The long-awaited outcome of the Epic Games versus Apple (AAPL, Financial) case has finally been decided. While Apple won nine out of 10 counts, the sole count on which it lost is the one that will have a lasting impact on the revenue of one of Apple’s most profitable monopolies – its App Store.
On Sept. 9, Judge Yvonne Gonzalez Rogers handed down the decision that Apple can no longer force developers to use in-app purchasing. Going forward, developers will be allowed to provide links or other communications to customers that allow them to purchase their products outside of Apple’s ecosystem.
Following the news, shares of Apple dropped 3% to around $149.80 apiece in midday trading.
In the past, Apple has leveraged its App Store platform to take a 30% cut of profits from all in-app purchases made on its devices, which has been an incredibly lucrative arrangement for the company, as the cost that Apple incurs to host these apps is peanuts compared to what it makes from taking 30% of developers’ profits.
The question that investors need to answer now is, how much will this ruling truly affect Apple’s profits going forward? Will developers begin rushing to leave Apple’s in-app purchasing ecosystem as soon as possible, or will they continue using it out of convenience? Is Apple’s growth in other areas enough to cover up a hit to App Store revenue?
App Store revenue
While Apple does not disclose how much revenue its App Store brings in, we can get an estimate by referencing the total that Apple has paid to developers. Using this reference point, along with the assumption that Apple takes a 30% cut of all sales, we can estimate that the company brought in $64 billion in App Store revenue in full-year 2020. This would represent a whopping 23% of the $274 billion in total revenue for fiscal 2020.
This is a hefty chunk of revenue to be charging from apps that Apple has put absolutely zero time or effort into developing. Apple styled its App Store like a toll road, requiring payment from anyone wishing to offer apps on it. However, if anyone tried to leave this toll road and take an alternate route, like Epic Games tried to do with Fortnite by adding an option to pay the company directly, Apple would yank them from the App Store. It goes without saying that Apple would never willingly allow a competitor to its App Store to operate on its devices.
The company’s justification for maintaining its controversial App Store policies thus far has been twofold. For one, the company argues that because it provides the phones and the operating system, it deserves a cut of any profits that were made via apps operating on its phones and operating system. The second justification Apple touts is that by forcing in-app purchases to go through its own payment ecosystem, it is protecting customers from hordes of fraudulent developers just waiting to scam them out of their money.
In a statement to USA Today, Apple said it remains committed to "ensuring the App Store is a safe and trusted marketplace that supports a thriving developer community," harking back to its argument that only Apple can be trusted as a payments processor for the in-app purchases made on its phones.
While developers may not necessarily buy into the idea that they owe Apple a cut just for providing the phones and the operating system, Apple’s efforts to provide a safer marketplace hold more water. Going forward, even when third-party payment methods and app stores are allowed to develop, customers might still be more likely to make in-app purchases if they are through Apple, since this is a company that customers know and trust. Thus, some developers might still choose to keep using Apple’s payment ecosystem or offer it alongside their own payment ecosystem.
Another reason why developers might keep using Apple’s payment ecosystem is because it takes time, effort and know-how to develop your own payment ecosystem. While big companies like Epic can easily implement their own in-app payment methods, smaller developers, especially those who are just getting started and are not yet generating high revenue, may want to focus more on their apps rather than the payment ecosystem. At the end of 2020, Apple also slightly changed its App Store policy to only take a 15% cut of profits from smaller app makers with less than $1 million in annual net sales on its platform.
A bad long-term policy
“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,” tweeted Epic’s CEO Tim Sweeney following the ruling.
No one can really blame Apple for wanting to maximize its profits. If they had the ability, wouldn’t most people try to take as big of a cut as possible from people who relied on their technology as their main source of income? However, analysts have often called this strategy short-sighted. Being so blatant about taking the biggest cut it can from developers was bound to result in an increasing amount of pushback.
Perhaps if Apple had only taken a 10% commission from the very beginning, or if it began to cut its commissions when enough developers started raising complaints that 30% was unfair, it would have been many more years before developers began pushing for their own in-app payments and app stores. However, that’s water under the bridge now.
What matters now is that Apple would be wise to take pre-emptive measures in order to prevent developers from leaving its in-app payment ecosystem. It needs to quickly transition to an App Store revenue model that is more sustainable in the long term, rather than its existing policy that is only focused on squeezing out as much short-term profit as possible.
One way to do this would be to push its “safe and more trustworthy than others” agenda, but another, more effective way would be to reduce the cut it takes from developers’ profits. Reducing its cut would mean that there was less of an incentive for developers to follow in Epic’s footsteps.
According to Nilay Patel, editor in chief of The Verge, the Epic case ruling could actually serve as the motivation that Apple needs in order to transition to a more long-term sustainable revenue model for its App Store. In a recent interview with CNBC, Patel said, “I think fundamentally, Apple has a huge opportunity to monetize other parts of the App Store ecosystem, and if this spurs them to do that, it will be a win in the long-term.”
Conclusion
Apple’s stock price hasn’t taken much of a hit at all considering the news that the source of a fifth of its revenue is now able to be bypassed by developers. Investors seem confident that Apple will be able to keep a significant portion of in-app purchases operating through its own ecosystem and make up for any losses with long-term growth in other areas.
They probably aren’t wrong. Apple’s trailing 12-month revenue as of the quarter ended in June was $347 billion, and analysts are expecting the company to report $366 billion in revenue for full fiscal 2021. If we were to assume that 23% of this would be App Store revenue just like in fiscal 2020, then even if we were to subtract App Store revenue from estimates for 2021 revenue, total revenue would still come out higher than in 2020.
In reality, it is highly unlikely that Apple will lose all of its App Store revenue just because of competition being introduced in an area where it was previously able to nip any competition in the bud. However, investors should still take note of this development and factor it into their valuation models for Apple. It might take a while for developers to successfully implement their own in-app payment methods, so Apple’s decline in revenue from this source might also be slow to develop. In the meantime, will the company be able to grow enough in other areas to make up for it?
