Epic Games wins injunction favoring alternative payments in antitrust lawsuit against Apple

A federal judge today ordered Apple to change its policies and enable developers to use alternative payment systems in their apps in a ruling in Epic Games antitrust lawsuit.

The permanent injunction could permit game and app makers to sidestep Apple’s 30% commission that it has had on the App Store for more than a decade, but that seems like a longshot based on a closer reading of the verdict. That commission generates billions of dollars a year for Apple.

The 185-page order from U.S. District Court Judge Yvonne Gonzalez Rogers in Oakland, California. She ruled that Apple violated California’s laws against unfair competition. Still, she ruled in favor of Apple on other important counts in the complicated antitrust lawsuit.

For instance, she favored Apple on a breach of contract allegation that stemmed from Epic deciding to enable alternative payments for its Fortnite players. In August 2020, Epic updated Fortnite with a “hot fix” to enable payments through the web, and  Apple removed Fortnite from its App Store. This prompted the antitrust suit from Epic. A similar confrontation happened with Google, and Epic’s antitrust lawsuit against Google is still pending. Epic and Apple argued their case before the judge in a 16-day trial with more than 900 exhibits and testimony from the likes of Epic Games CEO Tim Sweeney and Apple CEO Tim Cook.

The case is an important conflict between a platform owner and a powerful game company that could set the rules of engagement and competition in an era that will be filled with giant tech and game companies. A lot of money is at stake here.

When Apple set up the App Store in 2008, it instituted a 30% commission on every in-app purchase transaction. While Apple may have earned that commission with the investments it made in the App Store and the iPhone, Epic argued that it effectively became a tax that sucked billions of dollars out of the game industry and should have been reduced. Epic’s own store, the Epic Games Store, takes a 12% commission. Apple believes the fee is necessary for its continuing operating costs, but Epic offered evidence at the trial that Apple makes a lot of profits from the fees, while Apple said it could not calculate the actual profits. The court did not find that to be credible.

The judge noted Epic’s expert, Ned Barnes, calculated that Apple’s operating margins on the App Store are above 75%. Epic argued that Apple’s commission would be like a car dealer taking a fee on the sale of a car and then taking more fees every time someone put gas in the car.

Above: Epic takes a swing at Apple.

Image Credit: Epic Games

The judge’s order takes effect in three months, and Apple will have a chance to appeal. Under the ruling, Gonzalez Rogers found that marketplace owners such as Apple can set their own marketplace terms, but she directed Apple to end its rules that prohibit game companies from communicating with players and steering them to better deals elsewhere.

Apple had put in place “anti-steering” policies that directed developers to use its payment system — which generates the 30% commission — in part because it reduced security and privacy risks for players. The judge pointed out this enables Apple to monetize its intellectual property, and she noted evidence supports the argument that consumers value these attributes of privacy and security and trustworthiness.

Apple had argued that Nordstrom does not advertise prices inside Macy’s stores for its goods. But the judge said Apple created a “black box” where it enforced silence around competitive pricing elsewhere.

The judge found that Apple’s security argument was a valid reason for keeping developers inside its walled garden, and not just a pretext to block competition. She also found that Epic had a good argument with its argument for security provided by an “enterprise model” or “notarization model,” where Apple would certify companies that are found to have good security practices.

Under the injunction, Apple is permanently stopped from prohibiting developers from including external links or other calls to action that direct players to alternative payments.

“Looking at the combination of the challenged restrictions and Apple’s justifications, and lack thereof, the court finds that common threads run through Apple’s practices which unreasonably restrains competition and harm consumers, namely the lack of information and transparency about policies which affect consumers’ ability to find cheaper prices, increased customer service, and options regarding their purchases,” Gonzalez Rogers ruled.

The judge said Apple uses these policies so it can extract high commissions from the highly lucrative gaming industry. The anti-steering rules stop consumers from learning from developers that there may be lower prices on their websites.

A partial Apple victory

Above: Epic’s argument about its antitrust case.

Image Credit: Epic Games

Gonzalez Rogers said that Apple does not have a monopoly in the market of digital mobile gaming transactions under either federal or state antitrust laws. Because Epic failed to persuade the judge on this argument, many of the remedies under antitrust law also fail, the judge said.

She ruled that the relevant market for antitrust assessment is the digital mobile gaming market, not gaming generally, and not Apple’s own internal operating systems related to the App Store. She noted that the digital mobile gaming is a $100 billion-a-year market.

Measurement firm Sensor Tower estimated that overall consumer spending on Apple’s store hit $72.3 billion in 2020, with Apple taking a $21.7 billion fee. Mobile game spending was $47.6 billion, with Apple taking a $14.7 billion fee.

In doing the relevant market analysis, the judge found that Apple’s own operating system is not a “foremarket,” as she said it is “illogical to argue that there is a market for something [in this case, iOS] that is not licensed or sold to anyone.” She also noted that Apple has only 15% of global market share in the smartphone market. Market power determines whether a company can raise prices with impunity. Apple hasn’t raised its commission for the App Store. Monopoly power is different in that it has the power to control prices or exclude competition.

In terms of market share, the threshold for monopoly power is generally no less than 65% share, the judge said, and the Supreme Court has never found a party with less than 75% share to have monopoly power. There have been exceptions, based on evidence in antitrust cases, such as whether rivals are barred from entering the market. Apple’s revenue share is estimated to be 55%, or at least in a range of 52% to 57% over the course of three most recent years. It’s also worth noting that Google has a much larger share of the actual users compared to Apple.

Still, the judge said it was worth examining the state of the market, and she noted that Apple is “near the precipice of substantial market power, or monopoly power, with its considerable market share.”

But she found that neither party presented evidence of market barriers that would justify court action.

Gonzalez Rogers also rejected Epic’s claim that the App Store is an “aftermarket,” where Epic argued consumers are locked into Apple because of high switching costs, or the difficulty of moving to other smartphone types such as Android. Apple argued the switching between platforms is low because consumers are satisfied with Apple products, and Epic did not rebut that.

Epic supplied email evidence suggesting how Apple executives tried to keep consumers on its platform. But the judge said, “The court reads the email to suggest that Apple sought to compete by distinguishing their product, and in the process, making its platforms ‘sticker.’ That, however, is not necessarily nefarious.”

Above: The Lebron James skin in Fortnite.

Image Credit: Epic Games

She also noted that Apple has 55% market share in terms of revenue and “extraordinarily high profit margins,” but these factors alone do not show antitrust conduct and “success is not illegal.”

Apple’s general counsel Kate Adams said in an email to GamesBeat:

We are very pleased with the court’s ruling and we consider this a huge win for Apple. This decision validates that Apple’s “success is not illegal,” as the judge said.  As the court found “both Apple and third-party developers like Epic Games have symbiotically benefited from the ever-increasing innovation and growth in the iOS ecosystem.”

The court has confirmed, after reviewing evidence from a 16-day trial, that Apple is not a monopolist in any relevant market and that its agreements with app developers are legal under the antitrust laws. Let me repeat that: The court found that Apple is not a monopolist under “either federal or state antitrust laws.”

We are still analyzing the decision which is 180 pages long but the headline is that Apple’s app store business model has been validated.  The court correctly rejected Epic’s “artificial” view of the competitive environment in which Apple operates and determined that “developers like Epic Games have benefited from Apple’s development and cultivation of the iOS ecosystem, including its devices and underlying software.” Underlying the App Store business is a framework, including App Review, curation and protection of the security and privacy of our users. The court has ruled that this framework is lawful and Apple was justified in terminating Epic’s status as a developer on the App Store. Apple’s rigorous process for app review protects consumers.  As the court observed, “security and privacy have remained a competitive differentiator for Apple.”  The court agreed, and I quote, that “by providing these protections, Apple provides a safe and trusted user experience on iOS, which encourages both users and developers to transact freely and is mutually beneficial.” Importantly, the court also recognized the value of Apple’s ever-increasing innovation and growth of the iOS ecosystem.

The judge did pay attention to the fact that Apple has competition from Google’s Android platform in one respect. She noted that consumers who value the privacy and security focus of Apple can choose its “walled garden,” while those who value open distribution can choose Android devices. This is not great consolation for Epic, as it is also suing Google for alleged antitrust violations. Epic failed to prove that Apple’s focus on security was just a pretext for walling itself off from competition.

The judge also found that it was OK for Apple to terminate Epic’s Developer Program License Agreement (DPLA), and so Epic was liable for breaching that contract. Epic has to pay 30% of the $12.2 million it collected from Fortnite app users on iOS through direct payment to Epic between August 2020 and October 2020, plus 30% of any revenue collected since. That amounts to about $4 million that Epic must pay to Apple.

Apple retained the right to terminate this agreement if a company, in this case Epic, breached the terms of that contract. The judge found that Epic did so by issuing the hot fix for Fortnite that enabled sideloading for a way to users to purchase in-app currency in Fortnite without going through Apple — the whole event that triggered the litigation in August 2020.

And by terminating that license, Apple could very well prevent Epic from keeping its Unreal Engine — which is used by many game developers to make compatible iOS games — as current as it needs to be for games. This part of the ruling could be devastating for Epic and its Unreal Engine and its customers. On top of that, it may be why Apple can still block Fortnite from the App Store. These are matters where we’ll find out with more clarity what is or isn’t part of the judge’s ruling.

Epic wins

Above: Epic Games is debuting a new Ferrari car in Fortnite.

Image Credit: Epic Games

But that’s where Apple’s partial win ends. The judge said “the trial did show that Apple is engaging in anti-competitive conduct under California’s competition laws.” In particular, the “anti-steering provisions hide critical information from consumers and illegal stifle consumer choice.”

The judge found that the anti-steering rules that Apple put in place put in barriers to entry, as users may not be aware that cheaper game distribution is available on alternative platforms because Apple prohibits developers from advertising that in-app to gamers. This doesn’t create a lock-in, but it is a barrier. The introduction of the mobility-focused gaming platform Nintendo Switch in 2017 showed that the barriers are not so high that they deter new competition of any kind, the judge said.

Moreover, Microsoft and Nvidia have introduced mobile game streaming via cloud services. And the judge noted that Valve announced its own Steam mobile device recently.

She said, “Apple is only saved by the fact that its share is not higher, that competitors from related submarkets are making inroads into the mobile gaming submarket, and, perhaps, because the plaintiff did not focus on this topic.”

The court found that Apple’s app distribution restrictions do have some anticompetitive effects. One measure of that is the extraordinary profits that come from the 30% commission, which has no bearing to Apple’s actual costs. The suggestion from the judge was that the commission should be tied to real-world costs and monetization of intellectual property.

On September 1, Apple agreed to permit outside links for signups for what it called “reader” apps like Netflix and Spotify, following a regulatory probe in Japan. And South Korea implemented a new law to require alternative payment systems in that country. By ordering the same in the U.S., the judge agreed with the logic of that law. But it isn’t clear if developers can entirely avoid Apple’s 30% fee, as the judge noted that one of the inconveniences for Apple here is that it will become harder for Apple to collect its commission. The judge did not say Apple had no right to collect a commission, nor did the judge say Apple has to lower the 30% fee.

In a tweet, Epic’s Sweeney said that the ruling isn’t a win for developers or for consumers, a reference to the fact that the judge did not find Apple to be an illegal monopolist.

Today’s ruling isn't a win for developers or for consumers. Epic is fighting for fair competition among in-app payment methods and app stores for a billion consumers. https://t.co/cGTBxThnsP

— Tim Sweeney (@TimSweeneyEpic) September 10, 2021

The judge noted that evidence shows that most App Store revenue comes from games, not all apps, and so focusing on the mobile gaming is appropriate. And she said that the mobile game consumers are different from console gamers, again suggesting that they are separate markets. She also noted that there are two related lawsuits pending against Apple in Pepper v. Apple and Donald Cameron v. Apple, both alleging antitrust violations.

Gonzalez Rogers found that Apple’s rules, such as simplistic refund rules, increase the risk of fraud for developers, and its payment rules often give developers poor information when something goes wrong with a transaction. Epic also argued that a lack of direct connection to consumers — something that Apple blocks — denies it key analytics about its consumers.

“Ultimately, Epic Games overreached,” the judge concluded, though she noted the trial record wasn’t as complete as it could have been in arguments such as the discussion of the relevant market. And she noted she would issue a separate judgment based on the findings of fact and create a separate permanent injunction regarding remedies.

Insight into gaming

Above: Epic Games wants to free Fortnite in Europe.

Image Credit: Epic Games

During the trial, a lot of secret information about the game industry and Apple and Epic Games surfaced. Epic, founded in 1991 by Sweeney, has more than 3,200 employees and was recently valued at $28.7 billion. Tencent holds 37% of the ownership, the judge said.

Epic’s Unreal Engine generated $97 million in revenue for Epic Games in 2019, while Fortnite generated 400 million downloads (to date) and billions of dollars in revenue. The revenue share on Apple over two years was $700 million in revenue from Fortnite across more than 100 million iOS accounts.

Epic’s own store has more than 180 million registered accounts and 50 million monthly active users, but it is not expected to become profitable for Epic until 2023. At the end of 2019, Sweeney conceived of a plan called “Project Liberty,” which the judge said was a “highly choreographed attack on Apple and Google.”

The judge noted that Sweeney testified under oath that he would have accepted a deal with Apple to give Epic benefits that involved no other developers. But Epic had been saying that it was fighting on behalf of all developers and advancing the cause of open platforms.

On Apple’s side, the App Store started in 2008 with 452 apps, and by the end of 2019, there were more than 300,000 game apps on the store and more than 30 million registered iOS developers. (Apple has removed over 2 million outdated apps).

The judge noted that Apple set a 30% commission at the outset and did not change that until recently (it charges 15% for small businesses making under $1 million, and 15% after a period for subscriptions). In the early days, Apple’s commission was viewed as generous for devs compared to rev shares on other platforms.

In 2016, games accounted for 81% of all App Store revenues, the judge noted. She also noted evidence that suggested high spenders, or 1% of all iOS gamers, generated 64% of game billings in the App Store, spending $2,694 on average annually.

There are some things in the ruling that neither Apple nor Epic would like.

The judge noted, “From what little evidence there is in the record, these consumers frankly appear to be engaging in impulse purchasing and both parties’ profits from this sector are significant. This specific conduct is outside the scope of this antitrust action, but the court nonetheless notes it as an area worthy of attention.”

Perhaps the only consolation for both parties is that they can (and are fully expected) to appeal. And Epic will have a chance for a “do over” in the next trial that is pending, its antitrust lawsuit against Google, and it could find more sympathetic ears in places like the European Union.

Those who remember the trial may be reminded of all the kids who jumped on the call at the very outset demanding that the judge “free Fortnite!” That doesn’t look like it will happen very easily here, as it may be up to negotiations between Epic and Apple.

[Update: The story was updated multiple times as of 12:23 p.m. 9/11/21 to include more details from the ruling].