed books. Compare, IP Guidelines at §2.3 and
§3.2.1. The DOJ failed to consider that a restraint of trade in the market for the copyrighted work
(e.g., e-book) may have competitive effects in markets for the “final” or other “intermediate” goods
made using the copyrighted work (e.g., e-book devices and delivery systems), or it may have effects
further upstream, in markets for goods that are used as inputs, along with the copyrighted work, to
the production of other goods (e.g., the market for the acquisition of author manuscripts). 27
27

Id. This formulation of the relevant market concerning e-books has now been confirmed in the economic literature.
"As readers need to consume e-books through a particular e-book platform, the e-book market is best characterized as
a two-sided market with network externalities.” Yabing Jiang, e-Book Platform Competition in the Presence of Two-

10

In summary, the e-book market is best characterized as a stack of interdependent markets,
from upstream to downstream, comprised of (1) the acquisition of e-book manuscripts from authors,
(2) the acquisition of e-book distribution rights from publishers (or directly from authors), (3) the
sale of e-books to consumers, and (4) the sale of e-book devices (including the reader software that
operates on them) and the systems that deliver the e-books to the devices and otherwise support the
purchase, delivery, storage and other services related to consumer transactions in e-books. 28
However one looks at these markets, as separate relevant markets or as markets that are
interdependent with each other, if you are considering how a remedy affects consumers of e-books
and the public generally, the analysis is the same. Recall, the Tunney Act specifically requires the
Court to consider the impact of the proposed remedy upon “the relevant market or markets” and the
impact of the proposed judgment on the public generally. As noted above, even if the proposed
remedy has positive impact upon the relevant market alleged in the Complaint, if it harms
competition in related markets—such as upstream markets (e.g., markets for e-book devices and
platforms) or downstream markets (e.g., markets for e-book distribution rights and author
manuscript rights)—to the detriment of consumers or the public generally, the Court should find that
the government’s conclusions regarding the proposed settlement are unreasonable.
4.

DOJ Reached an Unreasonable Conclusion About the Remedy By Failing
to Consider the Pro-Competitive Effects of Defendants’ Alleged Conduct

The DOJ’s own IP Guidelines specifically acknowledge that a “number of different goods
markets may be relevant to evaluating the effects” of a restraint (IP Guidelines at §3.2.1) and the
Sided Network Externalities, 2012 45th Hawaii International Conference on Systems Sciences, IEEE Computer
Society 4777 (2012). The other side of this two-sided market is the market for e-book reader devices and the “cloud”
platform services that support e-book transactions. Related markets (or other sides to the multi-sided markets) affected
by the proposed settlement are the market for acquiring e-book distribution rights from publishers and the market for
acquiring e-book manuscripts from authors, both of which are inputs to e-books to be marketed to consumers.
28
In the digital world, this is the economic reality and [T]he Sherman Act has always been discriminatingly applied in
light of economic realities.”See, Broadcast Music, 441U.S. at 9. Leegin Creative Leather Products, Inc. v. PSKS, Inc.,
551 U.S.877 (2007) (Sherman Act evolves “to meet the dynamics of present economic conditions”). See also,
Business Electronics Corp. v. Sharp Electronics Corp., 485 U.S. 717, 731 (1988) (The term “restraint of trade” in the
Sherman Act “refers not to a particular list of agreements, but to a particular economic consequence”).

11

government must inquire whether the restraint of trade in question is “likely to have anticompetitive
effects and, if so, whether the restraint is reasonably necessary to achieve procompetitive benefits
that outweigh those anticompetitive effects.” IP Guidelines at §3.4 (emphasis added) (citing
Broadcast Music, among other cases and a leading treatise on antitrust law). 29 The IP Guideline’s
citations, in this context, of Broadcast Music—is significant.
To determine the legality of a particular restraint, it must be assessed whether the restraint in
question will contribute to a “countervailing pro-competitive virtue.” See, FTC v. Indiana Fed’n of
Dentists, 476 U.S. 457 (1986) (citing Broadcast Music, 441 U.S. at 16-24). See also, IP Guidelines
at §3.4. 30 Since the CIS, the DOJ Response, and the Motion for Entry of Final Judgment all fail to
address this precedent as established by the U.S. Supreme Court and Second Circuit 31 (which is
specifically reflected in the IP Guidelines)—the reasonableness of any government conclusion as to
the impact of the proposed remedy should be completely suspect.
5.

