Epic v. Apple Part 2: Benefits and Costs of Monopolization
In the last article on the Epic v. Apple trial currently underway, we analyzed some of the claims made by each company to nail down the optimal solution to the challenge Epic proposes - that Apple engages in anti-competitive practices regarding their App Store on iOS. Regardless of whether you agree with Epic or Apple, the solution to the claims of Apple using anti-competitive action on App Store developers would be to introduce competition in their iOS ecosystem rather than trying to regulate a set revenue share away from the current 70/30 split in favor of developers. Fair warning, we are not analyzing this from a legal perspective but instead from a resource allocation perspective.
To actually get to the question of “should Apple face additional regulation over their App Store?” we should analyze potential outcomes that could result from regulating Apple’s App Store. To be clear, I am unsympathetic to claims of financial liberty, that essentially companies became who they are by outcompeting others in the sector and that government interference on this process is analogous to “stealing” from a company. Companies that incorporate within the United States sign onto our democracy at their onset and are subject to our will through representative government, think of it like our terms and conditions. Apple’s founders knew during the establishment of their company that we have anti-trust laws, this should not be a surprise. Besides, anyone who holds the financial liberty view already has an opinion on the outcome.
I am however sympathetic to claims on monopolies related to innovation and economic productivity.
The consequences of Apple holding a monopolization on access into their iOS operating system have been argued in the current trial. Epic argues that Apple’s App Store is no longer innovative and that developers are forced to pay an exorbitant fee (30% of all in-app revenue) for what amounts to 80% profit directly to Apple (while Apple claims the profit from App Store revenue to be a much lower 20%). The drawbacks of this would be that developers and publishers have to either raise their prices to account for the “Apple tax” or to settle for higher margins on their application.
The glaring issue here is there are some applications exempt from the revenue share model, most notably those developed or published by Apple such as Apple Music. Apple Music and Spotify are direct competitors with very similar business models but only one receives 30% of the others revenue on iOS. This is particularly why Spotify might be the better claimant to appear against Apple and why their suit in Europe may ultimately prove to be more successful than Epic’s (it also will help Spotify that anti-trust regulation by the European Union has generally been considered stronger than by the United States in recent years). Regardless, if Apple had a lower take of revenue you would expect for either App Store prices to generally decrease OR for developers to increase profit with a likely scenario being a mix of both.
We all understand the potential benefits of lower prices on consumerism (essentially, lower costs should lead to more sales) but similarly there should be benefits of developers profiting more from a higher revenue share. More money to developers means more money to be spent on their employees, either through hiring or wage increases, and more money to be reinvested into their companies to develop their products. Do we prefer additional innovation to be done on the App Store or would we prefer more innovation in the applications themselves? This is precisely why action on anti-competitive claims is so difficult.
The potential revenue at stake over the trial is large. Between 2017 and 2020, consumers spent an estimated $213.1 billion on the App Store, a figure that has been steadily growing annually throughout the past decade. The revenue split during this time span of 70:30 in favor of developers results in $63.93 billion in revenue to Apple and $149.17 billion for the 20+ million developers on iOS (respectively, $21.69 billion and $50.61 billion in 2020 alone). Total software market revenue in the world for the same time span (2017-2020) is estimated at $1,840.02 billion giving Apple an estimated 3.5% of all software market revenue in the world.
If the past four years were under an 80:20 revenue sharing model we would be looking at an additional $21.31 billion of revenue going towards developers. If the model was 87.5:12.5, such as the new revenue sharing model implemented by Microsoft on PC, we would be looking at an additional $37.29 billion of revenue going towards developers. These are exceptionally large numbers. $213.1 billion would eclipse the entire gross domestic product of a few small countries. If we were to average the difference in revenue sharing models annually based off the past few years of App Store revenue we would be looking at an additional $5-10 billion in revenue distributed to developers each year. $5-10 billion is a lot of revenue that could be going towards developers of applications that help increase work productivity, make communication easier, or even connect one another in loving relationships. Those areas are not where app revenue is generated. In fact, over the 2016-2020 time period we see $170.9 billion of revenue generated from gaming on iOS – 80.2% of all App Store revenue. Gaming is great, but we can confidently say that most of the revenue generated for developers are those in the gaming sector instead of productivity sector. Our value-added would thus be reflected in additional reinvestment into the gaming space on iOS against a drop in revenue going to Apple.
Apple is an exceptional company that consistently grows in valuation while paying out a small dividend (last quarter was $.22). They are not a legacy player in the market like IBM or Intel focused on large dividends and instead heavily reinvest into research and development across their portfolio of hardware and software. Apple is a monopoly precisely because they have been so dominant at locking down an entire ecosystem with the development of hardware and software that works in harmony with each other. Their App Store may not be as innovative as it once was, but in other areas Apple’s innovation is unparalleled still today. For instance, Apple just recently became a microchip developer, developing their M1 chip which is a marvel of technological design and a potential game changer in the sector due to the performance they cranked out of ARM architecture. Time will tell, but the power efficiency of the Apple ARM chips has drawn numerous praise from various outlets and could be the future of many other chips.
Is Apple’s innovation as a company more contributive to increased economic productivity than additional investments into iOS application development, especially in the form of 80% additional investment going directly into iOS gaming developers? Would Apple have been able to innovate in the microchip sector without an additional $5-10 billion in annual App Store revenue? Probably. But could they have designed their M1 architecture without their many other profits generated from their monopoly standing? Maybe not.
Keeping with our four year analysis of 2017-2020, Apple reported research and development expenses of $60.78 billion dollars against a profit of $393.37 billion for an R&D expense to profit ratio of .154. This .154 R&D to gross profit ratio gives us an idea of how much research is going in to a company versus both other operating expenses (taken out of gross profit) and money either being retained for investing purposes, share buybacks, or shareholder dividends. Epic is not publicly traded, making our task a bit more challenging, but let’s try and check their industry by taking a look at other large gaming companies Ubisoft, Electronic Arts, Activision, and Take Two (we do have some for Fortnite). All these game companies exhibit a common theme: all have R&D to gross profit ratios above Apples and as their ratios decrease as does the overall size of the companies labor force. In order to compare against Apple, let us also look at each company’s gross profit margin.
Apple R&D spending is absolutely swamped by their gross profits compared to the large public-traded gaming companies. Every single gaming company pays out a higher proportion of profit on research and development, and yet Apple has about half the profit margin of the other four companies mean. Again, Apple is a giant company and it helps to have revenue about 68-225x these other companies which allows them to have a lower gross profit margin and still be the most valuable company on the stock market. It is hard to justify the gaming companies large gross profit margin in a battle of resources against Apple. Remember, the entire debate started over Apple’s large revenue share in the App Store, but it certainly appears Apple needs to make large gross profits in some areas due to lower margins in general, especially in contrast with the very high gross profit margins of the gaming companies examined.
Next: After the Epic v. Apple case, we will follow up on the decision (likely loss for Epic). Then we can get to the best version of the question to ask for the US citizen, where is the best use of capital on innovation? Are tech monopolies better instruments of innovation than the businesses they potentially undercut through anti-competitive practices?