Justice for the .001%
Justice for the .001%
Inside the DOJ's lawsuit against the Penguin Random House deal
Welcome to the 123nd edition of SHuSH, the weekly newsletter of Sutherland House Books. If you’re new here, hit the button—it’s free:
Last week we wrote about how the book world, reliably loose with the slur of fascist, dealt with the real article when it showed up at the Frankfurt Book Fair. Anna Porter writes to say this wasn’t its first appearance:
At many of the thirty-odd Frankfurt Book Fairs I have attended, I thought some of the ghosts of the fascist past were still walking the halls (Halle). One evening a few friends and I had dinner in a cellar (Keller) restaurant and after midnight, the music changed to rousing Nazi songs.
We have a new edition to our newsletter roll this week: Esoterica Magazine, which in its latest issue offers a Halloween-inspired short story about a tarot card reader who could see everyone's future but her own. Welcome to the family, Esoterica!
On Tuesday, the US Justice Department (DOJ) filed suit to block Penguin Random House from purchasing its rival, Simon & Schuster, for $2.18 billion. It promises to be a fascinating case, in part because there’s so much at stake for the two firms involved, and also because of the unusual angle from which the DOJ is attacking the file.
As one of two US agencies responsible for enforcing antitrust law (the other is the Federal Trade Commission), the DOJ believes the proposed deal, struck last year, would leave Penguin Random House, already the world’s largest publisher of consumer books, "towering over its rivals.” The combined entity would have revenues more than twice its next closest competitor, and “outsized influence over who and what is published, and how much authors are paid for their work.”
Bertelsmann, owner of Penguin Random House, and Viacom, owner of Simon & Schuster, promise to fight the DOJ in court. They acknowledge that the Big Five Publishers, a grouping that also includes Hachette, HarperCollins, and Macmillan, will be a Big Four after the merger, but maintain that these firms plus new publishing entrants, such as Amazon, and an abundance of small and midsize publishers will provide sufficient competition for authors and books. “The publishing industry is, and following this transaction will remain, a vibrant and highly competitive environment,” they said in a joint statement.
Last week, we learned German to bring you our report on the Frankfurt Book Fair. This week, we passed the D.C. bar to analyze this case for you. Here goes.
The proposed deal between Penguin Random House and Simon & Schuster is what’s known as a horizontal merger, meaning the union of two companies that do the same thing (a vertical merger would be if Penguin Random House wanted to take over one of its suppliers, like a printer).
Horizontal mergers get into trouble when the combined entity is large enough to gain an unfair competitive advantage in the marketplace. Such a firm can abuse its stature to bully suppliers and retailers, cut wages for its employees, raise prices on customers, deliver substandard goods to consumers, and behave in other anti-competitive ways.
How does the DOJ determine if a merger leaves one firm towering too high over its competitors?
A good question, and a difficult one.
The applicable law is Section 7 of the Clayton Act which prohibits one firm from buying another firm if the effect will be to substantially lessen competition or tend to create a monopoly.
To establish whether the combined firm will be large enough to dominate a market unfairly, you first have to define your market. For instance, are we talking about the market for trade books (the kind you find in a bookstore), or the broader book market, including self-published, religious, academic books, audiobooks, ebooks, etc.?
The Penguin Random House-Simon & Schuster deal has been proposed for more than a year and discussed extensively in the press yet I haven’t seen anyone put forth an authoritative estimate of what percentage of the market Penquin Random House-Simon & Schuster would control if allowed to merge.
According to the Wall Street Journal, which cites NPD retail data, Penguin Random House accounts for 21.2% of all trade print books sold in the U.S., while Simon & Schuster accounts for 6.1%. That’s 27.3% combined. The Atlantic reports that the merged entity will control roughly 33% of US trade book sales. Bertelsmann cites data from the Association of American Publishers indicating that the combined market share will be “below 20%” of the trade market. None of these conflicting numbers are prima facie evidence of insufficient competition. The leading firms in a lot of industries have market shares in the same range.
