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What The Ruling In The Epic Games V. Apple Lawsuit Means For iPhone Users

Bobby Allyn

A federal judge on Friday ordered Apple to loosen some of the rules on its App Store for how payments are processed. Patrick Semansky/AP hide caption

A federal judge on Friday ordered Apple to loosen some of the rules on its App Store for how payments are processed.

A federal judge on Friday issued a long-awaited ruling in Fortnite maker Epic Games' legal battle with Apple over its App Store policies.

Both sides are using the 185-page ruling to double down on their own positions, which is possible because the details are complicated.

If anything, though, Apple and Epic did land small wins, but neither got what it wanted.

U.S. District Judge Yvonne Gonzalez Rogers said Apple is breaking the law by forcing people to pay for apps and in-app items through the App Store, where it usually takes a 30% slice of the payment as commission. Gonzalez Rogers told Apple to ease up and let in other payment options, within 90 days. That will please Apple, but it is far from what Epic sought.

For Apple, Gonzalez Rogers upheld the App Store's overall structure as legal, a major victory for the tech giant. She also said Apple does not have an illegal monopoly over how developers can process payments for mobile games, which Apple applauded.

"It's a split decision," said Mark Lemley, a Stanford Law School professor who studies antitrust issues and technology. "It will improve competition on the edges, but it's not the fundamental change that Epic and advocates of the antitrust case would have hoped for."

OK. But what does this mean for people who buy apps for their iPhones and iPads?

It means that when you pay for, say, a Spotify subscription on your iPhone, or a cool new outfit for your avatar in the mobile version of Roblox, you could get the option to pay through Spotify or Roblox's own systems.

Apple long has banned app developers from offering these alternative payment methods. Gonzalez Rogers ruled that Apple was hiding information from consumers and limiting choice. That's prohibited under California competition laws.

So will this make apps and in-app items cheaper?

It could. When Epic violated Apple's rules and allowed people to buy credits for Fortnite through its own system, it offered a 30% discount, since there was no Apple levy involved.

If developers are no longer forced to use Apple's payment system — and can avoid the 30% commission — they could lower their prices. Or, they could just pocket the savings.

Will there be any visible changes to apps downloaded from the App Store?

Maybe. You might see a new button in some of your favorite apps that lets you buy things through the developer's own payment system, for example. Or, there could be a link inside the app directing customers to complete a payment on a browser. Whatever it looks like, Apple solely controlling what critics call a "toll booth" in the App Store will be no longer.

The appeals process will likely cause delays, so don't expect changes any time soon.

Is Apple's 30% commission going away?

No, but Apple can choose to drop the rate, and for certain developers, it has .

Epic Games considered Apple's take of most purchases "exorbitant" and an abuse of its market power. The judge did not completely buy this.

Yvonne-Gonzalez was skeptical of the 30% fee during the trial, and in the ruling she was suspicious about Apple's justification of the commission, writing that "the 30% is not tied to anything in particular and can be changed," but did not order Apple to do so.

She noted that while Epic chose to target Apple (and Google) over the fee, it seemed odd considering that Nintendo's Switch, Microsoft's Xbox and Sony's PlayStation all charge a similar cut on game sales.

"Antitrust law doesn't let you complain that the prices are too high," Stanford's Lemley said. "You have to show that some sort of conduct is preventing competition."

A separate case Epic filed against Google is scheduled to go to trial this year.

So then, why is this a big blow to Apple?

Apple's App Store, and the commission that critics call the "Apple tax" are just one aspect of the tech giant's empire. But developers' complaints about feeling mistreated and getting a raw deal on the App Store have grown louder in recent years. South Korea recently banned Apple and Google from forcing developers to use its payment system. Congress has introduced legislation to rein in the tech giants' strict App Store policies.

The ruling on Friday from U.S. District Judge Yvonne Gonzalez Rogers could trigger the most consequential changes yet to the multibillion-dollar mobile economy. Although she didn't go as far as Epic Games had hoped, she still put a dent in the all-powerful fortress Apple has built and maintained over how apps are distributed on iPhones and iPads.

"Apple has so far gotten a pass in the Big Tech antitrust scrutiny of the past several years, but this says that is not going to continue," Lemley said. "Apple's control over what goes on the phone and at what price may get hard for Apple to sustain."

Both Apple and Epic Games had wins in the ruling and both are likely to appeal the decision. Huh?

