by Brad Stone
Like some other chain stores, Target, the second-largest retailer in the United States, survived the downturn with layoffs at its Minneapolis headquarters and by closing one of its distribution centers.8 Target had outsourced its online operations to Amazon in 2001 but the relationship was far from perfect, with joint projects frequently falling behind schedule. “We had no resources to build infrastructure for Target,” says Faisal Masud, who worked on the Target business at Amazon. “It was all about Amazon first and Target next.”
But in 2006, Target came to the realization that it did not have the in-house capabilities to develop its own website, and, incredibly, it renewed its agreement with Amazon for another five years. After the new deal was signed, Jeff Bezos returned to Minneapolis to meet with Target executives Robert Ulrich and Gerald Storch and to give a presentation that was open to any Target employee who wanted to attend. Dale Nitschke, the executive running Target.com at the time, recalls that to fill the auditorium, he had to personally implore employees to attend. “These guys are going to be world-class competitors, you have to keep tracking them,” he told colleagues.
Target knew it had to master its own Web presence and wean itself away from a dangerous dependence on a competitor. In 2009, it belatedly announced it was leaving Amazon, and it finally ended the relationship when the contract expired two years later. It was a rocky breakup. The retailer’s new website, built and managed with the help of IBM and Oracle, went down a half a dozen times during the 2011 holiday season, and the president of its online division resigned.
No one had more to lose from Amazon’s ascendance than the folks in Bentonville, Arkansas. Despite years of being beaten by Amazon in the realm of e-commerce, Walmart had smartly resisted the temptation to outsource its website, and yet its Internet operation, established in 1999 in Brisbane, north of Silicon Valley, made little progress cutting into Amazon’s lead. After the recession, Walmart too began to view the Internet with renewed urgency.
In September of 2009, I wrote a lengthy story for the New York Times entitled “Can Amazon Be the Wal-Mart of the Web?”9 The headline apparently hit a nerve in Bentonville. A few weeks after it appeared, Raul Vazquez, then the chief executive of Walmart.com, told the Wall Street Journal, “If there is going to be a ‘Wal-Mart of the Web,’ it is going to be Walmart.com. Our goal is to be the biggest and most visited retail website.”10 In the e-commerce equivalent of a preemptive military strike, Walmart then lowered prices on ten new books by high-profile authors, such as Stephen King and Dean Koontz, to ten dollars each. Amazon matched the price on those same books within a few hours. Walmart.com then lowered its prices again, to nine dollars, and Amazon matched it again. It was just the kind of price pressure from Walmart that Amazon executives had always worried about—but it came ten years too late to do Amazon any harm. Now Amazon was large enough that it could easily withstand such losses.
Over the next month, the tit-for-tat price war spread like a brushfire. Target joined the fracas, and all three companies cut prices on DVDs, video-game consoles, mobile phones, and even the humble Easy-Bake Oven, a forty-five-year-old toy from Hasbro known for heating up small cakes, not tensions between billion-dollar corporations.11 With all three retailers now offering steep discounts on a range of hardcover books, the American Booksellers Association, a trade group of independent bookstores, wrote the U.S. Department of Justice to complain that “the entire book industry is in danger of becoming collateral damage” in a war among giants.12
They hadn’t seen anything yet.
* * *
In February 2009, Amazon took over a basement auditorium in New York’s Morgan Library and Museum to prepare for the announcement of the Kindle 2. The sequel to Fiona, the Kindle 2 (code-named Turing, after a castle in The Diamond Age) sported a thinner profile, a simpler and more intuitive layout, and none of the design excesses of the first device. Amazon had fixed its chronic manufacturing problems, but the company had yet to master the art of the product launch. In tension-filled rehearsals the night before the event, Bezos tore into his communications staff over a number of miscalculations, including the fact that the large screen behind the podium obscured his slides. “I don’t know if you guys don’t have high standards or if you just don’t know what you’re doing,” he said, sighing heavily.
