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Last Friday was day 15 of the Epic Games-Apple antitrust trial. Apple CEO Tim Cook completed his testimony. Both sides have rested on evidence presentations. Mr. Cook made his case that Apple puts users first and the exclusive, centralized distribution of native apps through the Apple App Store ensures protection of user privacy, security and safety. Judge Gonzalez Rogers put quite a bit of pressure on Mr. Cook with her own questions at the end of his testimony. She could be playing devil’s advocate, but she pushed a line of questioning suggesting that Apple generates a disproportionate amount of App Store revenue from in-app game purchases. She suggested Apple, by making 85% of apps free, effectively uses in-app game purchases with 30% commissions to subsidize App Store operations for the vast majority of developers distributing free apps. She cited a survey in the record that developers are not very satisfied with Apple’s App Store administration. She also hinted at her view of Apple’s market power by suggesting the company’s recent initiation of a reduced commission rate (15%) for small developers (below $1 million in annual revenues) was driven by litigation strategy, not competitive pressures. Mr. Cook said free apps drive a bigger addressable market for gamers who thus benefit from Apple’s monetization approach. As she has suggested at points during the trial, she is troubled by App Store policies that prohibit developers from informing users of alternatives (like going to the developer’s web site) to make game-relevant purchases and thereby avoid the App Store commission and enable a cheaper purchase. A similar anti-steering provision was upheld by the Supreme Court in the recent American Express v. Ohio case, but Judge Gonzalez noted that merchants in that case could at least display logos of alternative credit cards that purchasers could use (even if they could not request customers to use them). Apple defends by explaining that developers are free to communicate such options to users through non-iOS channels. At the outset of Friday’s proceedings, the lawyers discussed with Judge Gonzalez Rogers the issues to prioritize at next week’s “point-counterpoint” debate over core legal issues in the case. The first issue she suggested was remedies. Remedies only come into play if there is first a finding of liability. This does not mean she’s made up her mind, but it suggests she wants to address the issue if she concludes there is liability and some type of remedy must be imposed. Greater flexibility for developers to advise iOS users of alternative payment options outside the App Store would look like a remedy of interest to the court. Again, only if there is an ultimate liability finding. The court also suggested, as part of this week’s in-court legal debate, an interest in a focused discussion of market definition (perhaps the most critical issue in the case) and whether and how the application of antitrust principles in this case should be contoured to high tech markets constantly undergoing dynamic change. After trial proceedings close this week, we anticipate several weeks before the court issues its decision and opinion, recognizing that an appeal to the Ninth Circuit is likely. Judge Gonzalez Rogers noted that she has a jury trial in another matter starting in a couple of weeks and that could complicate the timing of her decision. We continue to give Apple the edge. Although Judge Gonzalez Rogers apparently has concerns about App Store dominance, commission rate levels and the anti-steering restrictions of Apple’s policies, relevant precedents on antitrust market definition and monopolizing conduct are challenging for Epic Games. Of critical importance in this context is App Store policy consistency, enforcing the same commission rate levels and anti-steering prohibitions virtually unchanged since the App Store launched in 2008, two years before Epic's own expert (Dr. David Evans) contends Apple obtained monopoly power in the app distribution market. Generally, in a case asserting monopoly abuse of market power acquired by locking customers into the defendant's ecosystem (too burdensome or costly to switch to competitors), liability stems from exploitation of the market following successful lock-in of the targeted customers. If Apple App Store policies have never changed (other than selected reductions in commission rates), proving monopolizing conduct is far more challenging. Moreover, even if the case reaches the remedies phase, it is not clear how much the App Store’s revenue growth would take a hit based on changes to the anti-steering provisions or if Apple is forced to lower commissions but change the way it imposes commissions on all developers who benefit from access to the App Store. Apple has substantial flexibility in the way the company chooses to monetize its intellectual property and it has already indicated a willingness to modify its approach within the App Store if forced to do so as a consequence of this litigation. We doubt the court would force Apple to enable Epic or other entities to establish their own third-party app stores inside Apple’s iOS App Store, the dream remedy Epic seeks in the case. *Note: This analyst holds shares in AAPL subject to Hedgeye's personal trading policy. |