Apple is expected to fight Gonzalez Rogers' determination that it is violating the law by blocking alternative ways to make payments, known as an "anti-steering provision." Ever notice why Netflix makes you visit its website to sign up for a subscription in iPhones and iPads? This is why. It wanted to avoid Apple's commission.

Epic was unhappy with the judge's decision that Apple is not an illegal monopoly because it has competitors in its definition of the "relevant market" — the $100 billion world of digital gaming transactions.

In antitrust cases, the term "relevant market" is important. It's legalese for: what exact part of the economy are we talking about?

Gonzalez Rogers said this fight was not about how digital video games are distributed, as Epic had argued, but how digital video game payments are processed. And in that market, which includes gaming outside of iPhones and iPads, the judge said there's a lot of competition, so Apple is not a monopoly. Epic is expected to try to convince an appeals court that the judge got that wrong.

"An appellate court can look at the market definition and say, 'wait a minute,'" Lemley said. "And if that piece was overturned, Apple could be found to be a monopolist."

The price tag for challenging the App Store's control

When Epic introduced its own payment system for Fortnite, breaking the App Store rules and effectively challenging Apple to kick it out, the judge ruled that it breached its contract with Apple.

During this time, Epic made more than $12 million of revenue. None of it went to Apple. So now, the judge said Epic owes Apple 30% of that amount, per the terms of its contract.

Epic turned Apple's move booting it from the App Store not just into a lawsuit, but a publicity stunt dubbed "Project Liberty" complete with the #FreeFortnite hashtag and a video mocking a famous Apple ad from 1984.

Unless revised by an appeals court, Friday's ruling means the cost of its PR crusade against Apple just got $3.6 million more expensive.

Editor's note: Apple is among NPR's financial supporters.

• competition law
• Yvonne Gonzalez Rogers

'Fortnite' Was a Blockbuster for Epic Games. What’s the Encore?

Brian Kenny : In December of 2000, little known Japanese film director Kinji Fukasaku released his new film to a limited number of theaters in Tokyo, and the reverberations are still being felt today. Battle Royale created immediate controversy both for its disturbing theme as well as its thinly veiled criticism of the pressures that Japanese culture placed on its children. And it sparked a cultural phenomenon that remains highly influential in global pop culture. Battle Royale is its own very lucrative genre—and in a case of life imitating art, competition in the video gaming industry resembles its own version of Battle Royale . To the victor goes the spoils.

Andy Wu : Thank you very much for having me, Brian.

Brian Kenny : I'm not a gamer. I'm just going to confess that right up front. I'm not part of that generation, but I certainly have children, a son in particular who is in his early twenties now who spent a fair share of time playing video games. Are you a gamer?

Andy Wu : I do occasionally, although I'm not very good myself.

Brian Kenny : Well neither am I, suffice to say. But I think many of our listeners are going to really enjoy hearing about Epic Games. It's a great case and I think it's highly relatable and somewhat ripped from the headlines, too. There's been a lot of publicity about (the game) Fortnite , which is their main product, so we're going to talk about that. But let me just ask you to start by setting up the case. How do we begin here?

Andy Wu : So Epic Games was started in 1991 by Tim Sweeney as a storied video game company, so they developed both video games as well as the game engines that other video game developers use to create video games. They have had a long series of big triple A titles that have been very successful. But the key thing we focus on in this case is the situation after September 2017 [when they released] Fortnite Battle Royale , the game that you were describing earlier. This is a free-to-play game that changed their path forever. They had unprecedented success with this game. By March 2019, they had 250 million players registered and then in February 2019, they had 10 million users logged in concurrently at once.

Brian Kenny : Wow.

Andy Wu : And given their current position of strength, the question is how do they parlay that strength into continued growth opportunities in the video game industry?

Brian Kenny : Part of that is about them becoming a platform company, I'm going to ask you to just describe for our users what a platform company is.

Andy Wu : So, a platform allows different types of stakeholders to directly interact and generate value through network effects and the positive feedback loops that result from network effects. And to clarify, there are two kinds of platforms that we might think of. First, there are marketplaces or transaction platforms. You can think of this as like eBay or Airbnb, and this is what we're talking about in the case with Epic Games' launch of the Epic Games store. Second, there's also what we consider innovation platforms, which are technical foundations for third parties to develop applications or content. Microsoft Windows is a classic example of this and Epic Games product, Unreal Engine, is also in that category.

Brian Kenny : What made you decide to write about this case? How does it relate to the research that you do?