If the original Kindle transformed Amazon and repositioned it for a digital future, then the Kindle 2 could fairly be considered the device that revolutionized the publishing business and changed the way people around the world read books. With instant brand recognition and broad availability, the new Kindle was coveted by customers and finally fulfilled Bezos’s vision of a mainstream electronic reader at an affordable price. With the Nook and the iPad yet to be introduced, Amazon had a commanding 90 percent of the digital reading market in the United States.13
For the big book publishers, Amazon’s dawning monopoly in e-books was terrifying. As suppliers had learned over the past decade, no matter the category, Amazon wielded its market power neither lightly nor gracefully, employing every bit of leverage to improve its own margins and pass along savings to its customers. If the company didn’t get what it wanted, the reaction could be severe. When the Kindle 2 became available, Amazon UK was no longer selling some of the most popular books of French publishing giant Hachette Livre, part of a protracted and bitter dispute over the terms of the Amazon/Hachette relationship. Customers could buy these Hachette books only from third-party sellers on the Amazon website.14
Publishers remained particularly troubled by Amazon’s $9.99 price for new releases and bestsellers. They were living the nightmarish reality of every manufacturer—this was the reason that, for example, Nike refused to supply shoes to Endless.com. Amazon, the publishing executives felt, was consigning their in-season products (new books, rather than shoes) to the bargain bin immediately upon their release. The lower price arguably reflected the decreased costs of printing and distributing digital books. But it neglected the new costs publishers faced in making the digital transition and also put enormous pressure on other retailers, particularly independent bookstores, and helped Amazon consolidate its control of the market. Publishers considered several ways to extricate themselves from this mess. In the early fall of 2009, two publishers, HarperCollins and Hachette, experimented with windowing select e-books—that is, delaying e-books’ release until the hardcover versions had been out for a few months. But consumers reacted badly and gave these titles withering reviews on Amazon.
There was another reason for publishers’ mounting anxieties at the time. That year Amazon introduced Encore, a program that allowed authors to publish their new or out-of-print books in the Kindle store and reap 70 percent of the sales. The service was widely interpreted as Amazon’s first step into direct publishing; for the moment, it was just unknown writers, but perhaps, one day, it would be giants like Stephen King.
Similar efforts from other retailers had worried book publishers in the past. Barnes & Noble had once had its own publishing program too. But Amazon alone had the tools to cut the major houses entirely out of the bookselling process: a dominant position in e-books, via the successful Kindle, and an on-demand publishing unit called CreateSpace that could print a physical book when a customer ordered it on Amazon.com. Amazon seemed to be cultivating its relationships with agents and authors, and the company hired a former Random House executive named David Naggar to join the Kindle team. It all seemed to point toward Jeff Bezos’s outsize ambition to control every square on the publishing-industry chessboard. “Amazon is in a great place to carry out their program to almost any conceivable scale,” blogged Eoin Purcell, a Dublin-based book editor, after the introduction of Encore. “Aside from what the author and their agents can grab, Amazon with Encore has successfully placed itself in control of the entire value chain.”15
Publishers believed their necks were being fitted for the noose. This view, widely discussed in publishing circles at the time, accounts for what happened next: a sprawlin
g, dramatic, multiyear imbroglio that would be laid bare in the thousands of pages of legal documents and weeks of courtroom testimony resulting from antitrust actions brought against the book publishers by the European Union and the U.S. Department of Justice.
Over the course of 2009, the chiefs of the six major U.S. publishing houses—Penguin, Hachette, Macmillan, HarperCollins, Random House, and Simon and Schuster—gathered, allegedly to discuss their shared predicament. They communicated over the telephone, via e-mail, and in the private dining rooms of upscale New York City restaurants, and the DOJ later claimed that they took steps to avoid leaving evidence of these discussions, which might be construed as collusion. Publishing executives say the meetings were not held for the purpose of talking about Amazon and that they involved other business issues. But the U.S. government believed the executives were specifically addressing Amazon and its deleterious e-book pricing strategy, or, as the publishers termed it (per the court documents), “the $9.99 problem.”
