Photo by NordWood Themes on Unsplash
Carter Ostrowski, Associate Member, University of Cincinnati Law Review
I. Introduction
Last month, Epic Games (“Epic”), developer of battle-royal sensation, Fortnite, launched a crusade to end Apple Inc.’s (“Apple”) alleged monopolistic control of the iOS[1] Software Application (“App”) Distribution Market and iOS In-App Payment Processing (“IAP”) Market.[2] This article explains Apple’s control of the multi-billion-dollar markets and the possible implications of Epic’s anti-trust lawsuit under the Sherman Act. Part II will provide a brief background on Sections 1 and 2 of the Sherman Act. Part III will address Epic’s complaint against Apple and will explain the requirements for app developers to use the Apple App Store (the “App Store”). Part IV will discuss Apple’s response to Epic’s complaint. Finally, Part V will discuss the potential outcomes of an Epic v. Apple trial and their repercussions in the tech industry.
II. Background of the Sherman Act §§1-2
As a company grows, so does its share of the marketplace. With a greater share, a company gains the power to restrict supplies, manipulate prices, and exclude competitors from the market. Whether market power rests in the hands of a single entity or several entities (i.e. a trust), the end result is often an injured consumer.
Enter anti-trust laws. Anti-trust laws were written to protect a competitive marketplace and maintain free entry into that marketplace.[3] By maintaining free entry into a marketplace, new competitors can introduce their products and force older competitors to lower prices or improve their products.[4] The US introduced its first anti-trust legislation in 1890 with the Sherman Act (the “Act”).[5] The Act includes two broad sections, among others, that continue to grant the government sweeping authority over anti-competitive activity: (1) Section 1, which makes illegal the means of monopolizing trade; and (2) Section 2, which outlaws monopolistic ends and attempts to reach such ends.[6]
Section 1 of the Act, which illegalizes monopolistic means of trade, states that “every contract, combination in the form of trust or otherwise, or conspiracy, in restraint of trade or commerce . . . is declared to be illegal.”[7] Illegal means are classified as either illegal per se or unreasonable.[8] Illegal per se acts are those that serve no purpose other than to restrict or destroy competition in the marketplace.[9] Common examples of illegal per se acts include price fixing and restricting production.[10] Unreasonable means are legitimate practices that substantially lessen competition, tend to restrain trade, or are carried out with the intent to restrain trade.[11]
Section 1 of the Act has also been read to restrict the use of tying arrangements.[12] Tying arrangements are agreements that force a buyer to purchase a product on the condition that the buyer also buy a second product.[13] The intended product, or the tying product, must be controlled by a monopolist; the idea being that if a consumer wants to purchase the monopolized tying product, buying the perhaps unwanted tied product creates a second monopoly.[14] To violate Section 1, the seller must have “appreciable economic power in the tying product market” and the arrangement must affect a “substantial volume of commerce in the tied market.”[15]
Section 2 of the Act, which outlaws monopolistic ends and attempts to reach such ends, states that “every person who shall monopolize, or attempt to monopolize . . . any part of the trade or commerce . . . shall be deemed guilty of a felony.”[16] However, extensive market power is not automatically illegal; there must also be unlawful conduct to maintain that market power.[17] Therefore, a monopoly may be acquired and maintained by lawful means, but can become illegal if it is maintained via anti-competitive conduct.[18]
III. Epic’s Complaint and the Apple App Store
Epic’s complaint against Apple alleges six counts of anti-competitive and monopolistic practices in violation of Sections 1 and 2 of the Act.[19] These six counts are split between two different markets: (1) the iOS App Distribution Market; and (2) the iOS IAP Market.
The iOS App Distribution Market is the market in which apps are available for download onto Apple’s iPhones and iPads.[20] There are a number of potential channels for an app to be downloaded onto an iOS device. The first channel is pre-installation.[21] Apple downloads various Apple-developed apps onto iOS devices before they are sold. The next channel is a website download. iOS devices are technologically capable of downloading apps and other software from internet websites.[22] The most common channel is an app store.[23] App stores allow users to find, purchase, download, and install apps onto their devices.[24]
Although there are multiple channels of app distribution, Epic claims that the iOS App Distribution Market is under anti-competitive control by Apple.[25] For a user to download an app onto an iOS device, the app must be compatible with Apple’s iOS. If an app developer wishes to use iOS, they must enter into Apple’s Developer Agreement (the “Developer Agreement”).[26] The Developer Agreement requires developers to distribute their apps solely through the App Store.[27] Thus, the App Store is the sole means by which a third party developer may distribute apps to iOS devices.