Andy Wu : I research and teach technology strategy for entrepreneurs in nascent markets, and one is just as far as impact goes, the game Fortnite has been unbelievably successful and I'm sure among our listeners here, almost all their children have seen or played this game.

Brian Kenny : For better or worse, right?

Andy Wu : For better or worse. And that's sort of the general impact level motivation. But as far as for me personally, I think what this game and Epic Games represents is the intersection of several trends in technology and media that we're seeing right now. The first is the rise of digital distribution and the idea that the games are being delivered via the internet as opposed to traditionally via like a disc that you would buy in a store. And in terms of Epic Games entering with the Epic Games store in itself becoming a distributor, this is very similar to what we're seeing with the pattern of Disney and HBO entering streaming themselves, bypassing say Netflix. Related to that, in the video game industry, I think we're seeing the forefront of many new business models that are going to apply to other industries. And what we'll talk about later I think is that this is a game that is free, Fortnite Battle Royale , is a free game and they monetize it in a very peculiar way to you and me, which is that they charge for micro transactions in the game that have no, at least to you and me, have no direct real value. Finally I'll just mention that this also represents I think the trend of globalization that we need to think about. So in 2012, the Chinese tech giant Tencent made a major investment into Epic, $300 million. And we're also seeing some of the patterns of that Chinese investment in Epic and in other video game companies.

Brian Kenny : Again, for those who aren't really following the gaming industry very closely, there's a lot of, I was surprised to learn in the case about how many different players there are in that landscape. What does it look like?

Andy Wu : Video games are a very complicated business, I'll say. Beyond the developers, there are publishers that take the games that the developers create and then bring them to market. And so these are big companies like Electronic Arts. And then you have hardware and operating system providers where the games are being played. So you could think of this traditionally as like things like Microsoft Xbox, Sony PlayStation, and also like you know a Windows PC, but increasingly the platform, the hardware OS that matters is the mobile operating system. So Apple and Android count in this category as well. And then there are game engines. Those are the tools that game developers use to create the game. And then there's finally the distribution, which is the marketplaces.

Brian Kenny : That's a really confusing ecosystem.

Andy Wu : It is very confusing because it's a complicated business with a lot of money.

Brian Kenny : How many of those businesses I guess, or aspects of the business is Epic involved in?

Andy Wu : At the time of the case, Epic is a developer. They occasionally publish. They have their own game engine, the Unreal Engine, and with the entry of the Epic Games store, they're also a distributor.

Brian Kenny : You need a little chart in front of you like you had in the case, but our listeners can't see the chart. How do they make money?

Andy Wu : With the time of the case, Fortnite is their big, big offer, and remember that this game is a free game. So how do they really make money on this? And for me it's very peculiar and that's what drew me to it. They make money through in-game microtransactions and these in-game microtransactions accounted for $2.4 billion in revenue in 2018. And so, what is a microtransaction? In Fortnite , essentially what the players are doing is they are paying money to have cosmetic aesthetic items that they put on their player during the game. This includes the clothing their virtual avatar wears. This includes even dance moves that their virtual avatar can do.

Brian Kenny : And we should tell people, if you want to describe kind of what the plot is behind Fortnite , that might be helpful for people.

Andy Wu : Fortnite Battle Royale is an online multiplayer game, online shooter game. And so the way it works is that a hundred players are dropped onto a map where they must explore and scavenge weapons and then fight to the death to survive, where the last man standing wins. One hundred players, one left standing, and an average game is about 15 to 20 minutes.

Brian Kenny : Okay. And live streaming is pretty critical to this whole business model.

Andy Wu : Absolutely. So what's really amazing about this setting is how many people watch other people play video games. To give you a sense of scale, more people watch people play video games than watch HBO or ESPN or Hulu combined.

Brian Kenny : That's amazing. Do people pay to watch? Do you pay for the live stream?

Andy Wu : It depends on who the streamer is. So some of the bigger celebrity streamers like Ninja will get paid for the work that they do by the subscribers. Also, they're also paid often by the video game companies to play a specific game.

Brian Kenny : Okay. And there's also a subscription service here, so even though the game is free, people are subscribing.

Andy Wu In this particular game they're not required to pay any direct subscription fee. There's an additional add-on feature they can pay for. That would be a subscription-based one. A subscription model is the counterfactual to the business model that Fortnite Battle Royale has gone with. So other companies that have similar types of Battle Royale games are instead pursuing a subscription model where users pay a monthly fee to play the game.

Brian Kenny : And have you looked at the efficacy of one model versus the other, or are they both pretty substantial?

