Apple’s Mounting Antitrust Woes
Apple is under antitrust siege in the United States. But it does not end there. The European Commission has opened an investigation into Apple’s conduct in its App Store.
United States
The antitrust challenges began in the United States when Robert Pepper filed a class action suit on behalf of iPhone owners. In essence, the plaintiffs alleged that they had been overcharged for apps due to Apple’s commission. The district court dismissed the suit for lack of antitrust standing. The court of appeals reversed, and the case went to the Supreme Court.
At the Supreme Court, the sole issue was whether Pepper had antitrust standing to sue Apple for antitrust damages. Writing for the majority, Justice Kavanaugh made this clear that the merits of the case were not under consideration. Instead, the sole question was whether Pepper had antitrust standing. Justice Kavanaugh found that Pepper did have standing to sue Apple. The case was remanded to the district court for further proceedings.
In dictum, Justice Kavanaugh observed that the app developers might also have standing to sue Apple. Shortly after, Donald Cameron filed a class action suit against Apple on behalf of app developers, alleging that they were injured by Apple’s commission. At the time of writing, both Pepper and Cameron are before Judge Rodriguez in the Northern District of California.
Apple also has been sued by Epic Games, the developer of Fortnite, a game played by over 116 million Apple users. When Epic tried to avoid Apple’s commission on in-app purchases (IAP), Apple made good on its threat to ban those who did not follow App Store rules and removed Fortnite from the App Store. In response, Epic sued Apple.
European Union
To compound Apple’s troubles, the EU began a formal investigation into the App Store in June 2020. Based on a complaint filed by Spotify in 2019 and the complaint of an e-book/audiobook distributor, the EU is investigating whether the mandatory use of Apple’s IAP system and restrictions on informing consumers of alternative purchasing methods should be considered anticompetitive. The EU is concerned that Apple exploits its role as a “gatekeeper” in the distribution of apps to limit competition for its own proprietary apps and services, such as music, email, and streaming services. Generally, developers respond to Apple’s mandatory IAP system by either incorporating the commission in their profit functions or disabling payment services within their app. Apple does not allow them to steer potential users to alternative purchasing sites, which increases search costs for iPhone owners. Presumably, a key question before the EU is whether these actions make Apple’s own apps and equipment features more desirable.
Additionally, the EU is concerned that Apple may be collecting data from its competitors, which it uses to its own unfair advantage. Telegram, a messenger app, Tile, an app that helps users find lost items, and Rakuten’s Kobo, which sells e-books, have filed complaints in the EU against Apple. If the investigation by the European Commission results in a final complaint, other disgruntled app developers are likely to complain.
Apple’s Mandatory Commissions
Apple forces app transactions into its App Store, which allows it to extract fees. First, all developers must pay an annual $99 fee to maintain a developer account. Next, Apple extracts a mandatory 30 percent commission on the initial purchase price of all positively priced apps. Recently, Apple reduced its commission to 15 percent for any developer whose annual sales revenue falls below $1.0 million.
If a developer wants to include in-app purchases, he or she must use Apple’s software and pay a 30 percent commission on all transactions. These transactions include purchases of in-app content, such as enhanced game features, or digital goods, such as e-books. Subscription services, such as Spotify and Netflix, are also subject to the 30 percent commission, which is reduced to 15 percent after the first year. Although Apple allows users to access previously purchased content, all in-app purchases are subject to the fee. This may be short lived. At least two states, Arizona and North Dakota, have considered legislation that would preclude Apple and Google from requiring app developers to use their in-app purchasing systems. More states may follow suit.
In addition, app developers are not permitted to inform users of alternative purchasing options, even if they do not sell content through the app. For example, an iPhone owner who downloads the Kindle app can access all previously purchased e-books. Since Amazon did not activate Apple’s IAP system, however, users cannot purchase new e-books from the Kindle app for their iPhone and are not informed of how to purchase content elsewhere.
