U.S. Warns Apple, Publishers

The Justice Department has warned Apple Inc. and five of the biggest U.S. publishers that it plans to sue them for allegedly colluding to raise the price of electronic books, according to people familiar with the matter.

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Apple CEO Tim Cook speaks during Wednesday's iPad product launch. Getty Images

Several of the parties have held talks to settle the antitrust case and head off a potentially damaging court battle, these people said. If successful, such a settlement could have wide-ranging repercussions for the industry, potentially leading to cheaper e-books for consumers. However, not every publisher is in settlement discussions.

The five publishers facing a potential suit are CBS Corp.'s Simon & Schuster Inc.; Lagardere SCA's Hachette Book Group; Pearson PLC's Penguin Group (USA); Macmillan, a unit of Verlagsgruppe Georg von Holtzbrinck GmbH; and HarperCollins Publishers Inc., a unit of News Corp., which also owns The Wall Street Journal.

Spokespeople for the five publishers and the Justice Department declined to comment. Apple, which introduced a new version of its iPad tablet Wednesday, declined to comment.

The case centers on Apple's move to change the way that publishers charged for e-books as it prepared to introduce its first iPad in early 2010. Traditionally, publishers sold books to retailers for roughly half of the recommended cover price. Under that "wholesale model," booksellers were then free to offer those books to customers for less than the cover price if they wished. Most physical books are sold using this model.

To build its early lead in e-books, Amazon Inc. sold many new best sellers at $9.99 to encourage consumers to buy its Kindle electronic readers. But publishers deeply disliked the strategy, fearing consumers would grow accustomed to inexpensive e-books and limit publishers' ability to sell pricier titles.

Publishers also worried that retailers such as Barnes & Noble Inc. would be unable to compete with Amazon's steep discounting, leaving just one big buyer able to dictate prices in the industry. In essence, they feared suffering the same fate as record companies at Apple's hands, when the computer maker's iTunes service became the dominant player by selling songs for 99 cents.

As Apple prepared to introduce its first iPad, the late Steve Jobs, then its chief executive, suggested moving to an "agency model," under which the publishers would set the price of the book and Apple would take a 30% cut. Apple also stipulated that publishers couldn't let rival retailers sell the same book at a lower price.

"We told the publishers, 'We'll go to the agency model, where you set the price, and we get our 30%, and yes, the customer pays a little more, but that's what you want anyway,'" Mr. Jobs was quoted as saying by his biographer, Walter Isaacson.

The publishers were then able to impose the same model across the industry, Mr. Jobs told Mr. Isaacson. "They went to Amazon and said, 'You're going to sign an agency contract or we're not going to give you the books,' " Mr. Jobs said.

The Justice Department believes that Apple and the publishers acted in concert to raise prices across the industry, and is prepared to sue them for violating federal antitrust laws, the people familiar with the matter said.

The publishers have denied acting jointly to raise prices. They have told investigators that the shift to agency pricing enhanced competition in the industry by allowing more electronic booksellers to thrive.

William Lynch, chief executive of Barnes & Noble, gave a deposition to the Justice Department in which he testified that abandoning the agency pricing model would effectively result in a single player gaining even more market share than it has today, according to people familiar with the testimony. A spokeswoman for Barnes & Noble declined to comment.

Prior to agency pricing, Amazon often sold best-selling digital books for less than it paid for them, a marketing stance that some publishers worried would make the emerging digital-books marketplace less appealing for other potential retailers. The publishers' argument that agency pricing increased competition hasn't persuaded the Justice Department, a person familiar with the matter said. Government lawyers have questioned how competition could have increased when prices went up. Amazon declined to comment.

It isn't clear if the talks will lead to a settlement or how many of the parties would sign on. One publishing executive familiar with the situation said that the talks have been going on for some time and "negotiations have taken many turns."

A second publishing executive said that "a settlement is being considered for pragmatic reasons but by no means are we close." This person said that there are significant legal costs associated with the probe. "You have to consider a settlement, whether you think it's fair or not," the person said.

Contracts such as Apple's prevent publishers from selling books to other buyers at a cheaper rate. Such terms, known as "most favored nation" clauses, have drawn the scrutiny of the Justice Department in recent years in the health-care industry because they can sometimes be used to hamper competition.

One idea floated by publishers to settle the case is to preserve the agency model but allow some discounts by booksellers, according to the people familiar with the matter.

Among the issues that the Justice Department has examined is the effort by three publishers involved in the probe to "window" e-books in late 2009, according to people familiar with the matter. That December, Simon & Schuster, HarperCollins and Hachette said they would delay the electronic publication of a certain number of titles for a limited time after the publication of the hardcover edition.

At the time, the publishers expressed concern that $9.99 digital best sellers represented a long-term threat to the future of the publishing business. The windowing efforts, however, gradually faded away.

The European Union has said it is also investigating the allegations. Several class-action lawsuits have been filed and consolidated in a New York federal court. Apple moved to dismiss the case this month, arguing it didn't coordinate with any publishers. "Apple's entry created new competition in eBook distribution and a vastly larger pool of eBook consumers," it wrote in its motion.

For publishers, digital-book revenue is still the fastest-growing segment of the business at a time when the sale of physical books is in decline. E-book sales more than doubled to $970 million in 2011, according to a survey of 77 publishers conducted by the Association of American Publishers. As more consumers migrate to dedicated e-readers and tablet reading devices, the number of consumers reading digitally will likely increase.

At the same time, there are fewer bookstores in which to sell physical books, highlighted by the liquidation last year of Borders Group Inc., once the country's second-largest book chain. In addition, the nation's largest bookstore chain, Barnes & Noble, has increasingly dedicated more of its space to nonbook-related items such as its popular line of educational toys and games.

It isn't the first time the Justice Department has taken action against Apple for allegedly colluding with other companies. In 2010, several technology companies agreed to settle Justice Department allegations that they colluded to hold down wages by improperly agreeing not to poach each other's employees.

The evidence that surfaced in that case, as well as an ongoing private class-action lawsuit that followed, showed Mr. Jobs as a prime mover behind that antipoaching agreement. Apple didn't admit to any wrongdoing.

Write to Thomas Catan at thomas.catan@wsj.com and Jeffrey A. Trachtenberg at jeffrey.trachtenberg@wsj.com