Epic vs Apple: Two Tims to Tango
Sweeney won't win this one, but Cook can still lose.
The lawsuit over app store rates between Epic Games and Apple that started last week is the most compelling content that the industry has produced in years.
After more than a year of buildup, when Epic first kicked Apple’s shins and found itself promptly booted off its platform, fight night is finally here. The outcome has the potential to up-end Apple’s grip on the $85 billion mobile games market and amplify antitrust regulations for Big Tech.
Background
I previously covered how platform holders have increased their control over the games market as a result of digitalization and the popularization of the smartphone. To be clear, platform holders aren’t necessarily automatically the ‘bad guys’. It was the strict policies that allowed Nintendo to bring the industry back from the dead in the 1980s after it collapsed. Curation and control over the ecosystem are critical to commercial success in consumer entertainment markets.
To get a sense of what’s at stake and the impact any changes to either Apple’s policies or the broader regulatory environment may have, I’m including an overview chart of the ten biggest companies in worldwide games industry and a breakdown of their revenue.
Based on the money they make in interactive entertainment, the six largest firms in the industry are all platform holders. Certainly, they also are vertically integrated to varying degrees. Companies like NetEase and Activision Blizzard, the largest ‘pure play’ game publishers, rely on mobile for a substantial part of total revenues. That, in turn, gives them less leverage and any reductions in the app store rates has an immediate positive impact on their bottom line.
It is a hotly debated issue. The Epic/Apple case resembles at least two previous cases that resulted in a change in regulatory policy and a restructuring of industry: the 1984 AT&T divestiture and the 2001 antitrust case United States v. Microsoft Corporation.
The former resulted in the breakup of the American telephony system into seven subsidiaries because AT&T held a monopoly. The breakup brought the phone company’s value down by 70% but oxygenated the market (even if cellular telephony today in the US is still expensive. Can you imagine?).
The latter forced Microsoft to unbundle its internet browser (Internet Explorer) from its operating software (Windows) because it created barriers to entry for other software providers. Ultimately, the court determined that Microsoft held a monopoly over the PC market and that it deliberated acted to stifle innovation and competition by making life hard for third-party software.
Both serve either as case studies of effective regulatory control to the benefit of US consumers, or as a warning for American titans, depending on who you ask.
Against the broader background of a growing antitrust sentiment, the change in administration, and glaring data and privacy issues, my expectation is that, irrespective of the outcome, the Epic/Apple case will become a critical reference point as governments everywhere try to figure out how to deal with tech monopolies.
We’re not quite there yet, of course. But—stepping outside of my own industry echo chamber—proponents from both camps have started to emerge. There is the pro-business camp, which argues that regulation of the app stores would be disastrous. But so far, its claims are void of analysis and largely unsubstantiated. I’d welcome a data-driven assessment on how Big Tech maintaining a monopoly position in their respective industries benefits consumers.
A more nuanced approach comes from academia. According to my colleague Joost Rietveld, who writes extensively on platform strategy in gaming at the University College of London,
“we’re witnessing a classic example of a complementor, Epic, being non-cooperative with a platform holder.”
Naked bananas
An important reason to avoid a fight is that people get to see a side of you that you may not want them to know. From the start, everyone is cast into a new role.
Apple is discovering that throwing stones from its circular glass house in Cupertino is ill-advised: to make its case as a benevolent dictator, the consumer electronics firm sent no fewer than 42 lawyers to take on Epic’s 19. That’s a lot of muscle. And its opening statement was nothing short of fear-mongering:
“The result for consumers and developers will be: Less security. Less privacy. Less reliability. Lower quality. Less choice. All of the things the antitrust laws seek to protect.”
If you continue down this path, no good will come of it. Perhaps. But this lawsuit comes with a loot box that has a spectacular drop rate. I mean, have you seen it? It’s just one deck after another spreadsheet after another chart after another email brimming with supersecret information.
Delicious.