Many developers find the commission objectionable, especially since they often must raise their prices or forgo IAP, which reduces their profit and the user experience. Epic Games is one such company that increased its prices to compensate for Apple’s commission. One thousand V-bucks, which are in-game currency, cost $9.99 when using Apple’s IAP system, while only $7.99 otherwise. Additionally, Apple’s commission may be restrictive. During the coronavirus pandemic, ClassPass, an app that allows users to register for in-person gym courses, offered virtual fitness classes. When it switched to digital services, Apple’s 30 percent commission applied to its sales. In response, ClassPass removed the virtual fitness classes from their Apple app and thereby reduced the quality of its service.
There is no doubt that Apple incurs some cost for maintaining the App Store and developing its IAP system, which benefit iPhone owners and app developers. The App Store offers convenience, quality control, security, and privacy safeguards, which improve the iPhone owner’s experience. Additionally, Apple offers developers promotion, sales, and payment services along with development tools and support. These qualities can be considered procompetitive since they differentiate the iPhone from Android products. Apple’s critics nevertheless object to Apple’s refusal to allow any competing app stores, which they claim reduces innovation and choice for iPhone owners and app developers and allows Apple to charge supracompetitive prices. For example, most payment services, such as PayPal, charge approximately 3 percent for every transaction, which is one-tenth of Apple’s 30 percent commission.
If the benefits of transacting business in the App Store outweighed the costs, iPhone owners and app developers would not resist using the App Store. But recent complaints by iPhone owners and various app developers demonstrate a reluctance to rely exclusively on the App Store. First, Apple does not allow other app stores on its iPhone. Second, Apple has embedded technology in the iPhone that precludes downloads outside the approved App Store. To avoid the App Store, an iPhone owner would have to engage in “jailbreaking,” which allows users to bypass Apple’s security restrictions so that they can download any software, including software not approved by Apple. But jailbreaking is not a major competitor to the App Store. First, it requires technical skills that most iPhone owners probably do not have or care to learn. Second, downloaded software not subject to Apple’s rigorous security checks may contain malware and viruses, making jailbreaking risky. Additionally, Apple introduced software into its phones that made jailbreaking more difficult and also threatens to invalidate the warranty on any jailbreaker’s iPhone. Third, most apps are inexpensive and, therefore, there is not much to be gained by avoiding Apple’s commission. The warranty on a $1000 iPhone is probably worth much more to most iPhone owners than any savings on commissions. Apple could argue that minimizing jailbreaking is procompetitive as it enhances security and differentiates the iPhone from Android phones. Those iPhone owners who would be willing to bear some additional risk in exchange for enhanced flexibility, however, may be harmed. Additionally, Mac laptop owners are not subject to the same security restrictions, which begs the question of why they are necessary on iPhones.
Apple also discourages app developers from bypassing the App Store by threatening expulsion from the App Store, which would foreclose developers from access to millions of iPhone owners worldwide. Before selling apps, app developers must enter Apple’s Developer Agreement, which forbids them from selling apps to iPhone owners outside the App Store and precludes them from creating competing app stores.
Recently, Apple has offered convincing proof that expulsion is no idle threat. When Epic Games set up its own IAP system in Fortnite, Apple expelled it from the App Store. Shortly thereafter, Google, whose Android system serves the vast majority of remaining smartphone owners, also expelled the game from its Play Store for similar reasons.
United States
The antitrust question for the courts is whether Apple’s allegedly coercive and punitive conduct constitutes a violation of Section 2 of the Sherman Act. Although Apple’s conduct is difficult to pigeonhole, an argument favoring liability can be made using the Supreme Court’s decision in Eastman Kodak v. Image Technical Services. Kodak sold copiers in what the Court found to be a competitive market. Those who owned a Kodak copier constituted an installed base of customers for the aftermarket for repair parts and services. The Supreme Court found that this aftermarket was monopolizable and that Kodak was guilty of monopolizing the market for services. Using the same logic, one could argue that Apple has monopolized the market for third-party apps, but with a twist.
