Earlier this week Apple, along with five of the largest book publishers, was sued by the United States Department of Justice and accused of colluding to jointly raise the retail price of ebooks sold through the iBookstore iOS application.

While three of the accused publishers immediately agreed to proposed settlements, Penguin Group and Macmillian have sided with Apple and are prepared to argue that the pricing of their ebooks "enhanced competition in the ebook industry."

iPad and Kindle
Credit: DigitalTrends

The Department of Justice (DoJ) believes that Apple colluded with publishers to raise the retail price of ebooks from $9.99 (£6.30) - which was the going rate charged by market-leader Amazon - to either $12.99, $14.99, or $16.99.

By allegedly attending private meetings in an upmarket New York restaurant, Apple is believed to have been hoping that all publishers would agree to its pricing, forcing customers to pay more. To understand just what is alleged here, we need to look at how things worked prior to this alleged collusion.

How did ebook retail work before?

Since Amazon launched its first Kindle ebook reader in November 2007 the ebook market has seen significant growth, and to ride this wave of growth Amazon took the aggressive strategy of pricing newly released and bestselling books at $9.99 - substantially less than the printed equivalent.

According to the DoJ, Apple and the publishers "saw the rise in ebooks, and particularly Amazon's price discounting, as a substantial challenge to their traditional business model."

They also "feared that lower retail prices for ebooks might lead eventually to lower wholesale prices for ebooks, lower prices for print books, or other consequences the publishers hoped to avoid."

The $9.99 price point was becoming the norm and publishers began to worry that customers might get so used to this low price that any increase would result in decreased sales.

It was then that the publishers realised that individually they could not force Amazon to increase its prices - thus earning publishers more money - and so they turned to Apple, which was preparing to launch the first iPad and considering whether it would sell ebooks to read on it.

The DoJ claims that "Apple had long believed it would be able to 'trounce Amazon by opening [its] own ebook store,' but the intense price competition that prevailed among ebook retailers in late 2009 had driven the retail price of popular ebooks to $9.99 and had reduced retailer margins on books to levels that Apple found unattractive."

What did Apple and the publishers do about it?

Apple soon learned that it was in the same boat as the publishers with wanting Amazon to increase its prices and move away from the industry norm of $9.99. Apple and the publishers reached an agreement whereby retail price competition (pricing lower than the competitors) would cease, retail ebook prices would increase significantly and Apple would be guaranteed a 30 percent commission on each ebook it sold.

The DoJ claims: "Apple and the Publisher Defendants jointly agree to alter the business model governing the relationship between publishers and retailers." Put simply, this is colluding to price fix as several companies in the same sector are alleged to have worked together to keep their prices the same, giving customers no choice but to pay more.

Replacing wholesale model with an agency model.

Previously the wholesale model gave Amazon - or any other retailer - the right to charge whatever it liked for ebooks, but the publishers moved to an agency model, where they could price ebooks for any price they wanted. Apple had no control over the retail price, and instead took a 30 percent cut from ebooks sold.

Apple employs a similar model for its App Store, which sees developers sell applications at a wide range of prices from free to $999.99.

Letting the publishers set their own prices meant that they could all charge more than Amazon, forcing customers to pay the inflated price. Further underlining the accusations of colluding, the DoJ said: "This change in business model would not have occurred without the conspiracy among the Defendants."

Continuing: "Apple clearly understood that its participation in this scheme would result in higher prices to consumers. As Apple CEO Steve Jobs described his company's strategy for negotiating with the Publisher Defendants, 'We'll go to [an] agency model, where you set the price, and we get out 30 percent, and yes, the customer pays a little more, but that's what you want anyway'."

Prices then went up

Under Apple's agency model the price of an ebook was set according to the hardcover list price ranging from $12.99, through $14.99, to $16.99.

After seeing positive results from the so-called Apple Agency Agreements, the publisher are then accused of imposing the same agency agreement on all their other retailers. "As a direct result," the DoJ said, "those retailers lost their ability to compete on price, including their ability to sell the most popular ebooks for $9.99 or for other low prices."

What does this lawsuit mean for the future?

The DoJ states that the lawsuit has been brought about to stop the publishers and Apple from "further violations of the nation's antitrust laws and to restore the competition that has been lost due to the Publisher Defendats' and Apple's illegal acts."

It is hoped that the lawsuit will encourage the courts to declare Apple and the publishers' behaviour illegal and to bring into effect an injunction to stop this practice happening again.

Apple has stated that the DoJ's allegations are "simply not true", while Amazon said, in a statement to website Mashable, "[The settlement of three publishers] is a big win for Kindle owners. We look forward to being allowed to lower prices on more Kindle books."

While Apple, Penguin and Macmillan are yet to settle, it seems that Amazon is confident that they will and it will then aim to bring the average price back down to that $9.99 point.