Key Takeaways from District Court Opinion Blocking Penguin Random House/Simon & Schuster Merger | Practical Law

Key Takeaways from District Court Opinion Blocking Penguin Random House/Simon & Schuster Merger | Practical Law

The US District Court for the District of Columbia enjoined a merger between Penguin Random House and Simon & Schuster, holding that the merger was likely to substantially lessen competition in the market for publishing rights for anticipated top-selling books in violation of the Clayton Act. The DOJ sued alleging that the merger would result in monopsony power, reduce competition over advances paid to authors, and reduce the quantity and variety of books published. The defendants challenged the DOJ's market definition, evidence of market conditions, and likely anticompetitive effects of the merger.

Key Takeaways from District Court Opinion Blocking Penguin Random House/Simon & Schuster Merger

by Practical Law Antitrust
Law stated as of 09 Nov 2022 • USA (National/Federal)
The US District Court for the District of Columbia enjoined a merger between Penguin Random House and Simon & Schuster, holding that the merger was likely to substantially lessen competition in the market for publishing rights for anticipated top-selling books in violation of the Clayton Act. The DOJ sued alleging that the merger would result in monopsony power, reduce competition over advances paid to authors, and reduce the quantity and variety of books published. The defendants challenged the DOJ's market definition, evidence of market conditions, and likely anticompetitive effects of the merger.
On November 7, 2022, the US District Court for the District of Columbia enjoined Penguin Random House, LLC's proposed acquisition of Simon & Schuster. The Department of Justice (DOJ) Antitrust Division sued to block PRH, which is the largest book publisher in the world, from acquiring S&S, the fourth largest book publisher in the US. The acquisition was announced on November 25, 2020, and valued at approximately $2.175 billion. For more information on the complaint, see Legal Update, DOJ Challenges Book Publisher Merger.
The DOJ alleged that the merger would substantially lessen competition in the relevant market, in violation of Section 7 of the Clayton Act. For more on the legal standards under Section 7, see Practice Note, Section 7 of the Clayton Act: Overview.
In enjoining the merger, the district court held that the DOJ:
  • Properly defined a relevant market of publishing rights for anticipated top-selling books (see Relevant Market).
  • Demonstrated that the post-merger market would be highly concentrated (see Prima Facie Case).
  • Provided credible evidence of likely unilateral and coordinated effects that would harm competition (see Unilateral Effects and Coordinated Effects).
In contrast, the court found that the defendants failed to:
  • Demonstrate that the proposed relevant market was not properly defined (see Relevant Market).
  • Establish that market share evidence presented by the DOJ fails to reflect market conditions (see Prima Facie Case).
  • Rebut affirmative evidence of likely anticompetitive harm (see Defendants' Rebuttal).

Industry Background

The court described the publishing industry in detail and highlighted some facts about the industry relevant to the case, including that:
  • The industry is dominated by five large publishing houses (the Big Five), which:
    • control approximately 60% of trade book sales;
    • may be able to take greater risks on new books because of their profitable back lists (books that continue to sell well after the first year); and
    • offer competitive advantages over smaller publishers in terms of marketing capabilities and overall support.
  • Self-publishing is generally not considered a significant factor in the publishing industry.
  • Publishing houses are made up of imprints (the industry name for an editorial group), and each is usually focused on certain types of books and authors. Internal imprints may compete with each other to secure rights to new books on a somewhat limited basis.
  • Only about 35% of books turn a profit, and the top 4% of profitable titles generate about 60% of profits.
  • Advances are generally the key term in a publishing contract, are often the only compensation for authors, and are generally determined:
    • based on an estimate of projected sales, taking into consideration other factors like the editor's relationship with the author or if the book is in a growing category;
    • in connection with other publishing contract terms, like royalty rates, audio rights, and timing of payments, which may be negotiated but have become more standardized over time; and
    • as the result of competitive auctions or one-on-one negotiations.

Relevant Market

The DOJ alleged that the relevant market product market is the market for publishing rights to top-selling books. This market includes books that:
  • Are expected to be big sellers, and for which authors receive significant advances.
  • Have distinct characteristics, including the need for extra marketing, publicity, and sales support to reach broader audiences.
This market is a submarket for the broader publishing market for all trade books (books intended for general readership, as opposed to specialized books like textbooks or manuals). Under the DOJ's monopsony theory, the submarket is made up of targeted sellers, that is the authors of anticipated top-sellers, to whom the merged company may lower the prices paid (in the form of lower advances).
The DOJ defined top-selling books as those for which a publisher pays an advance of at least $250,000.

Practical Indicia

The court evaluated the proposed submarket and its boundaries using practical indicia, such as whether the market is recognized by the industry or the public, along with other particular characteristics. The court first examined the $250,000 threshold and found that:
  • The use of high advances as a proxy for sales is logical and supported by market realities.
  • Industry standards support drawing the line at $250,000.
  • Other cases have used numerical cutoffs to identify a submarket.
  • Identifying the high end of a broader market as a distinct submarket has support in case law.
The defendants argued alternative price thresholds and defining the market on price alone was insufficient. The court disagreed, noting that the price point chosen was meant to be a useful analytic tool, rather than a bright line. Further, the court noted that the defendants' attempts to suggest and identify alternative markets and submarkets is not relevant to the present case. The Clayton Act, the court noted, only requires the plaintiff to identify harm to competition in any line of commerce, so the fact that other markets may exist does not render the DOJ's alleged market unusable.