Andy Wu : I think this is similar to what we'll see in all kinds of media distribution. There will be a proliferation of different business models. I will say that for the business model of Fortnite Battle Royale , I think this is one of the things that really stands out. Because the game relies on network effects and having a large user base to be successful, giving access to as many gamers as possible is really important to its success. And so of course making it free allows for that to happen. And in the course of getting that many users, you have some subset of users that are going to really spend some serious money on those micro transactions.

Brian Kenny : Are they the first to adopt this model? Was this sort of Epic's idea?

Andy Wu : They were the first to adapt this free to play model for the Battle Royale game format. But the concept of free-to-play is not new, and in fact, Epic was one of the early pioneers in the 90s in this type of business model. So, in the 1990s, they would distribute games via shareware. They would mail people CD disks that had a game for free and then you'd be able to pay money for extra content beyond what that disk contained.

Brian Kenny : We actually did a podcast on the whole story behind Candy Crush . Where do they fit in that scheme? That's not a multiplayer game, right? That's a, is that a single player game?

Andy Wu : Single player, but there's definitely a social virality effect related to that game. In this game, there's obviously direct interaction between the players in the game. One is you need all the players in a given game, but the more important part to think about is actually when you have a large number of players, it allows games to form faster. So what gamers really hate is the time in between games where the game is, they need to find all the players for the game and they're just sitting there waiting. With millions of players on board, you can form a game virtually instantly because there's another hundred people that aren't in a game yet.

Brian Kenny : Right. Tell us a little bit about Epic. How did they evolve over time?

Andy Wu : Tim Sweeney started Epic Games in 1991 and their first major hit was a game called Unreal in 1998, that was a shooter game. And so that game actually led to the technology called the Unreal Engine that they now license out to other game developers. I mentioned earlier that they leveraged their early shareware business model to grow early on. And then the next big hit they had was in 2006 with Gears of War . So this is another shooter game that was originally exclusive for Microsoft Xbox. And this is what we would call a triple A title. This is a big title, lots of money, very expensive to develop. The big transition for the company was in 2011, 2012 where Sweeney wanted to move away from the traditional model. So, in the case of Gears of War , that is a game where they went through a publisher, Xbox Game Studios and sold the game at retail for $50 or $60. Sweeney wanted to move away from that business model, and so they raised $300 million from Tencent to start this transition. And the transition was towards the model that we talked about earlier that is emblematic of Fortnite , which is that free-to-play model.

Brian Kenny : Now you mentioned there are millions of people on the system at any given time. Who are these people and how much time do they spend on the system?

Andy Wu : Majority of players are under age 24 so what we'd call Gen Z, although there's still millions of millennials and Gen X that are playing this game, and these players play a huge amount. Almost half of the players play more than 10 hours a week. So, more than an hour a day.

Brian Kenny : I don't know where they're finding the time to do that.

Andy Wu : I think they just basically take all their spare time and play, and remember that this is a game that you can play across platforms. You can play on your PC at home, but you can also play it on your mobile phone when you're waiting for the bus.

Brian Kenny : They faced a little bit of controversy around this, too. Fortnite I mentioned before has been in the headlines and not always in a positive way.

Andy Wu : That's right. And I think that the headwinds that Fortnite is facing are emblematic of the broader headwinds that the video game industry in general is facing. I think the first is that there is this concern about video game addiction. And so there's players who go beyond what they should be and play an enormous amount on these games, more than what is healthy. Beyond that, there's also the relationship that Epic Games has with China that has drawn some controversy. Again, they received investment from Tencent several years ago. And the company itself says that they're completely operationally independent from Tencent, but detractors would counter that.

Brian Kenny : One of the questions that's central to the case is them creating their own storefront, moving into that marketplace. What are some of the challenges that they face along the way in trying to do that?

Andy Wu : I think the first thing that's been very much on the message boards among gamers is that there is a question about the overall quality of the marketplace itself in terms of the technology that goes into the marketplace. They've taken much longer than Epic expected in order to develop the technology and add reviews and other features to the marketplace. The other thing is what we call the chicken or egg problem: how do you get users to use the marketplace if there's no games on it? And how do you get games on the platform, to list on the platform, if there's no users using the marketplace? And so they definitely had limited offerings at start. They obviously had a big advantage coming into this space because they can move users from Fortnite into this marketplace. But even with that, people are pretty frustrated if you're going to a store and there's nothing to buy. And so what they've done is that they've had to incur some huge expenses in order to get exclusive games from other video game developers to list on their platform as opposed to the competitor, which is Valve's Steam marketplace. And so they've had to pay lots of money to get those exclusives, and they also have to give away free games to get people on the store. If you sign up, you can actually get free games to play.

