Simon Business School Analyzes the Competitive Effects of the Agency Model

Entrepreneurs / 6th February 2017

When Apple first entered the e-books market, Amazon was promoting its e-books at $9.99, which was below its wholesale cost. Apple was thus faced with a difficult decision: take on Amazon with its own low prices, or convince the industry to drop the wholesale model—in which publishers sell their books to retailers, who then set the retail prices—and move to the agency model where retail prices are set by the publishers. Apple chose to move the industry, and overnight, best-sellers went from $9.99 to $12.99 and $14.99.

How and why this happened is explained by Greg Shaffer, of the University of Rochester’s Simon Business School, and his colleagues Hans Jarle Kind and Øystein Foros, in their research titled “Apple’s Agency Model and the Role of Most-Favored-Nation Clauses.”

“We found that delegating prices upstream makes sense if competitive pressures are lower there than they are downstream,” said Shaffer. “This was likely the case because publishers were worried that e-books would cannibalize their regular book sales, whereas Amazon wanted to create demand for their e-book reader.” The co-authors found the agency model is not intrinsically anti-competitive. “It can lead to higher or lower prices depending on whether consumers are more willing to substitute between goods or between platforms,” Shaffer explained. “In Apple’s case, it wanted higher prices, and it got them.”

Shaffer and his colleagues also analyzed why Amazon quickly followed Apple’s lead by also moving to the agency model—so quickly that it raised red flags with competition authorities. “We found this may have been due to Apple’s insistence on adopting MFN clauses, which mandated that publishers could not charge less at Amazon than at Apple,” Shaffer said. In other words, Amazon may have had little choice.

To learn more about the cutting-edge research being conducted at Simon Business School, please visit www.simon.rochester.edu