Other Market Characteristics

The DOJ argued that the proposed market also has particular characteristics that support the submarket definition. For example, the DOJ alleges that top-selling books:
  • Require stronger marketing, publicity, and sales support.
  • Have authors that are distinct sellers that:
    • care a lot about the publishers' reputation and services;
    • may receive more favorable contract terms than other authors; and
    • face different competitive conditions.
The defendants argued that all books are in the same market. The court disagreed, finding a clear distinction between anticipated top-selling books and the vast majority of books. The court also held that it was reasonable to conclude that the defendants are able to identify books likely to be top sellers, noting that the defendants' high market share and substantial profit margins suggest they are successful at identifying books that people will read.
The court also noted that authors of top-selling books have unique needs and preferences, and may not have as many options for suitable publishers or for alternatives, like self-publishing. As a result of this distinction, the court further found that publishers could target authors of anticipated top-selling books for a decrease in advances because it is not as likely that a price decrease would cause the publisher to lose a book.
For more on relevant markets, see Practice Note, Analyzing a Relevant Market in Horizontal Mergers.

Supply Substitution

The court next examined if the market satisfied the hypothetical monopsonist test, that is, whether, if a single buyer existed in the market that buyer, without price regulation, could profitably target sellers for price decreases. The court concluded that it could and that any authors who would substitute away to self-publishing would be insufficient to make an advance decrease unprofitable.

Prima Facie Case

The court held that the DOJ met its burden of proving market concentration, citing evidence that the merger would result in:
  • The merged firm controlling nearly half of the relevant market and the remaining Big Four firms controlling approximately 91%.
  • The post-merger Herfindahl-Hirschman Index (HHI) being 3,111, an increase of 891, well above the thresholds set by the Merger Guidelines.
In addition, the court noted that the Big Five dominate book acquisitions in the relevant market, and these market shares have been stable over time.

Unilateral Effects

The court found credible evidence that the merger would result in a loss of head-to-head competition, supported by evidence of:
  • High diversion ratios.
  • Industry participants' predictions that loss of competition would harm authors.
  • A likely reduction to the merged firm's motivation to compete for publishing rights.
  • Economic modeling that showed quantifiable potential decreases to author advances in the relevant market.

Coordinated Effects

The court also found credible that the merger was likely to result in coordination among the remaining publishers, noting that:
  • The market is highly concentrated.
  • There is a history of collusion and attempted collusion in the market.
  • There is evidence of a tacit agreement that exists today to compete only on advances by standardizing other contract terms across the industry.
  • The merger would strengthen the position of the merged firm as an industry leader that would make it easy for market participants to follow.

Defendants' Rebuttal

Finding the DOJ established its prima facie case, the court turned to the defendants' rebuttal. The court found the defendants' arguments unpersuasive, including that:
  • Existing competition would effectively constrain the merged firm (see Existing Competition), including competition from:
    • other publishers;
    • internal imprints; and
    • self-publishing.
  • There are few barriers to entry that would prevent new or existing publishers from competing effectively (see Barriers to Entry).
The defendants also put forth a number of other arguments they claimed supported approving the merger. The court rejected each in turn, holding that:
  • Literary agents do not wield enough power to restrain the industry.
  • The defendants were precluded from presenting evidence regarding efficiencies as a result of their failure to verify the proposed evidence.
  • Evidence regarding the purported lack of negative effects from the last major merger in the industry was inconclusive.
  • Antitrust law is concerned with the impact of a merger on competition, not with the desire of an entity to be purchased by any particular acquiror.

Existing Competition

The court rejected arguments that other publishers would effectively constrain the merged firm, noting that:
  • Where PRH and S&S would have been the winner and runner-up, the merged entity will obtain books for lower advances regardless of other publishers' bids.
  • Where another publisher would have won the book, the merged entity might submit a lower bid because it has a lower motivation to achieve organic growth, meaning that the other publisher would win the book for a lower advance than PRG or S&S would have offered as standalone publishers.
  • Publishers offer higher advances where they think there is more competition, so the general softening of competition with S&S removed as a standalone bidder, would lead publishers to offer lower initial advance offers.
  • Even if the advances paid do not go down in terms of actual dollars, the market has been increasing, so a reduction in competition may result in advances that are higher than they are today, but not as high as they would have been absent the merger.
  • Smaller publishers are not an effective competitive restraint because they lack the resources to compete regularly in the relevant market.
Internal competition between imprints will not constrain the market, according to the court, because:
  • This competition is highly restrained by the publishers.
  • PRH promises to allow S&S legacy imprints to compete against PRH imprints even with no external bidders is unreliable because the promise:
    • is not profit maximizing and as a result is unreliable to predict future conduct;
    • may be broken at-will; and
    • will not prevent the merged firm from reducing internal imprint competition in the same ways that it is restrained today.
Self-publishing will not constrain the market, according to the court, because it is very rare for authors to succeed through self-publishing.

Barriers to Entry

The court rejected the defendants' claims that there are not significant barriers to entry and expansion in the relevant market, noting that established publishers have significant advantages, including:
  • Substantial back lists.
  • Large and effective marketing, sales, and distribution teams.
  • Reputations and track records of success.
  • Lower variable costs due to economies of scale.
In addition, the court noted that the market has been stable, with no recent successful entry by a true Big Five competitor. Competitors that have entered have had minimal impacts on the Big Five and their collective market share.

Conclusion

The court held that the merger would violate Section 7 of the Clayton Act because it is likely to substantially lessen competition in the market for publishing rights of anticipated top-selling books, and enjoined the merger. Reduced quantity and quality of books published.
For more on how the antitrust agencies analyze mergers, see Practice Note, How Antitrust Agencies Analyze M&A.