According to the Justice Department’s filings, the publishing executives believed the only way to alter the balance of power with Amazon was for their industry to act, wielding the leverage that came from producing what amounted to 60 percent of the books Amazon sold. Court documents show that they considered a variety of options, including launching their own joint e-book venture. Then, in the fall of 2009, a white knight appeared in the form of Apple and its cancer-stricken leader, Steve Jobs.
Jobs had his own reasons to combat Amazon. He knew firsthand that Amazon could use its dominance in e-books to transition into other kinds of digital media—Jobs himself had used the iTunes monopoly in digital music to expand into podcasts, television shows, and movies. At the time Apple began reaching out to publishers, Jobs was preparing for the introduction of what would be his final masterstroke: the iPad. For Apple’s precious new invention, he wanted every kind of media available—including books.
The publishing executives negotiated that fall with iTunes chief Eddy Cue and a deputy, Keith Moerer (ironically, a former employee of Amazon), and the resulting arrangements with Apple would solve the publishers’ $9.99 problem, relieve some of the pressure on physical bookstores, and allow Apple to enter the e-reading space without having to match Amazon’s subsidized pricing on bestsellers and new releases. In the new e-book model, publishers themselves would officially become the retailers and could set their own prices, typically in the more comfortable (for them) zone of between thirteen and fifteen dollars. Apple would act as the broker and receive a 30 percent commission, the same arrangement it had for mobile applications on the iPhone. As part of this shift to what was known as the agency model, Apple received a guarantee that other retailers would not undercut it on e-book prices. According to the DOJ, that meant publishers would have to force Amazon to adopt the same model. In his internal e-mails and to his biographer Walter Isaacson, Jobs proudly referred to this as an aikido move.
The CEOs of the publishing houses all said that, independently, each of them considered the costs of Amazon’s dominance as well as what was known of the ruthlessness of its corporate character, and then decided to move to the agency model. It was not a painless choice. By giving retailers a 30 percent commission, the publishers would actually make less money per e-book than they would if they stuck to the traditional wholesale model, in which they generally collected half of the list price. “Although agency was more costly in the short term, the strategic advantages were so compelling that we felt—independently—that this was the right way to go,” one publishing chief told me.
There was one holdout: Markus Dohle, chief executive of Random House, worried that the economics of agency pricing were unfavorable and that he would be better off maintaining the status quo. Random House, alone among the six major publishers, decided to stick with the traditional wholesale model for the time being, so Apple declined to sell Random House’s books in its newly christened iBookstore.
Apple introduced the iPad on January 27, 2010, at the Yerba Buena Center for the Arts in San Francisco. It was one of Jobs’s last public performances and a spellbinding swan song from an iconic entrepreneur—someone Jeff Bezos clearly admired and viewed as a primary rival. After the event, Wall Street Journal columnist Walter Mossberg asked Jobs why anyone would buy e-books from Apple when Amazon sold them at a lower price. “The prices will be the same,” Jobs said, carelessly raising a giant red flag for antitrust regulators by suggesting that the companies had all acted in concert. “Publishers are actually withholding their books from Amazon because they’re not happy.”16
While other publishers informed Amazon of their new arrangements via e-mail or phone calls, Macmillan CEO John Sargent flew to Seattle to personally deliver the news of his company’s shift to an agency pricing model. In a tense twenty-minute meeting with Kindle executives that included Laura Porco, Russ Grandinetti, and David Nagar, Sargent offered Amazon the right to stick with the old terms and wholesale pricing, but at the cost of getting e-books several months after their publication. That clearly did not go over well. Amazon reacted to the agency move with overwhelming force, pulling the Buy buttons from Macmillan’s physical and electronic books on the website. Customers could still buy Macmillan’s print books on Amazon, but only from third-party sellers. The Kindle editions completely disappeared and remained unavailable for an entire weekend that January. For those unaware of the tense history between Amazon and publishers—the tortured “cheetah and gazelle” negotiations and so on—the sudden outbreak of hostility seemed shocking. “I think everyone thought they were witnessing a knife fight,” Sloan Harris, codirector of the literary department at International Creative Management, said at the time. “And it looks like we’ve gone to the nukes.”17
A few days later, under a barrage of criticism for making authors and customers collateral damage in the fight, Amazon relented. Bezos and his Kindle team collaborated on a public message, which they posted on an Amazon online forum: “We have expressed our strong disagreement and the seriousness of our disagreement by temporarily ceasing the sale of all Macmillan titles. We want you to know that ultimately, however, we will have to capitulate and accept Macmillan’s terms because Macmillan has a monopoly over their own titles, and we will want to offer them to you even at prices we believe are needlessly high for e-books.… Kindle is a business for Amazon, and it is also a mission. We never expected it to be easy!”