U.S. Supreme Court & Second Circuit has Justified Horizontal Price
Fixing When It is “Pro-Competitive” or When It Otherwise Contributes
to “Efficiencies in the Operation of a Market”

In the DOJ Response, the government’s cited FTC v. Indiana Fed’n of Dentists, 476 U.S.
447, 465 (1986) and Fashion Organizers’ Guild of Am. v. FTC, 312 U.S. 457, 468 (1941) for the
proposition that a competitor may not “take the law into its own hands.” These citations are inapt,

29

IP Guidelines at §4.1. This is also consistent with the 2004 Tunney Reform Act’s addition of the enumerated factor
that the Courts is required to consider in this proceeding: the impact upon “the relevant market or markets.” As noted,
the 2004 Reform Act was in part a response to what Congress judged to be the D.C. Circuit’s deference to the
government in Microsoft. In Microsoft I, Microsoft was accused of using its monopoly in PC operating system
software to monopolize the downstream market for copyrightable software products, such as word processing,
spreadsheet and database application software, each of which were “systems products” that had no value to consumers
without technical interoperability with Microsoft Windows. It should be clear that Congress, by using the phrase
“relevant market or markets” in the 2004 Reform Act intended future courts to look at the competitive effects of the
proposed remedy in all markets upon which it may have impact. Accordingly, the Merger Guidelines (§2.2.3) have
since been amended to consider the “network effects” operating in “one or more” relevant markets.
30
The DOJ “will assess whether the restraint in question can be expected to contribute to an efficiency-enhancing
integration of economic activity,” citing Broadcast Music, 441 U.S. at 16-24. IP Guidelines at §3.4.
31
Broadcast Music v. CBS, 441 U.S. 1 (1979); CBS v. ASCAP, 337 F.Supp. 394 (S.D.N.Y. 1972); CBS v. ASCAP, 620
F.2d 930 (2d Cir. 1980), cert. denied 450 U.S. 970 (1981).

12

because neither of them concerned actions by competitors to address market failures in the antitrust
context, which the U.S. Supreme Court has recognized will sustain “literal” collusive conduct. The
unlawful practice at issue in Indiana Fed’n of Dentists was a violation of an Indiana statute
prohibiting the unauthorized practice of dentistry; in Fashion Organizers’, it was the alleged tortious
copying of dress designs. While responding to the unauthorized practice of medicine or tortious
infringement of intellectual property is not a sufficient justification for collusion, conduct that has a
“countervailing pro-competitive virtue” is. See, Indiana Fed’n of Dentists, the government’s own
authority for the opposite proposition, at 459!
The Court need only turn back 6 pages from the DOJ’s citation in Indiana Fed’n of Dentists
to find where Justice White (who delivered the court’s opinion in Broadcast Music six years earlier)
not only reiterated the U.S. Supreme Court’s view that “redeeming virtue” will justify literal price
fixing, but went on to elucidate, if not extend, Broadcast Music as follows: Collusive conduct will
be sustained under the rule of reason where there is a “countervailing procompetitive virtue—such
as for example[32], the creation of efficiencies in the operation of a market.” Id. at 459 (citing
Broadcast Music). 33 (Some would attribute the Supreme Court’s justification for horizontal price
fixing in Broadcast Music solely to the need for the music publishers and their licensees to reduce
transaction costs. But this is a misunderstanding of the decision.). 34
32

Emphasis added to underscore the Supreme Court’s receptiveness to a range of potential countervailing procompetitive virtues that may justify collusive conduct.
33
FTC v. Ind. Fed’n of Dentists,476 U.S. at 459.
34
The transaction cost explanation of Broadcast Music assumes a relevant market of thousands of buyers who need a
more efficient means of licensing musical performances. But the relevant market actually at issue in Broadcast Music
was the market for musical performances used by television networks. The plaintiff was CBS, not Shanley’s Caberet.
In 1979, there were only three buyers in that market: CBS, NBC and ABC. Thus, while thousands of restaurants and
businesses need to keep the number of individual musical performance licenses and the costs of negotiating them to a
manageable level, the District Court found that the three major networks were less like restaurants and cabarets and
more like the film studios and producers in its use of music: direct licensing to network television producers, like to
producers of motion pictures, was held by the District Court to be feasible, because they already have an efficient
mechanism under which to negotiate and obtain synchronization licenses directly from music publishers and it could
feasibly negotiate with them for performance rights. CBS v. ASCAP, 400 F.Supp. 737, 755-56, 760-61, 765 (1975).
This finding was accepted by the Second Circuit and the U.S. Supreme Court. CBS v. ASCAP, 562 F.2d at 134-40;
Broadcast Music, 441 U.S. at 21 (“With the advent of television and radio networks, market conditions changed, and