In Kodak, the concern revolved around an installed base of consumers. In other words, Kodak exploited the owners of Kodak copiers. In a case against Apple, much the same argument could be made. The difference is that Apple does not set monopoly prices in the aftermarket for third-party apps. Instead, the economic reality is that Apple has a monopoly on the location in cyberspace where transactions between iOS app developers and iPhone owners take place. Apple goes to great lengths to ensure that app developers can only sell apps to iPhone owners through its App Store. There is ample evidence that Apple has monopoly power in this market—there are no practical substitutes such as other app stores—and Apple is able to charge a substantial commission on each transaction. Moreover, Apple has excluded the possibility of entry by other app stores. Due to Apple’s restrictions, a new entrant would be unlikely to attract iOS app developers or iPhone owners. Assuming that a court finds Apple’s conduct to be a Section 2 Sherman Act violation, Apple’s commission would appear to be an unlawful ad valorem tax.
European Union
The European Commission has launched an investigation to determine whether Apple reduces competition for apps that compete with its own apps. Apple’s control of its App Store would most likely be considered “dominant,” according to precedent in its Google Android case. The next question is whether Apple’s creation of a bottleneck violates Article 102 of the Treaty of the Functioning of the European Union (TFEU), which applies to any action taken by a dominant firm that may have the effect of reducing competition and thereby harming consumers. Proving liability may be easier in the EU than in the U.S., since the investigation focuses on the market for those apps that directly compete with Apple. Presumably, defining a market would be simpler. In any case, there is ample cause for concern as evidenced by the following three examples.
First, app developers who directly compete with Apple on various services, such as Spotify with Apple Music or Netflix with Apple TV, have asserted that they are disadvantaged by Apple’s commission. Not only does the commission reduce app developers’ profits, the commission also goes to a competitor.
In a series of articles with various co-authors, Steven Salop introduced and refined the strategy of raising rivals’ costs (RRC). The fundamental concept involves increasing the costs of one’s rivals and thereby gaining a competitive advantage. Before Apple began offering Apple Music, Spotify raised its price for premium services in the App Store from €9.99 to €12.99 thereby passing on the 30 percent commission to its subscribers. Apple Music launched in 2015 and charged €9.99 for its own premium music streaming services. In response, Spotify opted out of IAP, thereby precluding users from subscribing to premium music through the Spotify iOS app. From an RRC perspective, the commission raised Spotify’s costs so that it could not compete with Apple’s own music streaming service in the App Store. Although users can still download the Spotify app and stream music through a previously purchased premium subscription, they can no longer pay for premium services through the app, which diminishes the user experience.
Second, Apple can use its dominant position to reduce the quality of competing apps. For example, Tile, which sells tags that allow users to find items such as keys or wallets using their phones, sent a letter of complaint to the European Commission and testified in Congress that Apple was using its dominance to make Tile an inferior app. Tile users must periodically allow Tile continued access to location services, while Apple’s Find My users do not. Also, for the iPhone 11, Apple does not allow Tile to access UWB radio, which gives accurate location information and sends reminders to users if they leave an item behind. In effect, these policies reduce the quality of the Tile iOS app and make it easier for Apple’s Find My app to compete.
Third, Apple may foreclose rivals by using its App Store policies to unfairly eliminate competition for its apps. For example, shortly before the launch of its own screen-time tracking app in 2019, Apple notified developers with similar apps of policy changes that would require them to limit the functionality of their apps or face removal. A few of these apps, which allow users to control the amount of time they or their children spend on their devices, were removed from the App Store with little explanation. Allegedly, the multi-device management software the apps used made the apps “unsafe,” even though other apps that used this software were not affected. Moreover, Apple’s screen-tracking app was an inferior service since it had restricted functions and did not allow parents to control their children’s Android devices. In response to criticism, Apple eventually reinstated these apps to the App Store. As a further example of Apple’s foreclosure of competing apps, Coronavirus Reporter, which claims Apple unlawfully foreclosed its COVID tracking app from the App Store, is filing suit against Apple.
Apple plays the role of gatekeeper for millions of app transactions between iPhone owners and app developers. The temptation to reduce competition by raising rivals’ costs, reducing the quality of third-party apps, or foreclosing rivals may be irresistible.
Apple’s Commissions and Economic Reality
Apple’s commission is a 30 percent ad valorem tax that Apple levies on each purchase in its App Store. Under normal conditions, an ad valorem tax is borne in part by the seller (app developers) and in part by the buyer (iPhone owners). The mechanics of the transaction and the transmission of the tax receipts are not economically relevant. Concentrating attention on the mechanics is apt to result in a “form over substance” error.
