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By Diane Bartz
Fri Mar 30, 2012 4:26pm EDT
WASHINGTON (Reuters) - The Justice Department could reach a settlement in the next few weeks with Apple Inc (AAPL.O) and some of the major publishers suspected of colluding to push up electronic book prices, according to two people close to the negotiations.
While negotiations are still fluid, the settlement is expected to eliminate Apple's so-called "most favored nation" status, which had prevented the publishers from selling lower-priced e-books through rival retailers such as Amazon.com Inc (AMZN.O) or Barnes & Noble Inc (BKS.N), the people said.
The deal could also force a shift, at least temporarily, in pricing control from publishers to retailers, one of the people said.
Such a move to a "wholesale model" would not only benefit consumers but also Amazon, which had been the leading bargain e-book retailer with its Kindle reader.
"It would be a positive for Amazon because the company's greatest strength is as a high-volume, low-price retailer and the wholesale model plays into that," said Jim Friedland, an analyst at Cowen & Co.
The Justice Department is seeking to unravel agreements Apple secured from five publishers about two years ago, as the Silicon Valley company was launching its iPad and was seeking to break up Amazon's dominance in the digital book market.
The publishers are Simon & Schuster Inc, a unit of CBS Corp (CBS.N); Lagardere SCA's (LAGA.PA) Hachette Book Group; Pearson Plc's (PSON.L) Penguin Group (USA); Macmillan, a unit of Verlagsgruppe Georg von Holtzbrinck GmbH; and HarperCollins Publishers Inc, a unit of News Corp (NWSA.O).
The Justice Department declined comment. Apple did not reply to calls seeking comment. The publishers involved either did not return telephone calls or declined comment.
As part of the agreements with Apple, the publishers shifted to an "agency model" that allowed them to set the price of e-books and give Apple a 30 percent cut.
Prior to that, Amazon had operated on the wholesale model, in which publishers sold books to retailers, which were then free to set whatever price they wanted.
Amazon was able to charge only $9.99 for many e-books, sometimes pricing new releases or popular e-books below cost, to draw in shoppers.
The tactic worried publishers who felt readers might get used to cheaper books and that Amazon would gain more market power, putting downward pressure on sales and prices of physical books.
The Apple agreements effectively barred publishers from allowing rival retailers such as Amazon to sell the same e-books at lower prices.
Friedland estimated that a switch back to the wholesale model could increase Amazon's revenues by about $1.1 billion this year and $1.6 billion in 2013, although gross profit may not increase as much because of the expected discounts.
The impact on Apple is expected to be minimal. Apple generates about $50 million from e-book sales, a tiny portion of its revenue of more than $100 billion.
The Justice Department and the European Commission are examining whether the way that Apple reached its agreements with the publishers rose to the level of violations of antitrust law.
While agency pricing itself is legal, the Justice Department believes that publishers may have colluded to implement it with e-book retailers.
Apple's push for agency pricing was detailed in Walter Isaacson's biography of Apple founder Steve Jobs, who died last October. Jobs was aware of publishers' frustration with Amazon's low-price strategy and took advantage of it, according to the book.
Isaacson quotes Jobs as saying: "So we told the publishers, 'We'll go to the agency model, where you set the price, and we get our 30 percent and yes, the customer pays a little more but that's what you want anyway.' ... So they went to Amazon and said, 'You're going to sign an agency contract or we're not going to give you the books.'"
When Apple entered the digital books market with its iPad in January 2010, Amazon had nearly 90 percent of the e-book market.
Amazon now has about 65 percent of the e-book market, while Barnes & Noble has 20 percent and Apple has 10 percent at most, according to Cowen & Co estimates.
As the market shifted, prices have risen.
A class action lawsuit against Apple and the publishers that was brought last year in a Manhattan court on behalf of e-book customers said the price of e-books sold by the five publishers rose 30 to 50 percent in just a few months after Apple reached its deals.
Despite the higher prices, the digital book market has continued to grow rapidly.
The e-book industry has grown from $78 million in sales in 2008 to $1.7 billion in 2011, according to Albert Greco, a book-industry expert at the business school of Fordham University.
Greco estimates e-book sales will be $3.55 billion in 2012.
In its request to dismiss the private lawsuit, Apple said it individually negotiated separate vertical agreements with each of the publishers and it insisted on agency pricing because it had "no desire to incur the losses that would flow from retailing in such an environment."
Andrew Gavil, who teaches antitrust at the Howard University School of Law, said the consumer would win under a Justice Department settlement that rips up the agency model, even temporarily.
"The consumer will be the short-term winner because the autonomy to set the price of e-books will go back to Amazon. Manufacturers may have to lower the price of hard cover books. They may have to adjust their expectations of profits of hard copy books," said Gavil.
(Reporting by Diane Bartz with Additional reporting by Alistair Barr in San Francisco; Editing by Gary Hill)
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