Ironically, the shift to the agency model made the Kindle business more profitable, since Amazon was forced to charge more for e-books, and Amazon held a near monopoly on e-book sales. That helped Amazon sustain the gradual decrease in the price of the Kindle hardware. Less than two years later, the cheapest Kindle e-reader would cost seventy-nine dollars.
But Amazon wasn’t sitting back or letting others dictate their own terms. Over the next year, Amazon responded forcefully in several ways. Russ Grandinetti, who had moved over to Kindle from apparel, and David Naggar, the new hire from Random House, made the rounds of midsize publishers like Houghton Mifflin. According to several executives at those firms, they were warned that they did not have the leverage to move to an agency pricing model and that Amazon would stop selling their books if they did. Amazon also intensified its focus on its own direct-publishing business, which would cause another wave of distress for publishers in the years ahead.
In trying to loosen Amazon’s grip on the e-book market, the publishers and Apple created a significant new problem for themselves. A day after the standoff with Macmillan, according to court documents, Amazon sent a white paper to the Federal Trade Commission and the U.S. Department of Justice laying out the chain of events and its suspicion that the publishers and Apple were engaged in an illegal conspiracy to fix e-book prices.
Many publishing executives suspect that Amazon played a major role in provoking the legal brouhaha that resulted. But antitrust investigators likely didn’t need much nudging. Incredibly, even though Steve Jobs passed away in the fall of 2011, his earlier comment
s dug the legal hole deeper for Apple and the five agency publishers. In the biography Steve Jobs, Walter Isaacson quoted Jobs as saying, “Amazon screwed it up… Before Apple even got on the scene, some booksellers were starting to withhold books from Amazon. So 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.’ ”
Jobs’s patronizing statement was potentially incriminating. If publishers had engaged in a joint effort to make customers pay “a little more,” that was the foundation on which antitrust cases were built. The Justice Department sued Apple and the five publishers on April 11, 2012, accusing them of illegally conspiring to raise e-book prices. All the publishers eventually settled without admitting liability while Apple alone held out, claiming that it had done nothing wrong and that its intent was only to expand the market for digital books.
The case against Apple was heard the following June in a Manhattan courtroom and lasted for seventeen days. District judge Denise Cote then found Apple liable, ruling that it had conspired with the book publishers to eliminate price competition and raise e-book prices and had therefore violated Section 1 of the Sherman Antitrust Act. Apple vowed to appeal the verdict. A hearing on damages was pending at the time this book went to press.
The e-book battle played out publicly in both the courtroom and the marketplace. But despite the case’s visibility in the media, it was a sideshow to the larger rise of Amazon at the time, an ascent interrupted by the great recession that resumed with renewed vigor afterward.
Beginning in 2009, as the fog of the economic crisis lifted, Amazon’s quarterly growth rate returned to its pre-recession levels, and over the next two years, the stock climbed 236 percent. The world was broadly recognizing Amazon’s potential—the power of Prime and of Amazon’s mighty fulfillment network, the promise of AWS, and the steady gains seen in Asia and Europe. In part because of the e-book pricing war, investors began to understand that the Kindle could grab an outsize share of the book business and that the device had the potential to do to bookstores what iTunes had done to record shops. Analysts en masse upgraded their ratings on Amazon’s stock, and mutual fund managers added the company to their portfolios. For the first time, Amazon was spoken in the same breath as Google and Apple—not as an afterthought, but as an equal. It had blasted off into high orbit.