Apple's App Store payments loss isn't Epic enough

The court's decision to force Apple to permit use of external payment systems for in-app payments probably won't hurt the company's bottom line too much.

Apple, Epic, App Store, mobile, developers, apps
Apple

The first 185-page Apple-v-Epic judgment didn’t please anybody when it arrived on Friday. Apple will be required to permit people to pay for apps and in-app purchases using third party payment services that  developers will be entitled to link to.

Epic is appealing the decision, but it's interesting that while it sued Apple and Google over the 30% fee, it has not started litigation against Nintendo, Microsoft, or Sony — all three of which charge the same fee at their online stores.

What does the ruling mean?

Judge Yvonne Gonzalez Rogers’ ruling means that when you pay for a Spotify subscription or some in-app power up you may be given a link that lets you pay through payment systems other than Apple.

I guess developers will get to choose which payment systems to use, but I imagine Apple will still be able to insist on its payment systems being a choice. Developers will have a choice. Some will offer their apps/services at up to 30% less than the equivalent cost via the store; others will try to keep the extra change. Some will not bother offering alternative payment systems; others can’t wait to do so.

What this means in practice

What the judgement has done is set in motion a new kind of competition at the App Store, and if it happens there, it will happen elsewhere. After all, if Apple is required to open for payments competition (even a little), so logically should every other app store provider. Basically, app store payment systems just became a new competitive space, and while that’s bad for Apple’s bottom line in the short-term, it may be able to turn that challenge around.

What can Apple do?

Apple can compete. The judge noted the 70% profit margin generated by App Store sales right now, which is incredibly high and shows why Apple’s existing 30% margin should change. At the same time, Apple’s payment systems are relatively robust and some of the benefits of using them somewhat unsung. That’s going to change.

Apple will simply double down on illustrating the inherent benefits of its own payment systems and work to make the experience of using them better.

What sorts of things might improve?

There are lots of things Apple can do to improve its system. The judgment pointed some of these out, including dispute resolution between developers and customers. Other enhancements might include prompt resolution and a promise to return cash accidentally spent when kids get hooked on in-game purchasing.

The company may consider the customer inducements other payment processors provide and then cherry pick the best of them. Apple can focus on its strengths in usability and customer experience design to help ensure that, when given a choice, consumers continue to select its brand for in app payments.

Will consumers use alternative payments?

While Apple must now permit developers to include links to alternate payment systems in their apps, will consumers use them? I’ve seen several analysts conclude that the actual impact of the judgement against Apple will be minimal. Wedbush analyst Daniel Ives estimates a 3% revenue hit, but predicts: “The vast majority of consumers will continue to use the App Store for in-app purchases.”

Why might this be?

I think the friction of the payment processing services developers choose to deploy will make a difference. I also think many smaller developers (which most are) will simply not bother offering alternative payment systems. For its fee, Apple provides fraud protection, payment processing and payment-related customer support, which means customers and developers have a point of trust.

Not all customers are equal

One big take-away from the details in the ruling is that more than half of all App Store in-app revenue is generated by less than 0.5% of customers.

“In the third quarter of 2017, high spenders, accounting for less than half a percent of all Apple accounts, spent a ‘vast majority of their spend in games via IAP’ and generated 53.7% of all App Store billings for the quarter, paying in excess of $450 each.”

The inference is clear. Developers will need to deliver buying experiences that focus on the needs of that most premium customer segment. That's not going to be an easy market to please.

Will developers offer alternative payment systems?

As a result of the litigation, we now know thyat around 70% of App Store revenues are generated by games. Games also deliver 98% of in-app purchase revenue. That means games developers are especially likely to offer their own payment processing alternatives.

Developers who achieve the most success will be those who can deliver a more elegant and user-focused payment experience than Apple already does. Consumers will soon identify the also-rans and eventually we’ll see perhaps half a dozen big names in the App Store payments space.

In the absence of scale, proprietary payment systems are unlikely to be able to match the user experiences offered by larger payment providers. In this scenario, it seems inevitable that PayPal, Stripe, and other majors will emerge as Apple’s main competition. Smaller operators will be hard-pressed.

The impact? Developers may find they no longer need to pay 30% (or 15% for most developers) to Apple but will still be forced to pay something to their chosen payments services provider(s). The only real question is how much they need to pay and what kind of service they – and their customers – get in exchange.

Why isn’t Epic happy?

One of Epic’s main aims has been to force Apple to permit sideloading of apps. The games developer has argued users should be able to install apps from outside the App Store, just as Mac users can. The court didn’t agree.

Epic is also unhappy as it has also been required to pay Apple the App Store fees it avoided when it broke its developer agreement to offer sales outside Apple’s system.

The court felt Apple’s App Store model was justified based on security, competition and intellectual property rights. In other words, it will not permit Epic or anyone else to offer alternative stores or stores within a store. All it will permit is a slightly more open approach to payments.

Is Apple a monopoly?

It isn’t seen as one right now. Rogers rejected arguments that Apple is a monopolist, but did warn the company is:

“Near the precipice of substantial market power, or monopoly power, with its considerable market share. 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 plaintiff [Epic] did not focus on this topic.”

Apple must now work hard to ensure it stays on the safe side of that precipice.

What happens now?

The App Store is not going to change immediately. Apple has been given 90 days to comply, Epic has already appealed the ruling, and Apple may file its own appeal. It’s reasonable to expect months of legal wrangling before anything changes.

The judge also said it is logical that some fees are paid at some level. “However, it is also true that, with few exceptions, not every business is entitled to have access to what is effectively shelf space if they cannot afford to pay a commission to the platform host," she said.

In terms of damage control, we can speculate that Apple could begin supporting these external payment systems early next year when it has already said it will enable such support in Reader apps. That's not to say it definitely will do so, just that it could.

How can Apple make it all go away?

I don’t think Apple can make Epic happy. At the same time, I believe it can end most of this litigation by proposing a 15% rate for App Store fees and accepting third-party payments as it has been told it must. While there will be a cost, such action would almost certainly end most outstanding litigation and negative publicity.

But doing so will also define the rules of engagement. By coalescing around 15%, Apple may lose revenue, but it will also be telling everyone that in order to compete, developers and payments providers will need to be able to deliver a payment experience on the App Store equal to the one Apple already provides for that same fee or less.

I suspect doing so inside a 15% margin will turn out to be challenging. It certainly challenges Epic, which (the court documents suggest) runs an 88% to 12% revenue share on its own store (which the judge said runs at a loss). That 30% take may be too high, but 12% is too low. Ultimately the only negotiation is around how much it should cost.

One more thing

Apple makes the platform developers use to create the apps they sell. It also makes the tools developers can use to build those apps. The App Store and hardware sales help finance software development today, but Apple will need to find new revenue to make up for any lost because of the mandated App Store payment change.

Apple has some options available.

In the short term, it may choose to raise the at-present nominal annual fee it charges developers for access to its developer tools. It may link that fee to a developer’s revenue, or charge a distribution fee to carry anything other than free apps.

In the longer term, however, I believe Apple will not find the impact of the current court-mandated change to go as deep as many anticipate, with most consumers and developers continuing to use its own payment systems, because they are used to them and already feel trust.

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