13

The most significant economic consideration in Broadcast Music was the substantial
concentration on the buyers’ side of the market for musical performance rights. 35 In the market for
musical performance licenses for network television, there were three major buyers, CBS, NBC, and
ABC. 36 When there are only three major buyers, those buyers have substantial monopsony power—
the power to lower prices. 37 (Monopsony is “just as inconsistent with consumer welfare as
monopoly is.”) 38 The concentration of the television industry at that time enabled the networks to
reduce the price of musical performance rights below the competitive level. 39 In short, if individual
copyright owners were required to negotiate with the television networks or their program
producers, bargaining power would be overwhelmingly with the networks. Id. “No system short of
blanket licensing will adequately offset the monopsony power of network television.” Id.
Thus, the horizontal price fixing by music publishers in Broadcast Music was justified by the
need to balance the monopsony power of the three buyers of musical performances. As discussed
below, that precedent similarly justifies the book publishers’ far more limited, one-time (alleged)
collusive conduct in this action.

the necessity for and advantages of a blanket license for those users may be far less obvious than is the case when the
potential users are individual television or radio stations, or the thousands of other individuals and organizations
performing copyrighted compositions in public”). See, John Cirace, CBS v. ASCAP: An Economic Analysis of a
Political Problem, 47 FORDHAM L. REV. 277, 293-94 (1978-79). See also, Al Kohn & Bob Kohn, KOHN ON MUSIC
LICENSING (4th Edition 2010, Wolters Kluwer) at pp. 1085 to 1140. Accordingly, Broadcast Music represents a case
“unclouded by the issue of transaction costs.” Cirace at 295.
35
Cirace at 295 (see notes at 33-34). In accord, Richard S. Wirtz, Rethinking Price-Fixing, 20 INDIANA L. REV. 531
(1987): “After Broadcast Music and NCAA, the question is not whether exceptions to the general prohibition against
agreements among competitors will be recognized, but rather when. Potentially pro-competitive collaboration among
competitors is to be encouraged, within limits, even if it involves agreement on prices.” Id. at 627.
36
See, CBS v. ASCAP 562 F.2d at 132.
37
Cirace, at 281, fn 34.
38
See, Herbert Hovenkamp, FEDERAL ANTITRUST POLICY at 13-16 (2d ed. 1999). A monopsony is no less a market
failure, and no less harmful to consumers, than a monopoly. See, Horizontal Merger Guidelines of 2010 at §1
(“Enhancement of market power by buyers, sometimes called ‘monopsony power,’ has adverse effects comparable to
enhancement of market power by sellers”). “A monopsonist impedes efficient resource allocation by setting lower
prices for the affected input and using fewer resources than it would in a competitive market featuring many buyers.”
See, Gellhorn, Kovacic & Calkins at 80, citing, Roger D. Blair & Jeffrey L. Harrison, Monopsony, ANTITRUST LAW
AND ECONOMICS at 36-61 (1993).
39
Cirace at 297.

14

6.

Countervailing Pro-competitive Contributions to Efficiency in the
Operation in the E-Book Market Justified Defendants’ Conduct

The countervailing pro-competitive virtue of Defendants’ conduct was to restore efficiency
to an e-book market distorted by both Amazon’s monopsony power and monopoly power. The fact
that such powers were promoted by Amazon’s predatory pricing practices makes this justification
even more compelling. To find the pro-competitive virtues of Defendants’ conduct, one need not
look beyond the facts alleged in the Complaint.
a.

Countervailing Amazon’s Monopsony Power

Just as the music publishers were faced with a monospony of three buyers in the market for
musical performances in network television broadcasts, the book publishers were faced with a single
buyer generating 90% of all of their revenues from e-book distribution. 40 See, DOJ Response at p.
vi. As noted above, the Complaint itself alleges sufficient facts to demonstrate that Defendant
Publishers faced in Amazon a buyer with palpable monopsony power. The concentration of its
buying power allowed Amazon to, not only dictate terms to many publisher-sellers of e-books, but
to repeatedly use what has been described by the New York Times as Amazon’s buy button “nuclear
option,” a dramatic (but not the first 41) example of which is alleged in the Complaint itself. One
need only read paragraph 80 of the Complaint to appreciate how breathtakingly powerful Amazon’s
monopsony had become. When Amazon pulled the “buy” button for all of Macmillan’s books
(including e-books, as well as printed books) in the Amazon store, the nation’s sixth largest book
publisher was brought to its knees. 42 Had Amazon continued its boycott of Macmillan's books for
short while longer, Macmillan would have been unable to solicit new manuscripts from authors and
40

United States v. Grinnell Corp., 384 U.S. 563, 571 (1966) (in which 87% of the market constituted “monopoly
power,” citing American Tobacco Co. v. United States, 328 U.S. 781, 797 (1946) where “over 80%” constituted a
“substantial monopoly” and United States v. Aluminum Co. of America, 148 F.2d, 416, 429 (2d Cir. 1945) where 90%
of the market constituted market power).
41
See, Comments of Author’s Guild (ATC-0214, June 25, 2012), at 3, 5-6. Doreen Carvajal, Small Publishers Feel
Power of Amazon’s Buy Button, NEW YORK TIMES (June 16, 2008).
42
90% of Macmillan’s e-book revenues and 25% of its printed book revenues vanished in an instant.

