A Crack Opens in the App Store Economy

(Bloomberg Businessweek) -- When Apple Inc. introduced its App Store in 2008, the company’s founder and chief executive Steve Jobs had a message for iPhone app developers. “We are not trying to be business partners,” he told the New York Times. Jobs meant that developers didn’t have to feel threatened because Apple’s main business was selling phones, not taking 30% commissions on app sales. But the comment could be interpreted very differently today, when many developers—and government officials—see Apple less as a partner negotiating in good faith than as a feudal lord levying an unavoidable tax.

On Sept. 10 a federal judge partially vindicated the critical view of the company by ruling it had to allow app developers to direct users to web payment systems to complete transactions. The decision stems from a feud with Epic Games Inc., the creator of the smash hit Fortnite, over whether it could use its own billing service within the game, skirting Apple’s standard fee. When Epic did so over Apple’s objections the phonemaker removed Fortnite from its app store, and Epic sued.

In her ruling on the case, Judge Yvonne Gonzalez Rogers wrote that loosening Apple’s payment system would beneficially increase competition. She didn’t, however, agree with Epic that Apple was a monopolist. “Success is not illegal,” the judge concluded, and told Epic to pay Apple $6 million in royalties. Epic intends to appeal; Apple has declared victory. But while Apple avoided the worst possible scenario, the case could be the first major crack in the foundation of the $142 billion smartphone app industry it and Alphabet Inc.’s Google created when they launched parallel app stores 13 years ago. The ensuing wave of mobile apps revolutionized the way consumers interact with devices while concentrating a massive amount of power—financial and otherwise—with the companies who’d established themselves as gatekeepers.

Many app developers have done well with this arrangement, but there’s been a growing swell of discontent. Epic, Spotify, and Tinder-owner Match Group LLC led the charge against the app stores, blaming them for taking huge cuts while promoting their own rival services. (Both Apple and Google run music services that compete with Spotify. Match and Spotify praised the Epic decision.)

If the Epic verdict stands, it would apply only to the way people pay app developers rather than extend to concerns about other allegedly anticompetitive behavior. But there is undeniable momentum to overhaul how app stores operate. “It’s a huge deal,” says David Bos, chief operating officer for Maple Media, a holding company that owns an array of consumer apps, from Stocks+ to Mahjong. Developers could start steering people who make in-app purchases away from Apple’s App Store and toward the web, where payments processors such as PayPal Holdings Inc. and Stripe Inc. typically charge rates of 2% to 3%. (The judge didn’t require Apple to allow developers to incorporate their own payment systems within the apps themselves.) There would be some overhead costs for backend tasks that Apple currently handles, including managing refunds and detecting fraud. Still, in this new world, Bos believes the remaining savings would be a “meaningful percentage.”

Richard Crone, an industry strategist, predicts developers could slice a quarter of costs by going around Apple. Over the past year, the company has made a few concessions on app payments, cutting fees for smaller developers and announcing that it would allow media subscription services such as Netflix Inc. and Hulu LLC to direct users to web payments, beginning in 2022. Apple might make additional concessions to persuade developers to stick with its billing. Better economics and competition might help developers drive up sales. “The more places people can pay you,” says Bos, “generally, the more people do.”

Apple has argued that its fees and strict control over the App Store are necessary to maintain high standards on privacy and security. But irked app developers say Apple has used its market power to force them to give it a share of their revenue. Proton Technologies AG, a Swiss company that makes encrypted email and software, complains that Apple pushed it to institute in-app purchases in 2018 for features it previously billed over the web. Andy Yen, its chief executive, has likened Apple’s move to “Mafia extortion.”

Proton agreed to do it but raised subscription email prices by 26% on Apple devices. “It’s very, very damaging,” says Jurgita Miseviciute, the company’s policy lead. “Apple tries to paint us like we’re some greedy, less-successful rivals. But in the privacy industry, you have to pay for service.” Apple changed its policies in Sept. 2020 to allow companies such as Proton avoid in-app payments, but Proton says the rule change doesn’t address its concerns.

For many years, Apple was content to make money selling gadgets. But such services as the App Store are growing in importance as the company looks for new, more profitable ways to grow. Apple’s revenue from app sale commissions in 2020 was $21.7 billion, according to market research firm SensorTower. Analysts have guessed that it stands to lose $1 billion to $4 billion annually if the Epic verdict stands; it applies only to the U.S.

The area likely to see the biggest change is gaming. Some 70% of Apple’s app sales come from mobile games, and Judge Rogers wrote that Apple runs “primarily a game store and secondarily an ‘every other’ app store.” The Google Play store, she noted, despite less available evidence, works the same way. Shares of mobile gaming producers such as Zynga Inc. and Activision Blizzard Inc. popped after the ruling. Equity research firm Baird & Co. believes Zynga’s profit could soar 115% if its Apple fees were sliced in half.

The impact on Google, whose app store has more users but makes less revenue, is less clear. Unlike Apple, Google lets other app stores run on Android phones, and Google also tends to be more lenient on fees. But Epic is also suing Google, and critics have accused the search giant of resorting to intimidation, too. During a Senate hearing on app stores in April, Jared Sine, chief business affairs and legal officer for Match, a big advertiser with Google, testified that Google representatives called his company the night before to interrogate him about the prepared Senate remarks. “They could hurt us in big ways,” Sine told the senators. “We’re all afraid.” A Google lawyer at the hearing said the company would “never threaten” partners.

In the end, Google, which declined to comment on the ruling, will probably have to follow whatever action Apple takes on payments. 

Apple’s biggest critics see payments as just the beginning. After the ruling, members of Congress from both parties called for new anti-monopoly laws. Several bills under proposal would curb the special access Apple and Google sometimes give their own apps and would force Apple to let outside app stores operate on its devices. Still, even those measures wouldn’t necessarily undo the leaders’ dominance. After a regulatory beating in Europe, Google had to set up a choice screen on Android devices letting consumers pick its search engine or smaller rivals. Most still selected Google.

Developers that imagine windfalls from app store overhauls know these won’t come overnight—or that easily. These businesses must still persuade consumers to skip out on payment methods that Apple and Google offer with a few simple taps. “People generally do whatever is easier,” says Bos. “And we have more than a decade of people being conditioned to just pay in the app.”

©2021 Bloomberg L.P.