Of the estimates above, I trust the NPD data most, but it isn’t complete: it admits to covering only 85% of the physical book market, and tracks 500,000 ISBNs at a time, which is a fraction of the total. If you count every kind of book published, including reissues of old books, and self-published books, there are 3.5 million books published annually in the US.
By the DOJ’s own count, which seems low to me, Penguin Random House produces only 2,000 trade books annually, and Simon & Schuster another 1000, so this deal affects only the tiniest sliver of the total book market, or a slightly larger sliver of the trade book market which in the US appears to be about 339,000 books annually. If those numbers are correct, we’re a long way from even 20% of the trade market. Even if we use the total number of books published by Penguin Random House and Simon & Schuster globally (15,000 and 2,500 respectively), we’re still at less than 10% of the trade market.
In short, the case that a combined Penguin Random House-Simon & Schuster will tower over anything is not easily made. It comes down to how the market is framed. We can expect a lot more conflicting data and argumentation when we get to court.
The DOJ’s complaint doesn’t waste much time trying to establish that the proposed new firm will have too much weight in the trade book market. It notes that the Big Five group that dominates US publishing (Penguin Random House, Simon & Schuster, HarperCollins, Hachette, and Macmillan) would be reduced to a Big Four. It states that the combined firm of Penquin Random House-Simon & Schuster would be twice as big as the next largest competitor, and leaves it at that.
I had expected more but, on reflection, it makes sense. Arguments about the size of merged firms have not been terribly successful in American antitrust trials. The courts have tended to be relaxed about bigness so long as the firm benefits the consumer. Walmart is a big bully in the retail marketplace, but it has brought lower prices to the people. As far as the courts are concerned, that’s a reasonable trade-off.
With this suit, the DOJ is taking a narrower approach. One test of whether a merger results in illegal market dominance is spelled out in the Horizontal Merger Guidelines jointly issued by the DOJ and the FTC: it asks if the combined firm would be in a position to increase its profits by imposing a price cut—a small but significant and lasting price cut—on one of its suppliers. In other words, if the new and enlarged Penguin Random House is better able than the old Penguin Random House to squeeze one supplier on one product line, the merger is illegal.
To apply this test to the deal, the DOJ needs to identify which supplier and which product line is vulnerable if the firms are allowed to merge. It has a range of options. Book publishing is a complicated marketplace, with many suppliers and product lines. Publishers sell books to retailers, and market books to consumers; they buy distribution services, printing, advertising, editorial services, and so on. The DOJ might have argued that a merged Penguin Random House-Simon & Schuster would have the muscle to make its printers or copyeditors reduce their rates. Or that it could force retailers to accept smaller cuts of sales revenue.
Instead, the DOJ put its chips on the discreet line of business in which authors supply manuscripts to publishing houses. Its complaint says that the combined firm would have the power to improve its profits by significantly and permanently lowering the advances it pays to authors for the rights to publish their books.
Advances, notes the DOJ, provide the bulk of author income at the Big Five publishing houses (few authors earn out their advances and collect further royalties). Were Penguin Random House and Simon & Schuster to combine, there would be nothing to deter it “from imposing a small, but significant, and non-transitory decrease in advances.” And if it did so, the complaint maintains, authors would have nowhere to turn. The DOJ ignores the existence of the other three members of the Big Five. It admits that the US has 3,000 small and mid-size houses but, these, according to the complaint, are economically irrelevant, mere “farm teams” for the big houses. Self-publishing, it adds, is not a serious alternative.
That may sound like the DOJ is suing to stop this merger on behalf of the writing community, a heartwarming notion, but it’s not. The lawsuit is primarily concerned with a small subset of writers: those who produce “anticipated top-selling books.” According to the complaint, there exists a small but definable market for “anticipated top-selling books.” It represents a distinct line of commerce, as required under the Clayton Act, and that is the real focus of the complaint.
The DOJ is going to war for sellers of “anticipated top-selling books,” the .001% of the publishing world.