15

would have ceased publishing new books, effectively putting it out of business.
It has been said that a monopsony is the “mirror image” of monopoly. 43 Under the textbook
economic definition, the monopsonist, in depressing the price of the goods purchased, transfers
wealth to itself from the supplier of the goods. The government’s suggestion that Amazon’s exercise
of its monopsony power to lower e-book prices is good for consumers is wrong. According to the
DOJ’s own 2010 Horizontal Merger Guidelines, the monopsonist will not pass along the lower price
input to its downstream consumers. 44 And, as discussed infra, the use of monopsony power to
reduce the price paid to publishers and authors for e-book distribution rights is antithetical to the
exercise of the rights of copyright owners, whose pricing is already significantly constrained by the
free-rider/piracy problem. 45
Being the source of 90% of the book publishers’ e-book revenues, Amazon was a clear
monopsony in the market for acquiring license rights to e-books for distribution to the consumers.
Moreover, Amazon’s monopsony was not the result of competition on the merits, but rather it was
fed by its monopoly in the market for e-book sales to consumers, which was promoted and sustained
by Amazon’s illegal predatory pricing.
b.

Countervailing Amazon’s Monopoly Power & Specifically Its
Predatory Pricing Practices

In the DOJ Response, the government stated,
No objector to the proposed Final Judgment has supplied evidence that, in the dynamic and
evolving e-book industry, Amazon threatens to drive out competition and obtain the
monopoly pricing power which is the ultimate concern of predatory pricing.
No objector supplied evidence, because they didn’t have to. Sufficient “evidence” of
Amazon’s exclusionary threat is alleged in the government’s own Complaint and the CIS. As the
43

Todd v. Exxon Corp., 275 F.3d191, 202 (2nd Cir. 2001) (Opinion by Judge Sotomayor: “the equation for measuring
market power in monopsony is a mirror image of the relationships that create market power in a seller”). See also,
Merger Guidelines (2010) at §1.
44
See Horizontal Merger Guidelines of 2010 at §12.
45
Moor-Law at 763.

16

DOJ says, in its Complaint at ¶30 (and repeated in the DOJ Response on page 21), the government
reviewed data from Amazon and others to investigate Amazon’s e-book distribution business. The
Complaint then alleges that Amazon “lowered substantially the price of newly released and
bestselling e-books,” and according to the CIS, Amazon bought e-books from publishers for “a
discount (usually around 50%) off the price printed on the physical edition of the book (the ‘List
Price’).”

46

Thus, for example, an e-book with a List Price of $26.00 would be sold to Amazon for

$13.00 and Amazon would sell that copy to a consumer for $9.99 47 —a marginal loss of over $3.00
per unit. In the economics terms, this practice is known as “penetration pricing,” the practice of
reducing the price of a component of the system (e.g., e-books) to initial adopters of the system
(e.g., an e-book platform, such as Kindle), thereby enhancing the network effects operating in the
market to spur the consumer adoption of the system. 48 In legal terms, Amazon engaged in a clear
case of “predatory pricing,” an exclusionary practice that is illegal under federal and state antitrust
laws.
In the DOJ Response at page 22, the government quotes Brook Group v. Brown and
Williamson Tobacco Corp., 509 U.S. 209, 222-24 (1993) for the proposition that “Antitrust law
prohibits low prices only if the price is ‘below an appropriate measure of…cost.’” While in Brook
Group the Supreme Court had not yet filled in the ellipsis, 49 the DOJ completes the ellipsis with a
standard for predatory pricing heretofore unknown in this jurisdiction or perhaps in any jurisdiction:
As is alleged in the Complaint, the United States has concluded, based on its investigation
and review of data from Amazon and others, that “[f]rom the time of its launch, Amazon’s e46

See, CIS §II.A.
See Complaint, in passim.
48
Comments of Bob Kohn 24-39. See, Douglas D. Leeds, Raising the Standard: Antitrust Scrutiny of StandardSetting Consortia in High Technology Industries, FORDHAM INTELL. PROP. MEDIA & ENT. L.J. 641, 656 (1997); See
also, Michael L. Katz & Carl Shapiro, Network Externalities Competition and Compatibility, AMERICAN ECONOMIC
REVIEW, Vol. 75, No. 3 (June, 1985); Michael L. Katz & Carl Shapiro, Systems Competition and Network Effects ,
JOURNAL OF ECONOMIC PERSPECTIVES, Vol. 8, Issue 2 (Spring 1994); M. Gallaugher & Yu-Ming Wang,Network
Effects and the Impact of Free Goods: An Analysis of the Web Server Market, INTERNATIONAL JOURNAL OF
ELECTRONIC COMMERCE, Vol.3, No. 4, Summer, pp. 67-88 (1999).
49
Ortho Diagnostic Systems v. Abbott Laboratories, 920 F.Supp. 455, 466 (S.D.N.Y. 1996).
47