The iOS IAP Market is the market of software that apps use to process purchases made by Apple iPhone and iPad users.[28] Apps can be developed for virtually any purpose, including, but not limited to playing games, fitness tracking and coaching, streaming movies and television, reading, social media scrolling, and shopping. While some apps and app features are free, many apps and app features require and/or allow users to purchase the app, enhancements, or subscriptions to a service. For example, Epic’s Fortnite allow users to purchase virtual currency to exchange for in-game character customization items.[29] When purchases are made, apps use separate software to process payments.[30] Examples of existing third-party payment processing software include PayPal, Stripe, and Square.[31]
Apple has its own IAP that all iOS apps must utilize.[32] In accordance with the Developer Agreement, iOS developers are required to use Apple’s IAP instead of using competing payment systems or developing their own payment system.[33] If a developer opts not to use IAP, their only remaining options are to set up an off-app website that a customer must navigate to make a purchase, or not charge customers to use their apps.[34]
Apple’s Developer Agreement may simplify the process for iOS users, but it takes a heavy toll on developers in both the app distribution and in-app payment steps. Under the Developer Agreement, Apple takes a 30% cut on all proceeds when an app is sold on the App Store.[35] Apple also charges a 30% tax on all IAP proceeds.[36] While this does not apply to purchases for physical goods (i.e. Apple does not take 30% of the proceeds from Amazon Marketplace App sales), it takes a hefty portion of virtual purchase revenue.[37] In the case of Epic’s Fortnite, which grossed over $455 million in 2018 on iOS devices, Apple’s cut equated to over $136 million.[38]
In an attempt to forgo Apple’s tax, Epic added a separate payment method to its iOS versions of Fortnite and offered its in-game currency, V-bucks, at a discounted rate through its new payment method (now “possible” because it was not subject to the 30% tax).[39] Consequently, Fortnite was kicked off of the App Store for violating App Store guidelines. Epic, which seemingly anticipated the disciplinary action, quickly filed a sixty-five page legal complaint against Apple.[40] Epic claims that Apple’s 30% premiums via the two markets constitutes unreasonable restraint of trade and unlawful tying under Section 1 of the Act and unlawful monopoly maintenance and denial of essential facility under Section 2 of the Act.
IV. Apple’s Response to Epic
To prevent the court from issuing a temporary restraining order (“TRO”) and preliminary injunction against Apple on behalf of Epic’s complaint, Apple filed an opposition to Epic’s motions. One element necessary to sustain both a motion for a TRO and a preliminary injunction is a likelihood of success on the merits.[41] Apple argues that Epic’s complaint fails to establish “any—much less a ‘high’” likelihood of success on the merits.[42] Apple’s arguments fall within the following themes: (1) Apple lacks monopoly power; (2) the iOS IAP is not a separate market or product; and (3) Epic has not been denied essential facility.
The argument that Apple lacks monopoly power is the most significant issue of the present action. For a claim under Section 1 or 2 of the Act to avoid dismissal, a plaintiff must establish market power in a “relevant market.”[43] The relevant market of a product or service consists of all the products or services with reasonably interchangeable uses.[44] The more products or services that fall into a single relevant market, the more difficult it is to have significant market power.
