Apple v. Epic Games trial starts with all eyes watching

The Apple v. Epic trial gets underway today in a virtual hearing in federal court. It’s fair to say this is the trial of century between a platform owner and a game maker, and the consequences for both types of companies could be enormous.

The antitrust case is a struggle about whether Apple can make the rules for its App Store, or whether the actions alleged by Epic Games amount to monopolistic practices. On Friday, Epic got some support, as the European Union for the first time accused Apple of antitrust violations in how it dealt with Spotify in the music streaming market. Spotify and Epic are both members of a 14-company group called the Coalition for App Fairness that has accused Apple of anti-competitive practices.

Epic’s conflict started on April 13 last year, when Epic announced a discount policy and direct payment mechanism for Fortnite that Apple and Google said violated their respective terms of service. Epic CEO Tim Sweeney has long argued that the 30% commissions the big companies take from every game transaction is unfair and that Epic should be able to directly sell its in-app goods to players for lower prices. It argued that app distribution and payment could be as open on Apple’s iOS platform as it is on personal computers.

Apple and Google banned Fortnite, and Apple fired back with the claim that Epic sought to get itself a sweetheart deal other developers couldn’t get. (This was an easily refuted claim, as you’ll see below.) Apple said it built the App Store on top of the iOS mobile platform at great financial risk and that Epic was trying to get a free ride now it felt it had paid enough fees. Epic sued both Apple and Google for antitrust and posted a parody video mocking Apple’s stance for freedom in its groundbreaking 1984 ad. Apple then tried to withdraw developer tool support from Epic’s Unreal game engine, which 11 million developers use, and a federal judge granted Epic’s temporary restraining order to prevent that from happening. Microsoft, an Unreal user, supported Epic in the Unreal Engine TRO matter.

The case will be heard in the virtual courtroom of federal judge Yvette Gonzalez Rogers in U.S. District Court in Oakland, California. Epic’s CEO Tim Sweeney is expected to testify on Monday, and both sides are expected to offer opening arguments.

Above: Tim Sweeney is the outspoken CEO of Epic Games.

Image Credit: Epic Games

Epic claims it’s leading the charge for all game developers and says it can only do so because it isn’t beholden to the tech giants. Fortnite’s revenue has made the company valuable, and Epic Games recently raised $1 billion at a valuation of $28 billion. That sounds like a lot, but it’s puny compared to Apple’s stock market value of $2.2 trillion and Apple’s revenues of $89 billion in the quarter ended March 31 alone.

In its defense, Apple has been using the rhetoric of victimhood and innovation, while Epic is attacking on the grounds of freedom, openness, fairness, and revolution.

What’s interesting about Epic’s case is that it hasn’t asked the court for any damages. It is only requesting that Apple be prohibited from punishing Epic Games for its actions related to the direct payments in Fortnite. Apple has asked for compensatory damages, punitive damages, attorney’s fees, and interest, as well as restitution and disgorgement of all earnings, profits, compensation, benefits, and other allegedly ill-gotten gains Epic obtained as a result of conduct in violation of Apple’s terms of service.

While the dispute started with Epic trying to get Apple to accept an alternative payment system for Fortnite, the conflict is now about the future relationship between game and app publishers and the big companies that control their platforms. Indie developers will be watching closely to see whether companies will still be able to charge fees for the right to publish on their platforms.

Epic argued that Apple is a monopolist in two respects: its control of app distribution on the App Store and its requirement that users pay through its payment processing system.

Defining the relevant market

Above: Worldwide app gross consumer spending by store in Q2 2020.

Image Credit: App Annie

Epic argues that because Apple has monopoly power, antitrust laws say Apple can’t use that power to shut competition out of the market for either the app store or the payment system. Epic does, however, acknowledge that Apple created value with the App Store. It just wants to be able to use alternative payment models.

Apple has asserted its store isn’t a separate product, but Epic argues app distribution is an “aftermarket” derived from the primary market of the smartphone platform. Epic says the courts should view the relevant antitrust market as the aftermarket, which has a unique brand and a unique market and is not part of a larger single product. Epic isn’t challenging Apple’s rights on the smartphone platform, only in the aftermarket, where Epic alleges Apple is behaving in a monopolistic manner. It argues that Apple cuts off choices (such as downloading apps from websites) that are available to consumers in other markets.