17

book distribution business has been consistently profitable, even when substantially
discounting some newly released and bestselling titles.” DOJ Response, p.21-22 (quoting
Compl. ¶30, emphasis added).
The government provides no citation for the proposition that the standard for predatory
pricing under Section 2 of the Sherman Act 50 is whether the perpetrator’s business “has been
consistently profitable.” Instead of cheerleading Amazon’s pricing practices—characterizing them
as “One of Amazon’s most successful marketing strategies,” 51 it might have sought what this Circuit
had to say on the subject. In the Second Circuit, “The relationship between a firm’s prices and its
marginal costs provides the best single determinate of predatory pricing.” 52 Moreover, under the law
in this Circuit, “prices below reasonably anticipated marginal cost will be presumed illegal.” 53
Because marginal cost typically cannot be determined from conventional accounting
methods, the Second Circuit adopted “average variable cost” as its surrogate. (Average variable cost
is equal to the sum of all variable costs divided by output). But this case is not typical. Marginal cost
is traditionally defined as “the increment to total cost that results from producing an additional
increment of output.” Northeastern at 87 (quoting Areeda & Turner ¶712, at 155). Because
Amazon’s marginal cost is at least equal to the fixed wholesale price (e.g., $13.00, which is 50% of
list price) it pays to the publishers for each additional e-book it sells, no surrogate for marginal cost
is necessary. 54
50

15 U.S.C. §2.
Complaint at ¶ 2.
52
Northeastern Telephone Co. v. American Telephone and Telegraph Co., 651 F.2d 76, 86-89 (2d. Cir. 1981), cert.
denied, 455 U.S. 943 (1982) (emphasis added). See also, Ortho Diagnostic Systems v. Abbott Laboratories, 920
F.Supp. 455, 465-70 (S.D.N.Y. 1996). See generally, Philip E. Areeda & Donald F. Turner, Predatory Pricing and
Related Practices Under Section 2 of the Sherman Act, 88 HARV. L. REV. 697 (1975)) (“Areeda & Turner”). A firm’s
costs fall into two rough categories: variable costs, those which fluctuate with a firm's output, and fixed costs, those
which are independent of output. Variable costs typically include such items as materials, fuel, labor, maintenance,
licensing fees, and depreciation occasioned by use. Fixed costs generally include management expenses, interest on
bonded debt, the rate of return necessary to attract and maintain equity investment, irreducible overhead, and
depreciation occasioned by obsolescence. The sum of the firm's fixed and variable costs divided by output equals
average cost. See, Northeastern at 86 (citing, Areeda & Turner at 700, 712).
53
Northeastern at 88.
54
There are additional marginal costs, such as the cost of wirelessly delivering each e-book to an e-reader, but because
Amazon sells e-books at a price that is so significantly below its marginal cost, considering these additional marginal
51

18

Monopolization under Section 2 has two elements: first, the “possession of monopoly power
in the relevant market” and, second, the “acquisition or maintenance of that power” by improper
means. 55 First, given that Amazon had 90% share of the e-book market 56, there should be no
question Amazon had the requisite market power to meet the first element. The existence of such
power ordinarily may be inferred from the predominant share of the market. 57 Second, as to whether
Amazon attempted to maintain that power by improper means, we only need to turn to the DOJ’s
Complaint and its CIS, where we are informed that Amazon purchased e-books for $13.00 or $17.50
and then resold them for $9.99, a range of 23% to 42% below Amazon’s minimum marginal cost.58
(Not surprisingly, this coincides with the 30 to 50% increase in prices on many adult trade books
that the DOJ says consumers witnessed after the switch to the agency model. CIS at 9; DOJ
Response at 5).
Conduct, other than competition on the merits, that “reasonably appears capable of making a
significant contribution” to creating or maintaining monopoly power, is exclusionary, and therefore
illegal. 59 In the Second Circuit, such conduct is presumed to be a violation of Section 2 of the
Sherman Act where the alleged predator is selling below marginal cost. 60 There is good reason for
this. As former Circuit Court Judge Breyer elegantly explained, unless the price cutter can show that