It is tempting to fall into the Illinois Brick trap of searching for the direct seller in an underpayment case or the direct buyer in an overcharge case. In Apple Inc. v. Pepper, both the majority and the dissent fell into this trap and missed the economic reality of Apple’s commission system. Justice Kavanaugh, writing for the majority, found that iPhone owners were direct buyers from Apple and, therefore, had antitrust standing to pursue private damages. In contrast, Justice Gorsuch, writing for the dissent, argued that iPhone owners were not direct buyers from Apple and implicitly argued they should not be granted standing under Illinois Brick.
Pepper has been remanded to the trial court for further proceedings. Unfortunately, if the trial court is misled by the Supreme Court’s economic misconceptions, it is doubtful that the correct outcome will materialize. It is crucial that the trial court understands the economic reality of this case. It is essential to recognize that Apple does not buy and resell apps. Consequently, Apple is neither a direct seller nor a direct buyer. Instead, app developers sell their apps directly to iPhone owners. Due to Apple’s coercion, however, these transactions must pass through the App Store bottleneck. As they do so, Apple siphons off a 30 percent commission. This commission is an ad valorem tax with well-known economic consequences.
Identifying who pays the commission is informed by tax incidence analysis. The key is to find the pre-tax price received by the seller and paid by the consumer. This price can then be compared to the post-tax price received and the post-tax price paid. The differences—if any—identify the tax burden. When the demand is negatively sloped and the supply is positively sloped, an ad valorem tax is borne in part by the seller and in part by the buyer. In other words, the post-tax price received will be below the pre-tax price received and the post-tax price paid will exceed the pre-tax price paid.
There are, however, special cases in which the burden of the tax will not be shared. First, if demand is perfectly inelastic, i.e., vertical, and supply is positively sloped, the consumer will pay the full tax. Second, if supply is perfectly inelastic and the demand is negatively sloped, the seller bears the full burden of the tax. Third, for a perfectly elastic supply, the tax is borne by the consumer irrespective of whether demand is perfectly inelastic.
Irrelevance of the Mechanics
It is important not to allow the mechanics of collecting and transmitting the tax to the taxing authority to cloud the fact that both buyers and sellers share the tax burden. Consider the following scenario in which a taxing authority demands a 6 percent sales tax. A consumer enters a retail shop to buy a jacket. He turns over $106 to the merchant. She sends $6 to the taxing authority and puts $100 in her pocket. Who paid the tax? It looks like the consumer paid the tax. He received a jacket that the seller was willing to sell for $100, but he had to pay $106. In a sense, he paid $100 for the jacket and $6 to the taxing authority—he paid the tax. But there is another way to look at this transaction. The buyer paid $106 for a jacket. The seller received the $106 but had to transmit $6 to the taxing authority and, therefore she paid the tax. Hence, the mechanics of collecting and transmitting the tax are economically irrelevant.
The economic reality is that the tax is borne by both the consumer and the merchant under most economic circumstances. In the absence of the tax, the transaction price would fall between $100 and $106, say, for example $104. In that event, the consumer would have paid $2 of the $6 tax while the merchant would have paid $4 of the $6 tax. The same analysis is true for apps sold in the App Store and the Google Play Store. Recognizing the economic reality is crucial for identifying the victims and properly measuring their antitrust damages.
Private Antitrust Damage Suits
In the United States, private antitrust damage suits are governed by Section 4 of the Clayton Act and the Supreme Court’s interpretation of the statutory language. We argue that both iPhone owners and app developers should have antitrust standing to pursue damage claims under Section 4 of the Clayton Act, assuming that Apple’s conduct violates Section 2 of the Sherman Act. Moreover, the damage claims will not be duplicative and there will be no need for complex apportioning. We extend this analysis to the EU. If Google’s conduct in the Google Play Store is considered anticompetitive, injury and damages for smartphone owners and app developers can be computed in the same way as for Apple.
