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Epic v. Apple VI - Rule 52 Order After Trial
This is our sixth installment in the Epic Games v. Apple dispute.
Part I: Lawsuit filed
Part II: TRO filed
Part III: Opposition
Part IV: Court splits the TRO baby
Part V: Preliminary Injunction Order
In this post, we’ll review some highlights from the court’s September 10, 2021, “Rule 52 Order After Trial on the Merits” and reflect on the outcome.
Plaintiff: Epic Games, Inc.
Plaintiff’s Firm: Cravath, Swaine & Moore
Defendant: Apple Inc.
Defendant’s Firm: Gibson Dunn & Crutcher
The App Store Business
The court’s 185-page order provides a lot of interesting information about Apple and Epic’s respective business practices and the market for mobile gaming. The court made a number of interesting observations about the App Store business in particular:
One industry report describes mobile gaming as a “$100 billion industry by itself” that accounts for 59% of global gaming revenue
Apple enjoys considerable market share of over 55% and extraordinarily high profit margins
Game transactions overall accounted for 76% of Apple’s App Store revenues in 2017, 62.9% in 2018, and 68% in 2020
This ~70% of revenue is generated by less than 10% of all App Store consumers
By contrast, over 80% of all consumer accounts generate virtually no revenue, as 80% of all apps on the App Store are free
The App Store is primarily a game store and secondarily an “every other” app store
On the “positive” side of Apple’s App Store distribution restrictions, the court found:
App distribution restrictions increase security in the “broad” sense by allowing Apple to filter fraud, objectionable content, and piracy during app review while imposing heightened requirements for privacy
On the “negative” side of Apple’s App Store distribution restrictions, the court found:
Apple’s restrictions on iOS game distribution have increased prices for developers
Some of Apple’s practices unreasonably restrain competition and harm consumers; namely, the lack of information and transparency about policies which effect consumers’ ability to find cheaper prices, increased customer service, and options regarding their purchases. Apple employs these policies so that it can extract supracompetitive commissions from this highly lucrative gaming industry.
Why Did Epic Sue Apple?
Epic sought to disrupt Apple’s business model for two reasons. First, Epic sought “a systematic change which would result in tremendous monetary gain and wealth.” Second, Epic sought “to challenge the policies and practices of Apple and Google which are an impediment to Mr. Sweeney’s vision of the oncoming metaverse” which Epic views as the future of both gaming and entertainment. On that topic, the court recited Tim Sweeney’s metaverse definition: “a realistic 3D world in which participants have both social experiences, like sitting in a bar and talking, and also game experiences . . . .” It also provided an example Sweeney gave at trial involving players in Fortnite watching a Netflix show:
All in the virtual 3D world. You can stand there and watch Netflix with your friends, and it’s different than watching it in front of the TV. You can talk to your friends and you can emote and throw tomatoes at the screen. And so it is a very different experience than either a game or Netflix.
Epic saw, however, that Apple’s App Store “platform fees” posed “an existential issue” to both Epic’s “business plans and Mr. Sweeney’s personal ambitions for Fortnite, its digital gaming and retail store, and the evolving metaverse.” The court observed that “Epic Games also hoped to revive and reinvigorate Fortnite by pivoting its business whereby player-developers could create new content and plaintiff could ‘shar[e] [a] majority of profit with [those] creators.’”
We’ve previously discussed how Epic went about suing Apple, so we won’t cover that again here.
The court found that Apple Did Not Violate the Antitrust Laws
The court’s antitrust analysis in the order is long and complicated. But the gist of what the court found isn’t. It found that Apple isn’t a monopolist and that, even though Apple exercises considerable market power, it didn’t unreasonably restrict trade with its App Store rules — or, at least not within the meaning of the antitrust laws (more on that, below).
The parties vigorously disputed the relevant product and geographic markets and the court agreed with neither side. Instead, the court found that the relevant market is “digital mobile gaming transactions.” Although the court found that Apple exercises “market power,” in the mobile game market, it also found that its market power wasn’t extreme or substantial to the point where it could be said that Apple has “monopoly power.” Instead, the court viewed Apple and Google as duopolists (which gives us at least some insight into how the Epic v. Google case may fare). The court opined that “Apple is near the precipice of substantial market power, or monopoly power, with its considerable market share” and “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 [Epic] did not focus on this topic.” As a result, the court next looked to whether Apple nevertheless imposed an “unreasonable restraint on competition” with its App Store rules.
Using the “rule of reason” test, the court employed the Supreme Court’s burden shifting framework:
To determine whether a restraint violates the rule of reason, . . . a three-step, burden shifting framework applies. Under this framework, the plaintiff has the initial burden to prove that the challenged restraint has a substantial anticompetitive effect that harms consumers in the relevant market. If the plaintiff carries its burden, then the burden shifts to the defendant to show a procompetitive rationale for the restraint. If the defendant makes this showing, then the burden shifts back to the plaintiff to demonstrate that the procompetitive efficiencies could be reasonably achieved through less anticompetitive means.