costs would be superfluous. Amazon charges self-published authors a wireless delivery fee of 15 cents per megabyte
to transfer an e-book to a consumer’s Kindle if the author selects the 70% Royalty Option. Amazon absorbs the
variable cost of wireless delivery when delivering e-books of authors who select the 35% Royalty Option. See, Kindle
Direct Publishing Agreement, Pricing Page (as of July 28, 2012)).
55
Sherman Act, 15 U.S.C. §2. For a lucid discussion of the maintenance of a monopoly using predatory pricing, see
Barry Wright Corp. v. ITT Grinnell Corp., 724 F.2d 227, 230-34 (1st Cir. 1983) (Opinion by Circuit Judge Breyer).
56
Matt Phillips, Amazon eBook Share to Fall From 90% to 35%, Analyst Says, WALL STREET JOURNAL (February 16,
2010).
57
United States v. Grinnell Corp., 384 U.S. 563, 571 (in which 87% of the market constituted “monopoly power,”
citing American Tobacco Co. v. United States, 328 U.S. 781, 797, where “over two-thirds of the entire domestic field
of cigarettes, and…over 80% of the field of comparable cigarettes” constituted a “substantial monopoly” and United
States v. Aluminum Co. of America, 148 F.2d, 416, 429, where 90% of the market constituted market power).
58
See, CIS at §II.A. The bestselling biography of Steve Jobs by Walter Issacson has a list price of $35.00; under the
retail model, Amazon’s marginal cost would be $17.50; reselling the e-book for $9.99, a remarkable 42% below
marginal cost, would result in a marginal loss of $7.51 per unit.
59
See, Barry Wright, 724 F.2d 227, 230 (Opinion by then Circuit Judge Breyer, quoting Areeda & Turner, supra).
60
Northeastern, 651 F.2d at 88.

19

its low price is purely promotional (e.g., a “free sample”) or show that it expects costs to fall when
sales increase, “the firm cannot rationally plan to maintain the low price; if it does not expect to
raise its price, it would do better to discontinue production.” 61 “[E]qually efficient competitors
cannot permanently match this low price and stay in business.” Id. “[C]ompetitive industries are
typically characterized by prices that are roughly equal to, not below, ‘incremental’ [i.e., ‘marginal’]
costs.” Id. “At a minimum, one would wonder why this firm would cut prices” below its avoidable
costs “unless it later expected to raise its prices and recoup its losses.” Id. “These considerations
have typically lead courts to question, and often to forbid, price cuts below incremental [i.e.,
marginal] costs.”
Amazon sold every newly-released and bestselling e-book made available by the Defendant
Publishers and by most, if not all, independent book publishers, at below its marginal cost,
consistently, “[f]rom the time of its Kindle launch” (CIS §II.A.) until Amazon’s acceptance of the
agency model. This was no “promotion.” This pricing regime was not the equivalent of “free
samples” or “loss leaders.” The only e-books we are aware of which Amazon did not sell below
marginal cost at one time or another were books acquired from self-published authors under the
terms of the Kindle Direct Publishing Agreement. Under that agreement, with terms similar to the
agency model, Amazon guarantees itself a commission for every e-book sold, keeping 65% of the
sales price or over 30% of the sales price (depending upon the royalty scheme chosen by the
author). 62 Nor can Amazon expect its marginal cost for e-books to decrease with volume. Amazon’s
marginal cost for an e-book having a list price of $26.00 will always remain $13.00, whether
Amazon sells one copy or one million copies. As Judge Breyer suggested, “At a minimum, one

61

See, Barry Wright, 724 F.2d 227, 232. Amazon’s $9.99 price for virtually all best-selling trade e-books was
certainly not a “promotion.” Since Amazon would always pay $13.00 for an e-book having a list price of $26.00, it
can never expect its variable cost of acquiring the e-book will fall as sales increase.
62
For a comparison of the Kindle Direct Publishing Agreement and traditional book publishing agreements, see
Appendix §B(2)(d), infra or appended to Memorandum in Support of Motion to Participate as Amicus Curiae.

20

would wonder why this firm would cut prices” below its avoidable costs “unless it later expected to
raise its prices and recoup its losses.”
To make it clear this brief is not suggesting the DOJ sue Amazon or that the Court engage in
“an unrestricted evaluation of what relief would best serve the public,” here now is the relevance to
this public interest determination. The Sherman Act “was enacted to assure customers the benefits of
price competition.” 63 But Amazon’s $9.99 price was not the result of price competition on the
merits, 64 but of Amazon’s illegal predatory pricing activity. As the Second Circuit has
acknowledged, selling below marginal cost is antithetical to consumer welfare 65 and is
presumptively illegal. Accordingly, the Defendants conduct could not, as a matter of law, have been
aimed to illegally raise prices, as the Complaint alleges—unless the objective were to raise prices
above Amazon’s marginal cost. 66
Accordingly, any alleged conduct that resulted in raising illegally-low prices up to the level
of Amazon’s marginal cost cannot be a violation of the Sherman Act, because the government
cannot prove any consumer harm. See, Northeastern at 87. As Areeda & Turner explain, selling