Its lawyers foresee a time when Penguin Random House-Simon & Schuster will target John Grisham and his ilk with lower advances, and John Grisham will have no choice but to accept. So far as the DOJ is concerned, that is how this merger fails the Horizontal Merger Guidelines, and why it is illegal. The phrase “anticipated top-selling books” appears 29 times in a 26-page document.
The complaint is vague about the size and shape of the market for “anticipated top-selling books.” It consists of “hundreds of authors,” and if the merger is allowed to proceed, “Penguin Random House would account for close to half of the market for the acquisition of U.S. publishing rights to anticipated top-selling books. Penguin Random House’s next largest competitor would be less than half its size.”
Much of the rest of the DOJ’s complaint is given over to examples of expensive publishing deals (ranging from high six-figures to multi-millions) that it says would no longer happen if Simon & Schuster were eliminated as a competitor to Penguin Random House:
In January 2019, Simon & Schuster tried to acquire the memoir of a Grammy Award winning singer and avoid competing in an auction by making a pre-emptive offer for $5 million. After this initial offer was rejected, Simon & Schuster increased its bid to $6 million, and Penguin Random House countered with $7 million plus $2.5 million in potential bonuses. Upon hearing of Penguin Random House’s bid, Simon & Schuster’s then-President emailed his boss: “I’m concerned that if we offer less than $8 million, [the author’s agent] will go back to PRH. She said they were willing to offer more.” Simon & Schuster eventually won with a bid of $8 million.
Another:
In mid-2019, Penguin Random House, Simon & Schuster, and Hachette were invited to bid on a book proposal based on a Broadway play. Penguin Random House and Simon & Schuster submitted equivalent bids; Hachette’s was lower. The author’s agent then asked for “best bids” from Penguin Random House and Simon & Schuster, both of which knew they were competing against the other. Simon & Schuster submitted a bid of $1.4 million, whereas Penguin Random House’s bid was closer to $1.25 million. Upon learning this, Penguin Random House’s U.S. CEO agreed to match Simon & Schuster at $1.4 million. At that point the auction was a dead-heat, with each publisher trying to win the “beauty contest” between them by pointing to the superior services each could provide to the author, including marketing, publicity, and editorial support. As Simon & Schuster’s current CEO summed it up: “The choice is between Simon & Schuster and RH and we’ll find out today.” The author eventually chose Penguin Random House.
Aside from a couple of boilerplate paragraphs arguing that reducing the Big Five to the Big Four would make it easier for them to collude, that’s the government case.
It’s weird, no? If you’ve been following the media commentary, this was supposed to be a fight about ensuring the survival of a vibrant and diverse literature, about preserving jobs in the publishing industry, about resisting the blockbuster winner-take-all mentality of the dominant firms and sticking up for the mid-list author.
The DOJ’s complaint is only worried about “substantial harm” to the elite of the elite. It suggests that the rest of America’s 145,900 writers and authors, most of whom write for less than $10,000 a year, and will never sniff a five-figure advance, let alone a million-dollar advance, have nothing to fear from the deal. Nor do the employees of Simon & Schuster, never mind that half of them are likely to lose their jobs in the merger if Random House’s 2012 takeover of Penguin is any guide.
I suppose the DOJ lawyers may be following the time-honored legal stratagem of “any stick to beat a dog.” They may believe that there will be plenty of benefit to publishing employers, the average writer, and American readers if the merger is blocked, and that the important thing is to find the proper argument to win the case. The narrow market of “anticipated top-selling” books is where they see vulnerability, and they don’t much care if it looks like they’re fighting the merger to keep Margaret Atwood in new hats. Or to ensure that their political bosses will get the same $65-million advance that was granted the Obamas when it’s their turn.