While the court found that Apple’s app distribution restrictions do have “some” anticompetitive effects, it also found some “procompetitive justifications based on security and the corollary interbrand competition, as well as generally with respect to intellectual property rights.” As such, the burden shifted back to Epic and, while Epic proposed some alternatives to Apple’s restrictions, it did not meet its burden to show that those alternatives are “virtually as effective” as Apple’s current distribution model and can be implemented “without significantly increased cost.” The court found that “Apple’s business choice of ensuring security and protecting its intellectual property rights through centralized app distribution is reasonable,” and it declined “to second-guess that judgment on an underdeveloped record.”
What about the anti-steering provisions?
Even though Epic conceded that it breached the DPLA (the standard, non-negotiable developer agreement with Apple) and lost all of its antitrust claims, it still had an Unfair Competition Law (UCL) claim. California’s UCL prohibits business practices that constitute “unfair competition,” which means “any unlawful, unfair or fraudulent business act or practice.” Cal. Bus. & Prof. Code § 17200.
Under the “unfair” prong, as a competitor who claimed to have suffered injury from Apple’s unfair practices, Epic needed to show that Apple’s conduct:
(1) “threatens an incipient violation of an antitrust law,”
(2) “violates the policy or spirit of one of those laws because its effects are comparable to or the same as a violation of the law,” or
(3) “otherwise significantly threatens or harms competition.”
In evaluating this claim, the court highlighted that Apple uses “anti-steering provisions” prohibiting apps from including “buttons, external links, or other calls to action that direct customers to purchasing mechanisms other than in-app purchase,” and from “encourag[ing] users to use a purchasing method other than in-app purchase” either “within the app or through communications sent to points of contact obtained from account registrations within the app (like email or text).” Thus, “developers cannot communicate lower prices on other platforms either within iOS or to users obtained from the iOS platform. Apple’s general policy also prevents developers from informing users of its 30% commission.”
Relying on a Supreme Court First Amendment case, Bates v. State Bar of Arizona, 433 U.S. 350, 364 (1977) the court stated that “commercial speech, which includes price advertising, ‘performs an indispensable role in the allocation of resources in a free enterprise system.’” Thus, although Epic Games failed to prove a “present antitrust violation,” the anti-steering provisions “threaten an incipient violation of an antitrust law by preventing informed choice among users of the iOS platform.” The court decided these provisions in the DPLA violated the UCL’s “unfair prong” and should be stricken with an injunction.
The court found in favor of Apple on all counts except with respect to violation of California’s unfair competition law and only partially with respect to its claim for declaratory relief. The court also terminated the preliminary injunction.
Epic will get:
…a nationwide injunction…enjoining Apple from prohibiting developers to include in their:
Apps and their metadata buttons, external links, or other calls to action that direct customers to purchasing mechanisms, in addition to Apple’s in-app purchase system.
Nor may Apple prohibit developers from:
Communicating with customers through points of contact obtained voluntarily from customers through account registration within the app.
Apple will get:
(1) damages in an amount equal to (i) 30% of the $12,167,719 in revenue Epic Games collected from users in the Fortnite app on iOS through Epic Direct Payment between August and October 2020, plus (ii) 30% of any such revenue Epic Games collected from November 1, 2020 through the date of judgment; and
(2) a declaration that (i) Apple’s termination of the DPLA and the related agreements between Epic Games and Apple was valid, lawful, and enforceable, and (ii) Apple has the contractual right to terminate its DPLA with any or all of Epic Games’ wholly owned subsidiaries, affiliates, and/or other entities under Epic Games’ control at any time and at Apple’s sole discretion.
I had two big questions after reading the opinion:
First, between the termination of the preliminary injunction and the new declaratory relief, Apple now has discretion to terminate the separate DPLA between Apple and Epic International (which it threatened to do before the TRO issued), which would prevent Epic from accessing the tools and SDKs necessary to continue Unreal Engine development for iOS. Will Apple do that? It seems unlikely, but that would be very bad for developers, of course, if it happened.
Second, even though things could have been far worse, how much does this really hurt Apple? In big mobile game markets like Southeast Asia, many games — particularly those made by the biggest and most profitable developers — already send players outside of the app (e.g. to a developer website) to make purchases, thereby avoiding the 30% app store commission. If that practice becomes the new global norm after this ruling, won’t Apple face a material drop in revenue? Apple’s global revenues were $271 billion in 2020. If Apple does, in fact, control 55% of the $100 billion mobile market (i.e. approx $55 billion — or roughly 20% of Apple’s revenue), losing a significant chunk of that seems, at least potentially, pretty unpleasant. Even if Apple only loses half that amount, that’s still a 10% drop in revenue.
Needless to say, we’ll need to see the exact wording of the permanent injunction once it issues — and how game developers respond — but it probably won’t be much different (if at all) from what’s in the Rule 52 Order. For the time being, though, unless Apple decides to act vengefully and terminate access to the tools necessary to continue Unreal Engine development for iOS (again, I think that’s unlikely since that would hurt Apple, too), this order could strike an enormous blow to Apple’s revenue. The real winner here seems to be game developers who have the wherewithal to implement their own payment systems on other platforms, now that they have the freedom to tell their players that those other payment options exist outside the app.
Finally, I think it’s unlikely that Judge Rogers’ ruling will be overturned on appeal. The court’s antitrust analysis is thorough and compelling, and its unfair competition law ruling is solidly grounded in First Amendment principles. Still, there is a very strong chance the fight between Epic and Apple will continue well after trial and, with this much at stake, it’s hard to predict exactly how and when this war will end.