63

Associated Gen. Contractors of Cal., Inc. v. Carpenters, 459 U.S. 519, 538 (1983).
In fact, the government admits that Amazon was not reacting to its competition when it started selling e-books at
below marginal cost; on the contrary, its competitors were reacting to Amazon’s predatory pricing. As stated in §II.A
of the CIS, “From the time of its Kindle launch, Amazon offered a portion of its e-books catalog, primarily its newly
released and New York Times-bestselling e-books to consumers for $9.99. To compete with Amazon, other e-book
retailers often matched or at least approached Amazon’s $9.99-or-less prices for e-book versions of many new
releases and New York Times bestsellers.” (emphasis added). Thus, Amazon’s predatory pricing could not have been a
reasonable response to price competition or “competition on its merits,” because prior to the Kindle’s launch, the
competition was not charging below their marginal costs (which was virtually the same as Amazon’s). In fact, one of
Amazon’s existing competitors at the time of the Kindle launch, the Sony E-Book Store, was selling e-books at prices
above their marginal cost. As the government admits, Amazon’s competitors only began matching Amazon’s
predatory price after the Kindle launch “to compete with Amazon.” They not only had to reduce their prices to their
marginal cost—the cost at which consumer’s welfare is maximized—but to below marginal cost to respond to
Amazon’s illegal practice.
65
Northeastern, 651 F.2d at 87.
66
Not only is there no allegation of that, the Court can take judicial notice of the fact that no prices could have been
raised under the agency agreements to above Amazon’s marginal cost. For example, under the retail model, Amazon
bought a book for $13.00 and resold it for $9.99. Under the agency model, that publisher would sell the book for
either $12.99 or $14.99. Assuming a price of $14.99, Amazon’s marginal cost for the book would be the agency price
minus Amazon’s 30% commission. Thus, Amazon’s marginal cost under the agency model would be $10.49, or about
$1.50 lower than its marginal cost under the retail model (i.e., $12.00).
64

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below marginal cost leads to an improper allocation of resources and is inconsistent with
competition on the merits.
The monopolist is not only incurring private losses but wasting social resources when
marginal costs exceed the value of what is produced. And pricing below marginal cost
greatly increases the probability that rivalry will be extinguished or prevented for reasons
unrelated to the efficiency of the monopolist. Accordingly, a monopolist pricing below
marginal cost should be presumed to have engaged in a predatory or exclusionary practice.”
Areeda & Turner at 712. In accord, Northeastern, 651 F.2d at 87-88.
With such a presumption in hand, the DOJ should not be expecting from objectors evidence
of Amazon’s exclusionary threat (DOJ Response at 22), but disclosing to the Court facts that would
overcome the presumption of that threat. Since the government has alleged in the Complaint that it
has conducted an “investigation” into the facts of Amazon’s pricing practices, it is within the power
of the Court to the exercise its power under the Tunney Act “to take testimony of Government
officials or such other expert witnesses as the court may deem appropriate” or to authorize
“examination of witnesses or documentary materials” with respect to the result of the DOJ’s
investigation. As noted, the Complaint and CIS raise a presumption that Defendants’ conduct was a
legal countervailing pro-competitive response to Amazon’s predatory pricing. Accordingly, if the
DOJ does not provide transparency into the results of its “investigation,” then the reasonableness of
its conclusions cannot be sustained.
Because prices that are set below the seller’s marginal cost are presumptively harmful to
consumer welfare, the government has a heavy, if not impossible, burden to explain how any
conduct to raise those prices to the level of Amazon’s marginal cost could have resulted in harm to
consumers. Showing harm to consumers is fundamental to the factual foundation for the
government’s decisions. Without it, the government’s conclusions regarding the proposed settlement
are unreasonable. See, Keyspan at 637.

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B.

Impact of the Proposed Final Judgment Upon the Public Generally

This section of the brief summarizes the impact of the proposed judgment upon the several
constituents affected, including the public generally. (Because of space limitations, however,
subsections 1 and 2 of this Section B of the brief await the Court’s permission to be added). 67
While the public has a constitutionally recognized interest in the promotion of Writings, 68 it
does not have any interest, as the DOJ would have this Court believe, in “low prices.” This amicus
was gob-smacked to read the DOJ declare that, “Low prices, of course, are one of the principal goals
of the antitrust laws” (DOJ Response at 22) and that “low prices” are a “core ambition” of free
markets (DOJ Response at 21). Somehow, the government finds support for these propositions in
the following sentence written by Justice Brennan in Atlantic Richfield Co. v. USA Petroleum Co.,
495 U.S. 328, 340 (1990): “Low prices benefit consumers regardless of how those prices are set.”
Of course that was not where Justice Brennan ended his sentence: “Low prices benefit consumers
regardless of how those prices are set, and so long as they are above predatory levels, they do not
threaten competition.” Id. at 340.
The Antitrust Division seems to operating with a fundamental misunderstanding of both the
antitrust laws and the free markets. Low prices are not the core ambition of either the law or the
markets. Efficient prices are. As the Second Circuit has held, consumer welfare is not maximized by
“low” pricing, but by “marginal cost” pricing. Northeastern 651 F.2d at 87-88. Upon this
fundamentally flawed legal foundation, one should be hard pressed to find the reasonableness in the
government’s conclusion that the settlement is in the public interest.