Antitrust Damages
The Supreme Court defined antitrust damages in its Bigelow v. RKO Radio Pictures opinion. Plaintiffs must compare the actual price paid or received to the price but-for the antitrust violation. The difference is the cognizable damage assuming that the plaintiffs have accounted for any other factors that may have influenced the actual prices.
Following this guidance, it is clear that both iPhone owners and app developers have experienced antitrust damages. The iPhone owner pays more for an app than he or she would have paid had there been no unlawful commission. The app developer receives a lower price than he or she would have received had there been no unlawful commission. For both iPhone owners and app developers, the difference between the actual price paid or received and the but-for price captures the antitrust damage. The but-for price falls somewhere between the price paid and the price received. Then, the sum of the damage claims of the iPhone owners and the app developers will be equal to the total commissions collected on the specific app in question.
In principle, this damage calculation is no more complicated than any other antitrust damage calculation. Ordinary business records will provide the information on the actual price paid and received and the actual quantity of apps transacted. The challenge lies in estimating the but-for price. This may be no mean econometric feat, but it is not impossible. Moreover, it is precisely the same task that would be performed for any ordinary overpayment claim.
Those app developers that have been expelled from the App Store or have been forced to lower their quality due to Apple’s restrictive policies have suffered lost profits on lost sales. If this conduct was inappropriate, the developers should have standing to sue for the lost profits. Estimating this loss would not be easy, but it is not an impossible task. Suppose, however, that the expelled app developers could have mitigated their damages by paying the commission and abiding by Apple’s rules. In that event, an argument can be made that an expelled app developer should recover only the commission that it would have paid had it continued to sell apps through the App Store. In most cases, the unlawful commissions will likely be smaller than the lost profits.
Private Damage Suits in the European Union
In the EU, the victims of violations of Article 102 of the TFEU may sue to recover the antitrust damages suffered. Unlike in the U.S., indirect victims have standing to sue under Article 102. Consequently, if iPhone owners sued in the EU, the confusion created by the mischaracterization in Apple Inc. v. Pepper would not be a problem. The Court of Justice of the European Union held in Otis GmbH that plaintiffs can sue for damages as long as their injury can be causally linked to conduct that violates Article 101 (or 102) of the TFEU. There is no doubt that Apple’s commission can be linked to higher prices for iPhone owners and lower prices for app developers. The conduct also makes it more difficult for third-party apps to compete with Apple’s own proprietary apps. The difficult question is whether Apple’s conduct, which is under investigation by the EU, violates Article 102. Assuming Apple violates the TFEU, the damages can be determined in the same way as we have described above.
Practical Issues for Litigation
It is not clear just how the judicial system will be able to manage the private litigation that may ensue. There are over 1.8 million apps offered in the App Store, around 15 percent of which have positive prices. With about 270,000 apps potentially affected by the 30 percent commission, there could be tens of thousands of potential complaints by app developers. Yet, class actions would seem to be problematic.
Class treatment is appropriate if there is common proof, that is, if proof for one is proof for all. Since Apple’s rules apply to everyone, all developers and all iPhone owners would be forced into the App Store irrespective of which apps are involved. Since the burden of ad valorem taxes is ordinarily shared by buyers and sellers, app developers and iPhone owners seem to be impacted in the same way. Damages, however, are idiosyncratic. Demands and prices will be different depending on which app has been developed and sold. For example, Apple could argue that app developers who develop a music streaming app should not belong to the same class as app developers of gaming apps. It is obvious that much further thought must be devoted to these practical issues.
Conclusion
Apple uses its dominant position to create a bottleneck, which forces app developers and iPhone owners to transact their business in its App Store. In other words, Apple monopolizes the location where app transactions take place. For its efforts, Apple charges a commission on each transaction. The economic reality is that Apple’s commissions are ad valorem taxes that are borne in part by iPhone owners and in part by app developers. If Apple’s conduct violates the antitrust laws of the U.S., both iPhone owners and app developers should be permitted to pursue private damages. Recognizing this economic reality is important not just for the cases currently being litigated or investigated in the U.S. and the EU, but also for future cases against Google or others who monopolize the location of transactions in physical space or cyberspace.