Epic said Apple had a 40% revenue share of all smartphones sold from the first quarter of 2016 to the first quarter of 2020. Epic noted that Apple’s iPhones sell for $300 or more, with an average selling price of $790 during this period. Among smartphones that sold for $300 or more, Apple had a 57% revenue share and a 49% unit share. Those aren’t necessarily monopoly market shares, but the question is whether Apple still gets monopoly power because the cost of going with an alternative is so high.

Since Apple cut off Epic’s access to the App Store, Epic has seen a 60% drop in its daily active users on iOS. Epic might never see those users come back. That’s why Epic said it could suffer irreparable harm unless the court acts quickly and issues a temporary restraining order.

Apple notes that it isn’t doing anything different from other “walled gardens,” like Sony or Microsoft. While Apple doesn’t have a monopoly in the presence of Google’s Android, Epic argued the duopoly has negative effects on the market and that Apple, rather than Google, has the most valuable users. Epic noted that two-thirds of the profits are on Apple’s platform and that Apple has a virtual lock on a billion highly desirable users who spend more than those on Android. In his testimony, economist David Evans argued on Epic’s behalf that the cost of switching is very high for anyone thinking about moving from iOS to Android. It’s basically like starting over. And it says Apple basically has a lock on a billion high-paying users.

At least one antitrust expert found that argument convincing.

“It pretty much all comes down to market definition. And if you define the market the way Epic has been, you know, Apple is a monopolist,” said antitrust attorney Valarie Williams, a partner with Alston & Bird’s Antitrust Practice team, in an interview with GamesBeat. “They have all these restrictive practices” that could get them into trouble with the courts.

While the Android market is a real and larger alternative to Apple’s App Store and iOS market, Williams said that Epic argues that the switching costs between the markets are high and that makes it hard for both developers and users to switch to another market.

The payment case

Above: Epic takes a swing at Apple.

Image Credit: Epic Games

The payment side is another antitrust battleground. For digital purchases, Apple requires developers to use its own payment service, which is not the case with other platforms, like the PC. But in select cases, Apple permits app makers to use other forms of payment.

Epic pointed out that in the case of app developers who provide physical services, like ridesharing, app makers can use other payment processing systems. Stripe provides in-app payment processing for Lyft. And Braintree handles payments for Uber, among other things. These app developers typically rely on payment processors that are not from Apple or Google because the developer must enable the user to complete a transaction while using the app. But with digital content apps, Apple requires developers to use Apple’s in-app purchase payment processing for in-app transactions. At the same time, Apple permits alternative digital payments when people are using premium video entertainment apps, such as Prime Video, Altice One, and Canal+.

Epic said this is proof that developers have material demand to use third-party payment processing services for in-app transactions in the absence of restrictions Apple has imposed. Epic said users could use alternative payments with much lower transaction fees, such as Amazon Pay, Authorize.net, Braintree, Chase Merchant Services, PayPal, Square, Stripe, and Xsolla.

Apple argues that payments aren’t a separate business; they’re part of a larger business. The company said, “Even setting aside the dispositive law on two-sided platforms, Epic’s factual allegations provide no support for defining IAP as a separate single-sided product market. Where the alleged tied product is an essential ingredient of the overall ‘method of business’ that is sold to customers, courts view them as one product.”

Epic has also argued that Apple acted like a monopolist in rejecting cloud gaming apps that violate its payment system and app distribution monopoly from vendors such as Facebook, Microsoft, Google, and Nvidia. These might become separate antitrust cases, but while those companies have complained, they haven’t taken legal action yet.

Apple’s arguments

Apple criticized Epic for laying the groundwork for its lawsuit in advance, calling it a “sneak assault.” Apple said Epic used “subterfuge” in the form of a “hotfix” to change Fortnite so it could use a direct payment system that circumvented Apple’s cut. Epic technical executives argued such hotfixes are extremely common in the industry and that this wasn’t a case of a digital “Trojan Horse,” as Apple had termed it. But Apple said the hotfix was clearly intended to get around its security and payment system.

While Epic claimed the emergency started when Apple cut off Fortnite and then threatened to unplug the Unreal Engine, Apple called the situation a self-inflicted harm. Apple said Epic could simply return to the App Store with the prior version of Fortnite and pay some commissions while the lawsuit is pending.

“The harm raised by Epic here is completely avoidable — here and now. The asserted harm to Epic customers, whether of Fortnite or Unreal Engine, can be ended by Epic,” Apple said. “All of the users and developers that Epic asserts are at risk are disadvantaged only because Epic’s scheme included breaching its agreements and running into court for relief. Epic has put customers and developers in this position, not Apple.”