67

These subsections are set forth in the Appendix in Memorandum to Support Kohn’s Amicus motion. The Appendix
addresses (1) the impact of the proposed Final Judgment, with respect to Amazon’s monopoly powers, (a) upon
consumers, (b) upon other e-book service providers, and (c) upon new entrants to the e-book service provider market,
and (2) the impact of the proposed Final Judgment with respect to Amazon’s monopsony powers upon (a) upon
Defendant Publishers, (b) upon independent book publishers, (c) upon published authors, and (d) upon self-published
authors.
68
U.S. Constitution, Article I, §8. Copyright Act, 17 U.S.C. §101 et.seq.

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IV.

CONCLUSION

Defendants’ conduct was a reasonable means to accomplish a worthy end, a market-based
solution aimed at correcting a serious market failure brought about by the predatory conduct of a
dominant e-book systems provider. While not a “perfect remedy,” it resulted in undeniably
countervailing pro-competitive effects, which even the DOJ has not once denied in its Response. 69
The Defendants actions were a measured response to the circumstances. In Broadcast Music,
the monopsony faced by the music publishers justified the maintenance of collection societies each
having annual cost of over $150 million dollars to administer their respective horizontal price fixing
regimes, fee collection, and distribution operations. By contrast, as the Complaint alleges, “the effect
of the Defendants’ action was to alter the business model governing the relationship between
publishers and retailers,” a one-time shifting of that relationship from a retail to an agency model,
requiring no administration society or pooling arrangement that would warrant rate hearings and the
like. The means to this worthy end—with allegations of meetings in private dining rooms—may not
look “pretty” to the unsophisticated, but they were no prettier than similar meetings held by the
founders of ASCAP nearly 100 years ago. See Comments of Kohn at 21-23. Yet, the U.S. Supreme
Court and the Second Circuit have long since recognized that ASCAP’s collusive conduct, while
constituting literal price fixing, is not illegal, because of its “countervailing pro-competitive virtues”
and “creation of efficiencies in the operations of a market.” Indiana Fed’n of Dentists, 476 U.S. at
459.
If the Defendants “literally” engaged in collusive activity, it was a one-time event necessary
to countervail a serious market failure. Should the Court send the DOJ back to the drawing board,

69

According to the general theory of second best, the public would be better off if the government did nothing under
these circumstances. See, R.G. Lipesy & Kevin Lancaster, The General Theory of Second Best, 24 REV. ECON. STUD.
11 (1956-57).(“The distorting effect of overconsumption could be made worse if, in cases of horizontal price fixing,
antitrust laws are used to decrease prices”). See also, Christopher R. Leshe, Achieving Efficiency Through Collusion:
A Market Failure Defense to Horizontal Price Fixing, 81 CALIFORNIA LAW REV. 243, 270.

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the path to settling this case with all Defendants is clear: A consent decree that enjoins any
potentially collusive communications among the Defendants in the future, with some appropriate
monitoring of information exchanges for a limited period. This remedy—which would not
“evaporate” the pro-competitive effects of Defendants’ conduct or institute an unnecessary
regulatory regime—may not be “perfect,” but it would appear to be one that is certainly “within
reaches of” the public interest.
But to punish the Defendant Publishers with a return to a market suffering from monopsony
and monopoly power by a dominant systems provider (not only their biggest customer, but now
their biggest competitor), simply because the publishers took the effective and limited steps
necessary to correct a market failure caused by Amazon’s below marginal cost pricing, would
constitute a tragic miscarriage of justice. The Court would only compound that injustice by entering
the proposed Final Judgment, approving with the same stroke of the pen an instrument of wrong to
consumers and the public generally. Because the proposed settlement would reverse the procompetitive effects of Defendants’ conduct—whether such conduct is ultimately held reasonable or
not—entry of the Final Judgment is not in the public interest.

Dated: August 13, 2012

Respectfully submitted,

/s/ Bob Kohn
______________________
BOB KOHN
(California Bar No. 100793)
140 E. 28th St.
New York, NY 10016
[phone]
[e-mail]

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