Brian Kenny : Okay. Now you mentioned Valve's Steam. Who are some of the other players? Like who's doing this really well? What are the best marketplaces?

Andy Wu : The market leader is absolutely the Steam Marketplace by Valve. They've absolutely dominated the market. The other key marketplaces we want to think about are one, the marketplaces that are specific to certain consoles. So Xbox and PlayStation each have their own marketplace for games. And then the other thing I would say the more important one to keep an eye on is actually, not even what we think normally is a video game marketplace, it's the Apple App Store and the Google Play Store. As we shift more and more gaming to mobile gaming, those marketplaces are going to have an increasing amount of power. And again, they've already gotten into a lot of conflicts with the other, not even video games, with other third party applications that are listed on those stores. So, for example, Apple and Netflix. Apple and Spotify have gotten into lots of arguments about what's the right way to split the revenues coming off the store.

Brian Kenny : Talk about console games a little bit too because it feels like as everybody moves onto mobile devices, the need for a console kind of seems to be much less than it used to be. And that was where I think a lot of these companies were making a lot of their money was off the hardware itself.

Andy Wu : Actually, in the video game industry, there's been a traditional model of losing money on selling video game consoles. So the price of an Xbox or a PlayStation is below the bill of materials to produce the hardware. And the reason for that is to essentially create a large installed base of consoles so that video game developers and publishers will want to write games for that console. And so the way it works actually is that the video game console company, so Microsoft Xbox and Sony PlayStation, they make money by charging the video game publishers and developers. So they don't make money from the people who buy the consoles.

Brian Kenny : How is Epic thinking about they're moving this at this point. I mean do they know where they go next?

Andy Wu : I think they're going to push on this for a while. Again, they've got a lot of opportunity in terms of improving the product quality of the marketplace, in terms of refining the technology and then on top of that, again they're still going to put out money to bring additional games on the platform. I think we might want to keep an eye out for the possibility that they're going to try to raise a large amount of money in the near future in order to be able to continue to support the growth of the platform. And remember that for Epic and their marketplace, some of this motivation is more than just the direct ability to make money on the marketplace. There's been a lot of complaints in the industry about what Valve has done for the industry. So, Valve itself charges essentially a 30 percent cut of the revenue for a particular game that's being sold through that marketplace. Now, if you're an artist or creator that is developing a game and putting up millions of dollars to develop that game, giving 30 percent to a middleman seems a little bit unfair. What the Epic store marketplace does is they charge 12 percent, which is a much, much lower rate and they've been trying to change the status quo of Steam dominating the space.

Brian Kenny : There is a quote in the case by Sweeney where he talks about where this is all going, kind of the future of the gaming space. Can you describe his vision is around this?

Andy Wu : Tim Sweeney is a very under spoken guy, but I think his heart's in the right place and he's always been very true to the gaming industry. So Sweeney is striving towards what he describes as a “metaverse,” that is his vision for the future. What he imagines is that gaming is going to be a part of all the other virtual worlds. That includes things like virtual reality, augmented reality, social networks, and the other forms of entertainment and engagement that we participate in. In addition, I think his view is that there'll be an active ecosystem in the future where all parties can consume content as well as contribute content. I think he's much more about supporting the broader ecosystem as a whole.

Brian Kenny : He doesn't see this as a battle royale where Epic will be the only one standing at the end?

Andy Wu : I think they hope that a little bit with Fortnite , but they definitely had a differentiated position and I don't think he is out to fight it all the way to the last man standing, per se. But you know, at least with the marketplace, I think the hope is to make the space a bit more fair for the regular game developer.

Brian Kenny : Andy, thanks so much for joining us today.

Andy Wu : Yes, Brian. It's been an absolute pleasure. Thank you so much.

Brian Kenny : If you enjoy Cold Call, you might like other podcasts on the HBR Presents network. Whether you're looking for advice on navigating your career, you want the latest thinking in business and management, or you just want to hear what's on the minds of Harvard Business School professors, the HBR Presents network has a podcast for you. Find them on Apple podcasts or wherever you listen. I'm your host, Brian Kenny, and you've been listening to Cold Call, an official podcast of Harvard Business School on the HBR Presents network.

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