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Apple Inc. (AAPL) wanted to build an electronic book business to challenge Amazon.com Inc. (AMZN) and enhance the appeal of its iPad device, but the cost now seems high.
The Justice Department on Wednesday filed suit against Apple and five book publishers, alleging they violated antitrust rules by conspiring to raise e-book prices.
It's a case that can be traced to Apple's increasing rivalry with Amazon. The Seattle-based online retailer competes with the Cupertino, Calif., gadget giant in a number of ways: they both sell music, movies and, now, books. And Amazon has regularly undercut Apple's prices, even if by a few pennies.
That competition has expanded as Amazon has grown to include selling devices, such as the Kindle e-book reader. Last year, Amazon released the $199 Kindle Fire tablet as a lower-priced rival to the iPad, which starts at $499.
"Amazon really owns the entire value chain for publishing," ranging from devices to its own publishing imprints, said Allen Weiner, an analyst at Gartner Inc. (IT). "Apple does not have a comparable business."
The Justice Department suit alleges that Apple and CBS Corp.'s (CBS) Simon & Schuster, News Corp.'s (NWS) HarperCollins, Lagardere S.C.A.'s (MMB.FR) Hachette, Pearson PLC's (PSO) Penguin Group and Macmillan, a unit of Verlagsgruppe Georg von Holtzbrinck GmbH, had signed agreements to sell books with set prices, rather than allowing retailers such as Amazon the freedom to offer sharp discounts.
News Corp. owns Dow Jones & Co., publisher of this newswire, and The Wall Street Journal.
The suit alleges Apple got publishers to agree on its pricing scheme by offering to break Amazon's typical e-book prices of $9.99, enabling them to see more revenue per title. Apple's model included a 30% cut on all sales through its App Store and its e-book store.
But Apple's agreements allegedly also included rules that e-books would not be sold elsewhere for lower prices than in its store. "Apple realized that, as a result of the scheme, 'the customer' would "pay a little more,'" the Justice Department's suit said.
Apple declined to comment.
"It's pretty clear Apple didn't want to compete on price," said Steve Berman, a lawyer at Hagens Berman LLP, which is heading up a class action suit against Apple and book publishers in the U.S. District Court in the Southern District of New York. He added that book makers had an incentive to join Apple's alleged scheme.
"None of them were happy with Amazon's cost-cutting method of doing business," he said.
For its part, pricing has been key to Amazon's broader strategy of delivering relatively-low-cost entertainment across its own devices.
In the book market, Amazon's size allowed it undersell traditional sellers, under a wholesale pricing scheme that enables retailers to pay publishers about half of a book's cover price while setting discounts on the remainder. Amazon's advantages were compounded in the many states where Amazon has also not been required to collect sales tax.
That helped fuel the dramatic growth at Amazon, which saw annual revenue more than double to $34.2 billion in 2010, the year in which Apple allegedly struck a pricing deal with publishers, from $14.8 billion in 2007, when it had released the Kindle and started offering a wide selection of e-books.
Apple's alleged price-fixing agreement upended Amazon's model, and forced it to start raising e-book prices by about three to five dollars.
In early 2010, following discussions with Macmillan over the publisher's switch to a new model that would raise prices, Amazon advised its customers that despite its protests to Macmillan, "we will have to capitulate."
Last month, as reports of the possible legal action against Apple and publishers related to e-book pricing surfaced, a commenter in an Amazon Kindle forum wrote, "It's nice to finally know why the Kindle prices went up," adding, "As much as I love Apple products, I plan on boycotting them now."
An Amazon spokesman said in a statement Wednesday, "This is a big win for Kindle owners, and we look forward to being allowed to lower prices on more Kindle books."
--Jessica E. Vascellaro contributed to this report.