Williams said she believes the EU’s charges against Apple will be relevant to the Epic case, but she noted that Europe is more aggressive about pursuing monopoly cases than U.S. regulators are. Williams noted that if Epic wins, a lot of other app makers and developers will benefit as well. Still, while she believes the case is winnable, Williams believes that it will be a hard case. One reason is that Apple doesn’t treat every app developer the same, as companies like Lyft can do different kinds of payments than Epic can.

Among other things, Epic said Apple’s removal of Fortnite from the App Store will stunt Epic’s efforts to build the Metaverse, the universe of virtual worlds that are all interconnected, like in novels such as Snow Crash and Ready Player One. Epic describes the Metaverse as a multipurpose, persistent, and interactive virtual space.

Epic said Fortnite already bears many characteristics of the Metaverse, as it “fosters deep community, it’s an immersive experience centered around lasting social connection, it’s a playground to be anybody, yet it’s the most authentic expression of our true authentic selves.” Epic cited the flow of ideas in the social space of the game as a reason it could challenge and perhaps replace Facebook, Snapchat, and others. Epic noted that “major tech companies are focusing on the Metaverse frontier and have made significant investments, and Fortnite puts Epic ahead in this race.”

But Epic said the success of Fortnite’s evolution into a Metaverse depends on having a large user base, which will make interacting there a better experience for potential new users. Epic argued that mobile users are critical to the base. Over 116 million registered users have accessed Fortnite through iOS, more than on any other platform. They have spent more than 2.86 billion hours in the app. By eliminating many of these players from Fortnite and blocking its capability to access over a billion iOS users, Apple could irreparably harm Epic’s chances, and the company says Apple is threatening its ability to create the Metaverse. Apple has denied this argument.

An essential facility?

Above: Epic Games wants to free Fortnite in Europe.

Image Credit: Epic Games

Antitrust law often grants relief to plaintiffs who argue that the defendant denied them the use of an “essential facility,” such as a toll bridge across a river. But Apple argued, “The courts have well understood that the essential facility theory is not an invitation to demand access to the property or privileges of another, on pain of antitrust penalties.”

Apple said Epic claims Apple has denied it access to iOS but that this is “simply false.” Apple noted that even after it removed Fortnite from the App Store, Epic is still making Fortnite sales via existing iOS users. Apple said the App Store is not a public utility and that Epic has no right to reap “all the benefits Apple and the App Store provide without having to pay a penny.”

The App Store — and the idea behind it — has succeeded beyond anyone’s wildest expectations, Apple said. It began with 500 apps in 2008. Since then, the App Store has grown to 1.7 million apps. Apple said its human curators vet more than 100,000 apps a week in 81 languages.

“While Epic and its CEO take issue with the terms on which Apple has since 2008 provided the App Store to all developers, this does not provide cover for Epic to breach binding contracts, dupe a long-time business partner, pocket commissions that rightfully belong to Apple, and then ask this court to take a judicial sledgehammer to one of the 21st century’s most innovative business platforms simply because it does not maximize Epic’s revenues. By any measure, the App Store has revolutionized the marketplace and greatly benefited consumers and app developers like Epic. Apple looks forward to defending against Epic’s baseless claims,” Apple said.

Apple contends that its App Store was built on numerous innovations and that it should be rewarded by being allowed to charge what it wants. It notes that if the innovations were not valuable, it wouldn’t be getting paid so much money by so many developers. Apple also notes that its payment system is the way it ensures it gets paid.

“If developers can avoid the digital checkout, it is the same as if a customer leaves an Apple retail store without paying for shoplifted products: Apple does not get paid,” Apple said.

Apple added that the commission is hardly unique.

“Google’s Play Store, the Amazon Appstore, and the Microsoft Store, and many video game digital marketplaces, such as Xbox, PlayStation, Nintendo, and Steam, all have similar fees and requirements to use the marketplace’s official in-app purchase functionality,” Apple said.

Apple argued it has made big investments in security for the App Store and iOS over the years. If it allowed Epic to enable direct payments inside Fortnite, circumventing Apple’s own payment system, the company said it would run the risk of exposing users to security breaches.