The games industry at large is conspicuously opaque. Despite the pleas from indies and academics for years, secrecy is an important competitive advantage for incumbents. To know this industry and its inner workings is a barrier to entry and what platform holders and publishers rely on. Their aversion to sharing information is both their greatest strength and greatest weakness.
And we’ve learned quite a few things so far.
Epic pays a pittance. A broad range of small and medium-sized game makers is necessary to populate its Epic Game Store catalogue but the dollars tell a different story. It is investing to build its user base and the competitive value of its digital storefront. At the center sits a grainy image of a table that listed a slew of well- and lesser-known titles and what Epic paid for them to be freely available in its digital storefront. It spent around $12 million to acquire 5 million new accounts.
Worse, adding up all those developers that received up to $150,000 for their game, we observe roughly the same number of new Epic users (1.5 million) as for the firms that received between $150,000 and $1,000,000 (1.76 million), or more than $1,000,000 (1.6 million new users). The lowest paid developers fetched roughly 2.4x less per user than the highest paid ones. That’s a bummer.
It confirms what we already knew, namely that indies suck at negotiating because they have no leverage (which BTW is why it is so important that we develop more business school programs). And, of course, that despite its self-declared altruistic behavior, Epic remains a for-profit organization.
Next, Epic’s flywheel isn’t. Not yet anyway. On paper the firm manages an integrated array of activities that each build on top of each other to create its own momentum. With a steady stream of acquisitions, fund raises, and public appearances, similarities in strategy between Epic and Disney have started to emerge. However, between its Unreal Engine, the rainbow-colored Fortnite/Rocket League/Fall Guys portfolio, the Epic Games Store, and its budding crossover business in music and movies, the ratios are still way off.
There is a vision here, of course. Epic is hoping to become a platform, too, by establishing itself across a variety of different activities. To accomplish this, Epic will subsidize its efforts and hope to attract both third-party content creators and new users in order to generate network effects and increase its gravitational pull. It is therefore typical to see a big deficit on a firm’s balance sheet. Roblox, too, still hasn’t reached profitability yet. Earlier this week it reported stellar figures for its 21Q1 earnings: revenue increased +140% to $387 million compared to 20Q1, but maintained a quarterly loss of $134 million. Roblox and Epic follow the same logic.
But the point of a flywheel is that a business establishes self-sustained momentum. Epic currently still relies for 88% on Fortnite’s success. Its other activities remain notably smaller. In order of magnitude, its digital storefront generated $233 million in 2019, roughly 6% of total, games other than Fortnite represented 2.4% with $100 million, the Unreal Engine made $97 million for 2.3% of total, and merchandise generated $82 million (2.1%). The stakes for Epic are arguably astronomically high: as a private firm looking to go public, it has in effect provided an unaudited, poorly edited S-1 filing.
Apple is de-cloaking, too, albeit not by choice. It is in its adversary’s interest to get into the nitty gritty of app store economics. Transparency is its ally. Apple, in turn, requested court testimony to be sealed so as to not “confuse” investors. It was denied. That resulted in the release of a bunch of noteworthy information. Granted, some of it is for the fans, but never before have we had such a cohesive look into Apple’s underlying corporate practices.
One thing that stands out to me is the absolute avalanche of app submissions and subsequent rejections. In 2019 Apple received 4.8 million submission and rejected 1.7 million (36%). That is a whole lot, indeed. And it gives some credence to Apple’s logic to enforce its policies firmly and explains why its team of “500 human experts” can often seem so ineffective. But it is difficult to find sympathy for one of the world’s most valuable and most profitable firms. That’s what the 30% is for. Hire some more people. I know medium-sized game devs that have more QA testers than that.
Apple’s biggest risk factor by far is presenting itself as a bully. To a degree, Apple is acting quite predictably: it is a platform holder that is enforcing the boundaries of its proprietary eco-system against one of its larger complementors. Unlike many of the smaller app devs out there that have to live with Apple’s decisions and have little recourse, the tech giant now finds itself in court. Because it is in effect one of the first and rare opportunities where it discloses how its regards the market and its role in it, we’re getting a clearer read.
