Justice Denise L. Cote, in her recent ruling on Apple's eBook price-fixing trial:
The agency model presented one significant problem. Apple wanted its iBookstore to be a rousing success. For that to happen, Apple needed not only content but also customers. Apple realized that if it moved to an agency model with the Publishers, Apple would be at a competitive disadvantage so long as Amazon remained on the wholesale model and could price New Releases and NYT Bestsellers at $9.99, or even lower to compete with Apple. Since it was inevitable that the Publishers wouldraise e-book prices when given the opportunity –- indeed, Apple expected the Publishers to raise the prices to the tier caps -- e-books priced at $9.99 by Amazon would doom the iBookstore. Why would a consumer buy an e-book in the iBookstore for $14.99 when it could download it from Amazon for $9.99? To ensure that the iBookstore would be competitive at higher prices, Apple concluded that it needed to eliminate all retail price competition. Thus, the final component of its agency model required the Publishers to move all of their e-tailers to agency. Apple expected that this proposal would appeal to the Publishers. After all, it would allow them to “fix” their “problem” with Amazon’s pricing. (p39,40)
Can I just come out an say what a load this whole thing is? Amazon was promoting and executing an unsustainable business model, not unlike what Google did with Reader.
Amazon sells it at below wholesale, as a “loss leader”—breaking even or losing money on the deal to promote sales of the Kindle and grow its share of the market. (Giving away the blades to sell the razor, as it were.)
Thus, if a hardcover book has a suggested retail price of $24.95, Amazon pays the publisher about $12.50 for the e-book version—and loses about $2.50 when it turns around and sells it for $9.99.
As Cote herself notes, Apple's iBookstore was doomed to be a failure if Amazon was going to continue undercutting any other competitor who planned to make a profit. That means only others who were willing to be so-called "loss-leaders" would have any hope of competing, which is why Amazon had ~90% of the ebook market in 2009. And this unsustainable model had a very real dark side lurking for either consumers or publishers, as Laura Miller writes:
Obviously, however deep its pockets, Amazon would not be able to go on selling e-books at a loss indefinitely. But once Amazon was cemented in place as the uncontested sovereign of e-book retail, it could do whatever it wanted: force publishers to reduce their own prices, and/or raise prices on consumers.
Apple wasn't willing to be a loss-leader, and they knew what the future was for publishers if Amazon went uncontested for long enough. So they told the publishers that they intended to take 30% and still sell their books equal to the lowest price available - that of Amazon. They pushed the publishers in that direction and made them aware of Amazon's most likely end-game (being forced to sell books for less, often much less, and take a severe cut in profits). Here Alex Hern is in agreement with Laura Miller:
[I]nvestors expect Amazon's profit to increase at some point in the future. But there's only two ways that could happen: either Amazon vastly increases its revenue, or it vastly increases its profit margin.
It sounds almost conspiratorial, but the only way the company can really do this – and its actions indicate that it knows it – is by becoming the only player in town. Amazon's success to date has been built around winning every price war going, but once it gains control of a field, then it wins that price war by default.
There's nothing inherent in the Agency model that prevents any of the publishers from going cheaper and trying to undercut their competition. Apple essentially ensured that retailers could sell books at a profit and made sure that the publishers didn't shoot the price (at least on the iBookstore) through the roof.
When it comes to companies like Amazon, there's just no accounting for Jeff Bezos' gleeful willingness to sell at a loss — a long-term strategy that they would have gotten away with if it weren't for those meddling kids!