The company said its concerns about Epic’s request were “hardly theoretical.” Apple noted that in 2018, Epic announced the Android version of Fortnite would be available through sideloading, rather than through the Google Play store. Apple said websites appeared to advertise the Android version of Fortnite, but those sites also distributed malware inside the game and Epic failed to police them.

Apple said that by 2019, Epic acknowledged that security vulnerabilities in non-iOS versions of Fortnite exposed hundreds of millions of players to being hacked. Apple said, “Although Apple does not leave it to any developer to keep the iOS platform safe and secure, Epic, in particular, had demonstrated that it could not be entrusted with this type of responsibility.”

Epic has previously called this an exaggeration of the problem related to security.

The facts behind the arguments

Above: Epic Games says Apple’s 30% cut is unreasonable.

Image Credit: Epic Games

Epic argued that it already has evidence users want an alternative app store with direct payments. It said 54% of iOS Fortnite users had used Epic’s direct payments from August 13 to August 27. Incidentally, I wondered why Epic didn’t just sue after Apple rejected an email request for Epic to handle direct payments for Fortnite and circumvent the App Store. Evidently, Epic wanted to demonstrate that Fortnite users had a real desire to use alternatives to Apple, so it made changes to its app via the hotfix to enable the direct payments in Fortnite that led to Apple’s crackdown.

During those same weeks, iOS daily active users of Fortnite declined 60% after Apple cut off further downloads and prevented updates for the app. Epic also said that 63% of Fortnite users on iOS access Fortnite only on iOS.

Apple said it has invested heavily in making application programming interfaces (APIs) for all developers in iOS 14. Apple also said it handles more than 25 million customer support cases a year through AppleCare and handles $500 million in refunds per year. Apple also boasted that the iOS app economy has become one of the fastest-growing sectors of the economy, accounting for more than 2.1 million jobs in the U.S. in all 50 states, up 15% since last year, as part of the 2.7 million jobs Apple supports in the nation.

Apple also pointed out that it doesn’t have a monopoly when it comes to Fortnite. It noted that Epic itself said “of the more than $1.8 billion earned by Fortnite in 2019, less than 12% came from iOS.”

Factual disputes

Above: Fortnite remains a popular game.

Image Credit: GamesBeat

Apple made a couple of claims that are easily disproven. When players tried to download updates for Fortnite on iOS, or if they tried to download the app after August 13, they saw a message from Apple that said, “The developer has removed the app from the store.” Epic pointed out that this was untrue and that Apple had removed the app. It’s a small point but one that shows how each side is angling to win the hearts and minds of players.

Even more absurd is Apple’s claim that Epic’s Sweeney asked for a special deal. Apple pointed to an email Sweeney sent to Cook on June 30, apparently asking for a special deal.

According to Apple, “armed with the apparent view that Epic is too successful to play by the same rules as everyone else — and notwithstanding a public proclamation that Epic would ‘not accept special revenue sharing or payment terms just for ourselves,’” Sweeney asked for a side letter that would exempt Epic from the rules against enabling direct payments to a developer from app users. Apple said it rejected Epic’s request for a special deal, after which Epic resorted to its legal campaign.

But this point was easily fact-checked. Sweeney said in a tweet that in his email he specifically asked Apple to make the same conditions Epic was seeking available to all developers. In other words, Sweeney asked for a special deal for Epic and asked that all developers be given the same deal — consistent with his previous public claims.

Apple’s statement is misleading. You can read my email in Apple’s filing, which is publicly available. I specifically said in Epic’s request to the Apple execs, “We hope that Apple will also make these options equally available to all iOS developers…” https://t.co/yRio08fPSy pic.twitter.com/HsqjApFQeo

— Tim Sweeney (@TimSweeneyEpic) August 21, 2020

The legislative wild card

All this legal wrangling is happening amid other controversies involving the tech giants. Apple has had to delay its move to retire its Identifier for Advertisers (IDFA) after opponents argued it would disrupt the mobile ecosystem in the name of improving privacy without replacing it with an alternative. And Congress hauled the CEOs of Apple, Google, Facebook, and Amazon before a committee to question them about possible anticompetitive practices. If Congress or government agencies find that these companies violated antitrust laws, the results could prompt federal cases and Congress could make the current antitrust laws more stringent. U.S. Senator Amy Klobuchar, Democrat from Minnesota, applauded the EU’s decision to sue Apple.

Whatever happens with Apple and Epic following these opening arguments, the dispute could take years to adjudicate in the courts.