I have to say, I find it disappointing, especially given all that we’ve been hearing about US antitrust law of late. The academic literature says that economic analyses prove the last forty years of lax policing of horizontal mergers has been bad for the economy, allowing firms to consolidate, collude with one another, punish rivals, suppress wages, stifle innovation, and otherwise abuse their dominant positions. That literature prompted the DOJ and FTC to significantly increase their antitrust actions in the last years of Trump, and the Biden administration is promising still higher levels of enforcement. The two agencies say that they will be bringing a new “evidence-based approach” to prosecutions—building them on credible empirical economic evidence of harms to competition.
But there’s not much of anything empirical in this DOJ complaint. There’s no compelling description of vicious wrongs needing to be righted. Even the argument that the .001 percent are about to be screwed is unconvincing. Big-time book publishing has run on blockbusters for the last half-century (along with much of the rest of the entertainment industry), and the demand for “anticipated top-selling books” is unlikely to shrink much, if at all, with four firms instead of five. Advances for big-time writers did nothing but skyrocket in the wake of Random House’s takeover of Penguin a decade ago (the same sort of arguments were made against that deal). Even if advances for big-time writers do drop substantially, that may allow mid-size firms to step up and compete with the big boys, which in the long-term would be good for the entire industry.
Interestingly, the DOJ and FTC manage to kill only 10% of the horizontal mergers they challenge. I found that statistic startling until I spent some time with this complaint.
Something else revealed by the DOJ’s complaint is that Penguin Random House and Simon & Schuster blew their attempt to avoid a lawsuit by reassuring the government that it need not worry about the merger. “Aware of the competitive concerns raised by agents and authors, as well as the ongoing antitrust scrutiny of this merger by the United States,” reads the complaint, “[the] defendants have tried to salvage their deal by making an unenforceable promise to continue competing after the merger is consummated. On September 20, 2021 Penguin Random House announced that, after the merger, it would allow Penguin Random House imprints and legacy Simon & Schuster imprints to continue bidding against one another up to an unspecified amount.”
This was never going to fly with the DOJ. The other antitrust regulator, the Federal Trade Commission, tends to like these behavioral remedies, where the parties offer assurances that they’ll behave competitively and put up firewalls between the merging entities if they’re allowed to consummate their deal. The DOJ, however, believes that “no matter how well crafted, the risk of collaboration in spite of the firewall is great.” DOJ wants structural remedies, forcing the sale of businesses or assets by the merging firms. These are “clean and certain, effective, and avoid ongoing government entanglement in the market,” says the DOJ.
The two publishers have known all along they’re dealing with the DOJ, and shouldn’t have been surprised to read in the DOJ’s complaint this brisk dismissal of their suggested remedy: “In short, after securing nearly half the market for publishing rights to anticipated top-selling books, Penguin Random House asks this Court to trust that Penguin Random House will not use its market power to maximize profits for the benefit of its shareholders but rather, it will essentially compete with itself to reduce those profits. This proposal defies economic sense, can be evaded or violated without detection and is unenforceable.” Hence the DOJ’s lawsuit.
A final revelation from the DOJ’s complaint concerns Penguin Random House’s motivation for the merger. Or, more properly, Bertelsmann’s.
As I wrote in an earlier newsletter, the initial valuation of Simon & Schuster from the financial community was about $1.2 billion, or eight times the company’s EBITDA of $145 million (a figure inflated by years of vicious cost-cutting). That seemed a generous enough price for an established company in a slow-growing industry. Yet Bertelsmann stepped up and offered $2.175 million cash. A multiple of fifteen, as though S&S were run by Elon Musk. Why?
Bertelsmann’s stated reasons for the purchase at the time it was announced were almost identical to those it used to justify its Penguin acquisition a decade earlier: it’s important to have scale when you’re dealing with megacorps like Apple and Amazon, and bookselling chains like Barnes & Noble. Being big makes it easier to develop direct-to-consumer book sales networks so the company is not as dependent on Amazon and Barnes & Noble.
This was never convincing. Penguin Random House has all the size it needs to wrestle Barnes & Noble, and it will never be large enough to stand up to Amazon, whose revenues and market capitalization are orders of magnitude beyond Bertelsmann’s.