Apple concludes that the iOS App Distribution and iOS IAP markets are not relevant markets in and of themselves for a few reasons. First, courts have found that single-brand markets, or markets that consist of a single product, are extremely rare.[45] Second, a manufacturer’s own products typically do not create their own relevant markets.[46] Lastly, a company does not violate the Act for having a monopoly over its own product.[47] Simply put, Apple argues that the markets based solely on iOS apps cannot exist because it has the right to control how its own products are managed. Further, Apple claims that iOS apps are interchangeable with other phone systems and game consoles, thereby leaving Apple with less than monopoly power in the relevant market.[48]
Argument two, that the iOS IAP is not a separate market or product, further attacks Epic’s definition of markets. Apple considers the App Store a transactional platform, which mediates between developers and consumers.[49] As a transactional platform, distribution and payment would be combined as one process.[50] Apple also lumps distribution and payment into one product as part of its overall method of business, emphasizes that they have been integrated since their release in 2008, and claims that there is no purchaser demand for Apple’s IAP.[51] Thus, if distribution and payment are integrated under one process, a tying claim cannot be substantiated. Finally, Apple states that its IAP tax is a legitimate way for Apple to make a profit on its own product[52] – a defense to allegations of anti-competitive conduct.[53]
Lastly, Apple argues that the essential facilities doctrines are harshly criticized, but even if it is utilized, that Apple in no way denied Epic access to iOS.[54] Apple goes on to stress that it is no way obligated to coordinate with competitors under the Sherman Act.[55]
V. Discussion
Epic’s anti-trust claims against Apple are likely to boil down to whether the court finds the iOS App Distribution Market and iOS IAP Market to be independent relevant markets. If they are, then it is indisputable that Apple has a complete monopoly over both markets. In making this determination, the court must wrestle with the question: how large must a product’s impact be to create its own irreplaceable marketplace?
On the merits alone, Epic’s claims are not likely to be successful. It is well established that single-product markets are extremely rare.[56] In Apple v. Pystar,[57] the Northern District Court of California found that MacOS, Apple’s computer operating system, was not a single-product market because it was interchangeable with other operating systems. This was found even though MacOS was programmed to only work on Apple-labeled computers.[58] Further, the Supreme Court held in United States v. E. I. du Pont de Nemours & Co.,[59] that cellophane was not a single-product market because it fell into the broader market of “flexible packaging material,” even though one company manufactured 75% of all cellophane in the US and sold it at a price much higher than competing cellophane manufacturers. In the case of markets limited to iOS apps generally, it is reasonable to find that iOS apps are comparable in function to other app platforms, computer programs, and game consoles.
But how interchangeable is the entirety of iOS apps, really? There are approximately 1.5 billion active iOS devices, each device having the capability to download apps and make purchases.[60] If iOS apps were used by only a handful of smartphone users in the US, or even the world, a lack of access to iOS app users may not be significant. However, there are nearly one billion iPhone users worldwide and the average iPhone user spent $100 on apps and in-app purchases in 2019.[61] While courts agree that single-brand product markets are rare, it is also rare for a market like the iOS app market to be one that developers cannot willingly pass up or switch out if they wish to distribute their products broadly, efficiently, and profitably. Even though iOS may function similarly to other phone operating systems, iOS is the only system that gives a developer access to the 1.5 billion devices that use it.
In relation to the app distribution and IAP markets specifically, Epic’s complaint seemingly anticipated Apple’s attempt to undermine their status as single-product markets. Epic structured its claims against Apple similar to the aftermarket theory of Eastman Kodak Co. v. Image Technical Services, Inc.[62] In Kodak, a photocopier manufacturer was found to have a monopoly in a single-product aftermarket of service and replacement parts for its equipment.[63] The Supreme Court found that the single-product aftermarket was viable even though Kodak did not have a monopoly on the actual equipment because it had locked its customers into purchasing additional Kodak products and services without the customer’s knowledge.[64]
The app distribution and IAP markets can be interpreted as aftermarkets of Apple’s iOS devices. Epic argues that iOS device users are stuck in the Apple device market due to high switching costs and because they are unaware at the time of purchase of the additional costs they will pay for apps and software over time.[65] Alternatively, developers are required to agree to the Developer Agreement and pay the 30% tax just to get their product on the App Store. While this may be reasonable for a new developer to reach potential consumers, if that developer achieves unexpected success, the Developer Agreement would prevent him from substantially expanding his practice. The developer would be barred from entering the iOS app distribution and IAP markets and remain locked into paying 30% of his app proceeds to keep his product in customer hands. Therefore, even if iOS apps are interchangeable in a market where Apple does not have monopoly control, the iOS App Distribution and iOS IAP markets can be considered aftermarkets in which Apple does have market control and is in violation of the Sherman Act.
