An anti-trust exhibit - Apple's Epic Battle

One of the most important corporate battles of recent times in the tech space is the anti-trust suit filed by gaming major Epic, the maker of popular Fortinite game, against Apple. The issue at hand is the mandatory requirement of using Apple's in-app payment mechanism for purchases on third party applications through the App store and the collection of a high 30% fee on such transactions. Epic is only channelling what other digital services providers like Spotify, Kobo, Tinder, and so on have long accused Apple.

The crux of the issue is captured in Epic's suit,

“What Epic wants is the freedom not to use Apple’s App Store or in-app purchase, and instead to use and offer competing services.”

The dispute surfaced formally when Epic recently introduced a direct payment option for Fortnite, bypassing Apple's in-app payment mechanism for iPhone and iPad users, and charging 20% less than what Apple does. Apple retaliated by blocking Fortnite from its App store. Almost anticipating this, Epic immediately filed a lawsuit against Apple for anti-competitive and unfair practices. 

Richard Waters touches on most of the important issues at the heart of the dispute,

At the centre of the fight is the “Apple tax” — the 30 per cent levy on some transactions that has made this a big business for Apple. What seemed a fair cut when the store was new and experimental feels, now it has become an integral part of mobile life, more like putting a gate up across one of the internet’s biggest highways and extracting an excess toll. But in challenging how the App Store operates, Epic Games, maker of Fortnite, has done more than take aim at an important Apple revenue stream. More significant are the issues it has raised: Who should have the power to distribute apps — and manage user experiences — on Apple’s mobile computing platform? That makes the fight over the App Store one that Apple can’t afford to lose, and guarantees it will be a long and messy battle... The costs of running the digital storefront are negligible given the scale of the revenue, exposing Apple to charges of price gouging. For companies like Spotify, the fee is also a heavy weight to carry when trying to compete head-on against Apple’s own services.

Rizwan Virk points to another important dimension of the dispute,

Mobile smartphones have become the largest and fastest-growing computing platform in history, and app stores like Apple’s and Google’s have become the standard way to download software onto your device. At stake is whether one company can decide what apps you can or cannot consume by not allowing other app stores to be installed on its company’s devices (in Apple’s case, on iPhones or iPads), such as Epic’s own game store or the popular Steam Store. By not allowing alternative app stores and tightly controlling the payment mechanisms, Apple not only limits competition but plays kingmaker and censor, deciding what you can or cannot do on your personal computing device and forcing apps to play by its rules or lose out on reaching Apple-product users.

Tim Sweeney, Epic CEO, tweeted,

“This is a critical consideration in these 30% store fees. They come off the top, before funding any developer costs. As a result, Apple and Google make more profit from most developers’ games than the developers themselves. That is terribly unfair and exploitative.”

Yes, Apple ends up making more money than the developers themselves! In fact, Apple is the third biggest revenue earner in the gaming industry, without actually making or selling any game! These  should make us sit up and think twice about the pricing.

The exorbitant fee looks more like a parasitic rent than a return on innovation. Just look at the sheer magnitude of the fee, 30%. Yes, 30% of the price goes to Apple as a fee for performing a service which is a bit more than offering itself as a transacting platform and, given the digital space, comes with negligible recurring expense. What's more, the same service is offered by several others at far less than what AppStore charges. In fact, more than any technical superiority of the product, the USP of this platform is the access to a vast network of Apple devices and Appstore users (along with developers). Even utilities who need to recover the very high cost of their pipes do not charge anywhere even remotely close to such exorbitant rates!

Have we reached a stage in human thinking and progress that we find nothing odd about such exorbitant appropriation in itself, verging on gouging or predation? What does it tell us about such progress?

Sample this rationalisation from a Morgan Stanley report pointed to by Richard Waters,

The returns Apple is now reaping don’t look out of proportion to the risk of the endeavour or the scale of its success. Its gross profit margin of 38 per cent has actually fallen over the past five years — the period in which its supposed monopolistic power has come to the fore — as sales growth has lagged and R&D spending has soared.

For a physical product company, Apple's margins are phenomenal. But in any market, such margins will naturally decline. The Morgan Stanley report is subtly normalising such trends by expressing concern at its decline.

Does innovation require such exorbitant margins, and that for sustained periods? And that too in an age where the cost of investment and capital have been declining. Never mind the merits of the  claims of innovativeness of Appstore's service or the value addition to the underlying activity (people's enjoyment from playing games) from the innovation inherent in the AppStore.

Further, if this is what a support service provider can charge for a service, it is only natural to expect the provider of the main service itself to extract a much higher margin from the service. Is gaming a market where margins in the range of 70-80% justified? Alternatively, is the market commercially viable with such margins?

What makes this egregious is also the differential treatment accorded to physical services compared to digital services. Apple has exempted services like Amazon, Uber, Doordash etc from mandatory App store mechanism and have struck separate deals with them collecting lower fees. Furthermore, it is well-known that Apple has its own services in the digital space, and therefore this rent is also effectively an entry barrier on potential competitors. This assumes greater significance in light of Apple's declining profit growth from its traditional hardware business and increasing reliance on its digital marketplace business.

A final word. This is not an issue of Apple Vs Epic. Epic's motivations too are not exactly altruistic. Epic is doing what Apple did when it fought IBM in the eighties. It need not come as any surprise if Epic emerges as the Apple of gaming world in a few years, indulging in all the same practices to keep competitors out. The issue is about competition and conflicts of interest in networked digital marketplaces. I'll discuss that in the next post.