Far from the glitzy, tightly-controlled product announcements and its mythical presentation of “one more thing”, Apple seems to be standing on the same ground as the rest of us. Remember how everyone thought Marc Zuckerberg was a robot after he testified to the US Senate? Or how Jack Dorsey seems completely insufferable? Tim Cook is too smart for that. He’s already successfully put the rest of Big Tech on the back foot by taking the position that “privacy is a fundamental human right.” But like his iPads, such a thing cracks easily.
Even so, transparency can work in Apple’s favor. Despite Epic’s claims, the release of internal memos and email weakens its position as a victim. Its defection from the App Store was deliberate.
That helps Apple’s case. But it has to be careful: where two fight, two are to blame. Is Apple being a self-serving monopolist that is extracting as much money from the ecosystem it built? Yes. Is Epic deliberately poking a bear and playing victim? Also yes.
Outlook
Epic won’t win this round. Judging from the conversation over the past week-and-a-half, I’d say Apple is looking stronger. Epic’s claim that Apple is a monopoly feels unconvincing since Fortnite is available across six different platforms. The very notion around cross-play demands this. More formally, the discussion around what constitutes a ‘relevant market’ is going to determine who is right.
If you’ve looked at the first graph with the circles (above) you’ll have noticed that Epic’s revenue share in mobile is 7.8% of total earnings, compared to 8.4% from PC and 84% from console. Critically, iOS serves as the connective tissue between players as they switch platforms throughout the day: in 20Q4 mobile accounted for 40% of new installs. It allows Epic to reach its Fortnite playerbase even when they’re not sitting at home behind their 55” TV set or custom PC rig. None of that changes that it simply broke its agreement.
Apple can still lose. A large part of what its argumentation has revolved around how hard it is for the world’s most expensive tech company to deal with scammy apps. Cry me a river. Not only that, Apple’s release of a self-congratulatory ‘news’ item on what a great job it does stopping all that fraud is suspicious and, in my opinion, entirely political. Being right isn’t always the best strategy.
Unlike its previous and far more intimidating CEO, whose brand of ‘loudership’ (get it?) gave us nicer computers, finding common ground now will avoid repercussions later. Apple is currently on a path of mistakenly honoring Steve Jobs’ legacy by not valuing content creators. He especially didn’t care for video games. But Steve isn’t running the company anymore. The team at Apple has to decide whether it is going to chill out a bit on its rates—win some goodwill and make life easier for creatives (“bicycle for your mind,” remember)—or treat the world the same way that Steve treated them.
Bonus
If the devilish details of this lawsuits aren’t enough for you, then perhaps the absurdist theater that is taking place is more your speed.
After a lengthy debate on what a game is (oof) and arriving at “an experience with games,” we were no wiser. It is proudly held tradition in the games industry to have its ontology, regulation, and raison d’etre discussed by those who know absolutely nothing about it.
During the questioning of each other’s practices around adult content, Matthew Weissinger, Epic’s VP of marketing, was asked about Fortnite’s humanoid fruit avatar, Peely.
Attorney: “Is there anything inappropriate about Peely without a suit?”
Weissinger: “No, there is not.”
Attorney: “If we could just put on the screen a picture of Peely — is there anything inappropriate about Peely without clothes?”
Weissinger: “It’s just a banana, ma’am.”
Finally, when quizzed on revenue models in adjacent app categories like dating apps, Adi Robertson, senior reported from the Verge, observed: “Everyone in the courtroom is extremely eager to clarify that they totally have no idea what Tinder is and have never used it.”
If you want to learn more, reporting on the case has been stellar. Perhaps encouraged by the flurry of revelations, a host of strong writers at The Washington Post, WSJ, WIRED, Law360, and The Verge have been doing an excellent job.