Maybe there are some efficiencies to be gained by combining the operations of Simon & Schuster and Penguin Random House? Again, if the Penguin and Random House merger is any guide, the efficiencies of this merger will be scant. Bertelsmann overpaid for Penguin and promised all kinds of operational improvements, from attracting better talent to developing new markets and offering new products as well as economic efficiencies. None of that was realized. Beyond being larger, Bertelsmann has little to show for the Penguin deal.
A source at Simon & Schuster suggested to me that Penguin Random House wants to go into retail competition with Amazon, opening its own direct-to-consumer bookstore, carrying not only its own books but everyone else’s. But the DOJ complaint blows that out of the water. Its lawyers have internal documents indicating that Penguin Random House “plans to embrace Amazon even more closely after the merger.”
So what justifies the price? My best guess remains that Bertelsmann is trying to buy and overpay for Simon & Schuster for two reasons.
First, as a publicly held company, Bertelsmann needs to grow, otherwise its shareholders will sell their stock and invest their money elsewhere. Penguin Random House has to contribute to Bertelsmann’s growth, preferably by producing more revenue. If it’s not able to grow its revenue, which it has trouble doing, it has to cut costs and improve its profitability. There are limits to how far you can cut costs without pulling down your revenues and getting yourself deeper into trouble. And that leaves growth through acquisition as one of the few avenues open to the company.
The second and probably more important reason for Bertelsmann to buy and overpay for Simon & Schuster is fear. I imagine that when S&S came on the market last year, Bertelsmann was terrified that someone like HarperCollins would buy it.
The combination of HarperCollins and Simon & Schuster would make a new firm almost the size of Penguin Random House. That would be a real competitive threat for Bertelsmann. HarperCollins plus Simon & Schuster would bid up the prices for the blockbusters that Penguin Random House needs, year after year, to keep its nose above water. Far better to overpay for S&S than let HarperCollins grab it, setting yourself up for regular bidding wars with Rupert Murdoch.
I would have preferred Rupert and HarperCollins to wind up with S&S. Two equal-sized book publishing competitors would have been better for authors and the rest of the literary food chain. But they were outbid.
I still maintain that the whole of the book publishing industry is nevertheless quite dynamic and a lot could change over the next decade or two. It was only thirty years ago that Simon & Schuster was the biggest publisher in America. Just because Bertelsmann owns a lot of imprints now doesn’t mean that it always will, or that it will succeed with what it has, especially if it is suddenly under enormous pressure to justify two major and hellishly expensive acquisitions in a single decade. Down the line, buying Simon & Schuster may prove to have been riskier for Bertelsmann than letting Murdoch have it. We’ll see.
Order Christmas books now!
All the stories you’ve been reading about supply chain disruptions in the retail market are true, and they’ve hit the book world as well. If you’re considering ordering books for gifts or your own holiday reading, best not to wait. Go here!
Our Newsletter Roll (suggestions welcome)
Esoterica Magazine: Literature and popular culture.
Benjamin Errett’s Get Wit Quick, literature and other fun stuff
Jeet Heer’s The Time of Monsters: political culture and cultural politics
Lydia Perovic’s Long Play: literature and music.
Tim Carmody’s Amazon Chronicles: an eye on the monster.
Jason Logan’s Urban Color Report: adventures in ink (sign-up at bottom of page)
Anne Trubek’s Notes from a Small Press: like SHuSH, but different
Art Canada Institute: a reliable source of Canadian arts info/opinion
Kate McKean’s Agents & Books: an interesting angle on the literary world
Rebecca Eckler’s Re:Book: unpretentious recommendations
Anna Sproul Latimer’s How to Glow in the Dark: interesting advice
John Biggs Great Reads: strong recommendations
THAT’S IT FOR THIS WEEK. THANKS FOR READING. PLEASE SIGN UP OR CONVINCE SOMEONE ELSE TO SIGN UP, OR SHARE, OR LEAVE A COMMENT: