The DeanBeat: Sorting through the steamy evidence in Apple v. Epic Games

The game industry has been buzzing about the Apple v. Epic Games antitrust lawsuit since testimony in the three-week trial began on Monday. The arguments aren’t surprising, but much of the material coming out of the trial extends far beyond the battle between these two companies.

I remain interested in it for three reasons. First, I believe 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. A second reason is that interesting details about how the game industry really works are accidentally leaking out.

Lastly, the trial has had some occasional hilarious moments, like when gamer kids took over on Monday morning — screaming as if they were in the lobby of their favorite game — when they learned their microphones to the trial were live. Another moment was when I saw the 2015 email Epic Games CEO Tim Sweeney sent Apple CEO Tim Cook asking for iOS to be more open. Cook’s reply to his executive team was, “Is this the guy who came to one of our rehearsals?” This show of cluelessness is an indication of the company’s level of appreciation for the game industry. Sweeney was asking Cook (starting out with the greeting “y’all”) to separate App Store curation from compliance review and app distribution.

When I sort through files available in the evidence, I never know what I’m going to find. I’m sure many companies in the secretive game industry consider the disclosures to be disastrous, but this information can surely benefit those who have been operating in the dark.

The federal court of Judge Yvonne Gonzalez Rogers of the Northern District of California in Oakland accidentally shared documents publicly that were supposed to remain private. Many documents in the file have very little to do with whether either party has the better argument in the dispute, in which Epic contends that Apple has used illegal monopoly power to close off competition in the distribution of apps and the payment systems for those apps. But Epic is powerful enough to challenge Apple in court, while many smaller developers wouldn’t dare.

Apple’s own position is that it has innovated on everything from its Metal application programming interface (API) to enable great games on its platform at its own expense to the fact that its royalty rates are far lower than the 70% that publishers used to take before the iPhone.

The evidence that matters

Let’s start with the evidence related to the case itself. In opening statements, the lawyers laid out each side’s argument.

Epic pulled out statements referring back to former Apple CEO Steve Jobs’ intentions to “lock in” consumers in Apple’s ecosystem, in opposition to rivals such as Google.

Epic said Apple no longer earns the 30% fee it has charged since the launch of the App Store. Epic compared this to Apple getting a share of the purchase price of a car and then getting a 30% share of money paid for gas for the car every time the driver refuels. Epic also noted that Apple’s profit margin on its App Store is 78%.

Epic has also said Apple controls payments through its own payment system, even though rival payment systems work perfectly well. And it noted Apple does not uniformly enforce its policies, as it allows Uber to use a different payment system because it is in a different app category from Epic.

In testimony yesterday, an App Store executive struggled to define activities on Roblox — a platform for user-generated games — as something other than games. If Apple isn’t able to define the experiences on Roblox as something other than games, that would suggest Apple treats one game maker (Epic Games) differently from the way it treats another (Roblox). While Apple has said that it doesn’t do special deals with developers — and that’s one reason relations went downhill with Epic — evidence has surfaced about how some apps are treated different. Hulu, for instance, was one of the “whitelisted apps,” based on an Apple email. Another email talked about Tribe, a game that was banned because it had “mini games” in it, and that happens to be in the same category of game as Roblox, which has never been banned by Apple.

The case will live or die on how the court defines the “relevant market” for evaluating anticompetitive behavior. If that market is just the App Store, Apple could be declared an illegal monopoly. But if it is the whole games market, Epic has no case, as Apple has less than 50% of the global smartphone market and only accounts for 7% of global Fortnite revenue, compared to 46.8% for Sony’s PlayStation platform.

Epic said Apple has behaved as a monopolist by erecting barriers within its App Store, freezing out other payment systems that could lead to lower prices for consumers. Epic also says Apple has a lock on a billion users who spend a lot of money on games and that switching costs are high enough to leave consumers effectively without much choice in the market. (Sweeney at one point expressed interest in knowing the valuation of Xsolla, a payments company, and if Epic needed a full stack payments solution).

Apple argues that it has plenty of rivals in PCs, Android, Sony, Microsoft, and Nintendo. And Apple notes all of those platforms erect their own walled gardens and charge 30% royalties. (Microsoft changed to 12% royalty for its Windows store but not its Xbox store, which remains at a 30% royalty.) Apple also said internal data showed the cost of switching phones can be as high as 26%.

But Epic has a good counter. Since its launch on iOS on March 16, 2018, Fortnite has generated 88 million downloads and $631 million in revenue. On Android, Fortnite has generated 80 million downloads and $47 million in revenue since August 13, 2018. That shows a huge difference in how willing iOS users are to spend money compared to Android users and means Android isn’t really that viable a competitor to the iOS App Store.

Recode’s Peter Kafka opined that it’s OK for Apple to have a monopoly on content distributed on its devices and that it should retain that control, as should companies like Sony, Microsoft, and Nintendo. But he argued that Apple should not have the freedom to push developers around with rules that stop them from mentioning other retail options for things sold in Apple’s App Store. The judge could very well change the industry by ordering Apple to stop such practices — even if she ultimately rules in Apple’s favor on most matters.

I think whenever Epic argues in this case that it should gain an advantage over Apple for itself, it will lose. Apple should not be forced to cut a special royalties deal with Epic simply because Fortnite is a popular app.

But whenever Apple’s decisions impact the prices consumers pay, I believe Apple will likely lose. Apple has planted the idea that Sweeney was seeking a special deal to cut the royalties Fortnite pays to Apple, which have been stuck at 30% for big game makers. (Apple has pointed out at every opportunity that in the second year of a subscription, the rate drops to 15% and that Apple recently instituted a 15% royalty rate for small business app makers.)

Sweeney pointed out that he hoped Apple would extend any discounted rate Epic got to other developers, and he has also said Epic is suing on behalf of all developers and is not seeking any damages from Apple. But oddly enough, when asked point-blank if he would have taken a special deal, Sweeney said yes. That’s at odds with Sweeney’s contention that Epic has brought this lawsuit on behalf of all developers. And such an admission could lead both the judge and the developer community to conclude Epic’s bluster is just a marketing ploy.

Epic started a lot of its anti-Apple and open platform campaign in a keynote talk that Sweeney gave at the Dice Summit in February, 2020. He took Apple and Google to task in that talk about how their behavior wasn’t good for consumers or competition. It had the sting of antitrust allegations, and he called Android a “fake open system.” He also highlighted the struggles to make Fortnite into a crossplay game where friends could play with friends on other systems. At the end of the day, I asked what some industry leaders at a town hall thought of Sweeney’s speech, and Ted Price of Insomniac Games (now owned by Sony) praised Sweeney’s words.

Epic’s own plan for “Project Liberty” noted that the tide was turning against Apple and Google, as they have unhappy customers, negative press, and multiple investigations in the U.S. and the European Union. Project Liberty had both a legal strategy and a public relations strategy. As an example of the latter, Epic’s Daniel Vogel worried that the inability to update Fortnite on iOS would result in users getting mad at Epic for causing the legal hassles.

At every chance it gets, Apple has pointed out that Epic is a big company. Epic recently raised $1 billion at a $28 billion valuation. (We won’t mention that Apple’s market value is $2.16 trillion). Apple has painted itself as the victim, saying Epic conducted a sneak attack by launching the antitrust suit. Sweeney testified that Epic generated gross revenue of $5.1 billion in 2020, compared to a plan (in chart below) for $3.8 billion in 2020 revenue. That compares with our own discovery that in 2019, Epic Games reported $4.2 billion in revenue and $730 million in earnings before interest, taxes, depreciation, and amortization (EBITDA, a key measure of profitability).

How the dispute started

In the events leading up to this case, Epic asked Apple for permission to charge and advertise a lower royalty rate, a request Apple turned down. Then Epic performed a “hotfix” — updating its app in the middle of the night on August 13, 2019.

Epic offered its V-bucks virtual currency (which people use to buy things like skins in Fortnite) for $8 on the Epic Games Store and enabled players to conduct that transaction through a link in its app. Players immediately began buying lots of V-bucks on the link to Epic’s site. After Apple learned about this, it declared Epic in violation of its policy disallowing such sideloading and shut down Fortnite on iOS. Epic implemented the same workaround on Google Play, and Google likewise shut it down. Then Epic filed antitrust suits against both Apple and Google. It also launched a cartoon video explaining why Apple was wrong to do this and unveiled a campaign to “Free Fortnite.”

It turns out Epic had been planning this move for a long time, according to the “Project Liberty” slide deck for its entire plan, which was included in the court documents. The goal was to end the “anti-competitive 30% tax on the Apple app and Google Play stores. In that deck, Epic said it is “prepared to fight as long as it takes and will not back down from direct payments” that would enable it to offer lower prices and a way around the 30% tax.

Epic concluded that it would be a long protracted battle, the time was ripe given the egregiousness of Apple and Google’s stances, the downside was mitigated by Epic’s business performance, and all consumers and developers would benefit alongside Epic from “freeing the industry from payments and store monopolies.”

While Android allows sideloading, Apple does not, citing security concerns. Apple noted that Epic’s Android version of Fortnite had such bad results on the security front that Epic was forced to go back into the Google Play store.

Both companies have fired shots at each other over security issues. Apple acknowledged in one email that 128 million people were affected by the XcodeGhost malware. In emails, Apple executive Phil Schiller complained to his team that Apple’s security was embarrassing, with numerous security issues and instances of fraud. But Sweeney had a moment of embarrassment in 2019 when he had to apologize to Ubisoft CEO Yves Guillemot because at one point 70% of downloads of The Division 2 game on the Epic Games Store were fraudulent, forcing Epic to halt sales.

In one email, Epic executive Daniel Vogel said “payment fraud is an existential threat to our store.” Apple will likely point to this as evidence that Epic isn’t capable of providing app security in a store.

Apple also noted that its iOS devices accounted for only 1.72% of all malware infections, compared to 26.6% for Android and 38.9% for Windows. Epic pointed out that Apple allows sideloading on the Mac, without being as restrictive as it is about security for the iPhone.

Apple, meanwhile, noted that Sweeney tried to enlist the help of Apple competitor Microsoft’s games leader Phil Spencer in a scheme to call out Apple on its alleged anticompetitive practices — before filing the lawsuit, as a kind of marketing blow — even while alleging that Apple was far more powerful than all competitors and that competitors like the PC and the consoles, which Microsoft produces, don’t matter. While Spencer said he couldn’t react quickly to Sweeney’s request to cut royalty rates, he said that he would try. Sweeney replied that he hoped Spencer would enjoy the “upcoming fireworks show” just a week later with the August 13 clash with Apple.

Both Microsoft and Nvidia testified about the hoops they had to jump through in order to get cloud gaming apps on Apple’s store. They ultimately chose to go through the Safari web browser — through the open web — because Apple had put so many restrictions in place. Apple wouldn’t let them get away without paying a 30% fee per cloud game played, even though the business model for both services is to charge a monthly fee so players can play as many games as they want.

Apple’s greatest weakness in this case is the special rules it puts in place that seem arbitrary and capricious — what Epic calls the actions of a company trying to preserve an illegal monopoly. But Epic’s greatest weakness may be the contortions it has gone through to argue Apple has a monopoly when it clearly has competitors.

Perhaps Epic’s greatest hope is that the European Union, which just sued Apple after Spotify made a complaint similar to Epic’s, will rule in Epic’s favor even if the U.S. courts do not. Regulators may eventually change the rules to stop Apple from throwing its power around.

Other surprising facts leaking out

Now let’s consider things that aren’t as relevant to the case. One is a category I would call “collateral damage,” in which a partner of Epic’s gets splashed with damage. Sony is friendly to Epic, having invested hundreds of millions of dollars in the company. But under questioning, Sweeney confirmed that Sony is the only platform owner that requires Epic to pay compensation for crossplay, or enabling people to play with friends no matter what platform they are using to play a game like Fortnite. Sony extracted a payment from Epic, while other companies did not. That sounds like anti-competitive and anti-consumer behavior.

But as long as Sony has competition, it’s not a monopoly, either. And as long as it’s not a monopoly, it can play with bare-knuckle rules like any capitalist. Apple, on the other hand, has to hold back because it is so much bigger, and its actions can be interpreted as antitrust violations.

Another thing that spilled out was a complete list of the games Epic made available for free in its Epic Games Store and how much Epic paid developers for the right to keep their games exclusive and available in order to increase the number of store accounts.

Epic buying users

GameDiscoverCo’s Simon Carless found documents that mentioned the details of Epic’s game giveaways in 2018 and 2019. Subnautica had more than 804,000 users when Epic Games gave away the game on its then-new Epic Games Store. Epic gave the developers $1.4 million, and roughly 17% of the players were new to the Epic store. On average, the cost of acquiring each new user was $2.36. That means the giveaways were a relatively inexpensive way to acquire new users.

For Borderlands 3, Epic paid $146 million in advances to have the game as an exclusive on the PC. Epic recouped the minimum guaranteed fee of $80 million for marketing, bundle deals, and fees. Additional marketing cost $15 million, and there $20 million in non-recoupable fees. Bundle deals drove the cost up another $31 million. Overall net revenue was $9.2 million.

And it got more than 1.56 million players. Of those, 53% were new to the store. Epic lost around $181 million on the Epic Games Store in 2019 and projected it would lose around $273 million in 2020. By 2024, Epic expects to make $45 million in gross profit on $1.1 billion in gross revenue.

With this evidence, Apple might be able to point out how hypocritical Epic’s claim is. Epic is buying market share, and rivals like Steam could claim this is anti-competitive behavior. Epic’s answer is that Steam could lower its royalties from 30% to 12%, as Epic has done, and Epic would stop. But again, Epic can do this because it doesn’t have a monopoly.

One of Epic’s own slides pointed out why this makes sense. Once you get a user to sign up for an account, and that user begins to spend money, you can calculate the lifetime value of that user. For Facebook, the lifetime value of its users is $465 billion. For Activision, it’s $39 billion. Per user, Facebook can make $192.65 per user. Activision makes $119.58 per user. So long as you spend a lot less than that to acquire each user, you’re making money.

In an October 2019 document, Epic had 20.7 million unique users for the Epic Games Store. A paid game netted 2.2 million users. About 49% were new to the store. The average revenue per paying user was $52.70. Total lifetime revenue was $116 million. For a free game, Epic netted 18.5 million users, with 7%, or 1.32 million users, converting to paid users over time, for a life-to-date average revenue per paying user of $42.42. Total lifetime revenue was $56 million.

Over five years, from 2019 to 2024, Epic expected to sign about 110 deals with game makers to get their games on the store through some kind of free deal. It was willing to spend above $1 billion to acquire those titles. In an aggressive scenario, it expected to have 34 exclusive deals with minimum guarantees. In this plan, it would capture 50% of all PC revenue if rival Steam didn’t react. By 2024, Epic expected to make $1.17 billion in gross revenue and a profit of $12 million. By that time, Epic would be launching 340 new titles and 250 catalog games per year. But its cumulative losses over five years would amount to $680 million.

Microsoft’s testimony

Apple complained that Epic surprised it by naming Lori Wright, Microsoft’s vice president of business development, as a witness. One of Wright’s comments got picked up internationally, as she articulated a well-known but never officially disclosed fact: Microsoft loses money on every console it sells.

She was there to testify about Microsoft’s attempt to launch a cloud gaming app, Project xCloud, on the iOS store and confirmed that Microsoft sells its Xbox consoles at a loss. (Microsoft uses a “razor and razor blades model,” losing money on the razors and making money on the blades — with the console the razor and the games the blade.)

An Epic Games lawyer asked, “Does Microsoft ever earn a profit on the sale of an Xbox console?”

She replied, “no.”

Another document from Microsoft was an evaluation of the competitive exclusive games in the console market, and it included a full review of Naughty Dog’s award-winning game The Last of Us Part II. It included criticisms about how Naughty Dog still couldn’t make “decent gun combat” in any of its games, including this one.

In 2018, Xbox leader Spencer had a discussion with Sweeney on email about the sticky problem of “cross purchases” in Fortnite, where one player might spend money to buy Fortnite currency, V-bucks, on one platform and redeem the currency by buying an item like a skin on another platform. That becomes an issue if, because of subsidies in the console model, it costs more to buy currency on Xbox than it does on other platforms like the PC. Spencer said he wanted to work through this.

Industry profits

Still another document from Microsoft spelled out the profitability levels of the top publishers on the consoles, mobile, and browsers. Those making more than $1 billion in profit from software and services included Tencent, Apple, Sony, Google, NetEase, Nintendo, Microsoft, Activision Blizzard, EA, and Epic. The document said that publishers captured 66% of total industry profit.

The document noted that total game industry profit in 2018 was $50.5 billion and the profit margin was 33%. Mobile was No. 1 in both profits ($26.5 billion) and revenues ($86.5 billion). By contrast, PC revenues were $31.9 billion and PC profits were $10.4 billion. Fortunately for Microsoft, much of the company’s own financial data was redacted from this document. Epic Games was the outlier on revenues at more than $4.5 billion thanks to Fortnite, while Sea (Garena) was No. 1 in profit margin thanks to its Free Fire free-to-player shooter game.

For the same year, Sony had an estimated $13.3 billion in game software and service revenue, and a 31% earnings before income taxes (EBIT) margin. Nintendo had $5.2 billion in such revenue and a 45% EBIT margin. Ubisoft was the weakest in this group with $2.2 billion in revenue and a 9% profit margin.

One email exchange talked about how Apple was concerned about a CNBC reporter who was doing a story on Apple’s app reviewers, with some of their names and work location. Apple tried hard to keep that secret, but some details were included in that story. With some relief, Apple noted that it paid its reviewers properly in contrast to Facebook.

The documents also show Fortnite’s budget in 2017, how much Epic paid various vendors for outsourcing tasks, and a redacted copy of Epic’s agreement with Microsoft to publish Fortnite on the Xbox One game console.

Epic took great pains to enable crossplay on Fortnite on all platforms. It succeeded, but its documents showed that Epic pays money to Sony for allowing crossplay, while Epic doesn’t pay any money to others for that purpose.

A whole email thread in 2018 bon this subject was contained in one court document, capturing a conversation (with redactions) between Sweeney and Sony’s Phil Rosenberg. Sweeney warned that Sony’s “interoperability restrictions have put both of our companies in an untenable position adversarial to our customers. Many Fortnite players are kids, and their friendships are being torn apart by Sony’s segregation of players on competing platforms.”

He added, “Frankly, we do not believe Sony’s position is even legal,” based on analysis of European Union law. Rosenberg tried to appease Sweeney in his messages. And Sweeney emphasized how Epic believed cross-platform play was both a “legal right and moral duty” and that it should join Apple, Google, Microsoft, and Nintendo in enabling crossplay.

According to a presentation in June 2020, Fortnite had 81 million monthly active users, the Epic Games Store had 45 million monthly active users, and Epic’s Unreal Engine had 540,000 monthly active users. Epic is under no obligation to disclose these numbers as a private company, but now they are out in the open.

Sweeney testified that Fortnite transcends gaming, with special entertainment features such as concerts and films. He believes it’s a contender for metaverse, a universe of virtual worlds that are all interconnected, like in novels such as Snow Crash and Ready Player One. He said Apple’s actions stand in the way of Epic’s goal of creating a true metaverse.

More funny moments

The court has game consoles in the courtroom for demo purposes. Sweeney was asked to assemble a Switch and its Joy-Con controller. He failed and admitted, “As you can see, I’m not a Switch player.”

Judge Gonzalez Rogers replied, “Well, now the world knows.”

The companies are treating this as a kind of life-or-death battle when it comes to the future of the game industry, the rights of game and app developers, and the freedom to innovate. But let’s hope that the three weeks of the trial produce more funny moments, like when a lawyer asked Sweeney, who has many important things to do, “What is a game console?”

I don’t know if the judge, who will decide this case rather than a jury, really needs that kind of elementary background. But the back and forth has been a bit mind-numbing as we wait for more exciting testimony to surface. I’m looking forward to watching Apple executives take the stand soon, and the whole world will be watching.

[Updated: 12:38 p.m. 5/8/21 with more details and court documents]