While there are many more arguments to be made by both parties, especially one of device security by Apple,[66] the court’s decision on the significance of a market comprising nearly one billion users will be determinative of major issues. If the iOS app market is deemed too big to be interchangeable, the doors to various iOS-based markets will open. If the iOS app market is found to be interchangeable, those doors can still open if the iOS-based markets are considered single-product aftermarkets.
VI. Conclusion
Under the current conditions, it is likely that Apple will succeed in preventing Epic’s pre-trial motions, but Epic’s well-planned attack will see it’s day in court.[67] If it does, it is likely that Epic will succeed and the tech conglomerates that paved the way for developer success will be forced to open the door to healthy competition and continued innovation.
[1] iOS refers to the operating system, iOS, for iPhones and iPadOS, for iPads. There are no relevant differences between them in the context of this article.
[2] Complaint for Injunctive Relief ¶ 3, Epic Games, Inc. v. Apple Inc., 2020 WL 5073937 (N.D. Cal. Aug. 24, 2020) No. 4:20-CV-05640-YGR.
[3] 1 Malla Pollack, Callmann on Unfair Competition, Trademarks and Monopolies § 4.1 (4th ed. 2020).
[4] Id.
[5] 54 Am. Jur. 2d Monopolies and Restraints of Trade § 1 (2020).
[6] 1 Malla Pollack, Callmann on Unfair Competition, Trademarks and Monopolies § 4:21 (4th ed. 2020).
[7] 15 U.S.C. § 1 (2004).
[8] 1 Malla Pollack, Callmann on Unfair Competition, Trademarks and Monopolies § 4:20 (4th ed. 2020).
[9] Id.
[10] Id.
[11] Id.
[12] 54 Am. Jur. 2d Monopolies and Restraints of Trade § 88 (2020).
[13] Id.
[14] Id.
[15] Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451, 562 (1992).
[16] 15 U.S.C. § 2 (2004).
[17] Pollack, supra, § 4:21.
[18] Id.
[19] Epic’s complaint also alleges three different counts of California Cartwright Act violations. Complaint for Injunctive Relief ¶¶ 247, 258, Epic Games, Inc. v. Apple Inc., 2020 WL 5073937 (N.D. Cal. Aug. 24, 2020) No. 4:20-CV-05640-YGR.
[20] Id. ¶ 51.
[21] Id. ¶ 59.
[22] Id.
[23] Id. at ¶ 58.
[24] Id. at ¶ 52.
[25] Id. at ¶ 59.
[26] Id.
[27] Id. at ¶ 72. Apple does offer a limited number of other methods for distribution, such as Custom App Distribution, TestFlight, and Ad Hoc distribution specifically for commercial users and beta testing. Id.
[28] Id. at ¶ 109.
[29] Id. at ¶ 113.
[30] Id. at ¶ 110.
[31] Id. at ¶ 126.
[32] Id. at ¶ 120.
[33] Id.
[34] Id. at ¶ 116.
[35] Id. at ¶ 125.
[36] Id.
[37] Id. at ¶ 117.
[38]Ben Gilbert, ‘Fortnite’ made nearly half a billion dollars on just Apple devices in 2018, according to a new report, Business Insider (Jan. 12, 2019), https://www.businessinsider.com/how-much-does-fortnite-make-on-iphone-2019-1
[39] Compl. Epic Games 2020 WL 5073937 at ¶¶ 19-20.
[40] Id.
[41] Rovio Entertainment Ltd. v. Royal Plush Toys, Inc., 907 F. Supp. 2d 1086, 1092 (N.D. Cal. 2012).
[42] Defendant Apple Inc.’s Opposition to Epic Games, Inc.’s Motion for a Temporary Restraining Order and Order to Show Cause Why a Preliminary Injunction Should Not Issue at 17:1-2, Epic Games, Inc. v. Apple Inc., 2020 WL 5073937 (N.D. Cal. Aug. 24, 2020) No. 4:20-CV-05640-YGR.
[43] United States v. E. I. du Pont de Nemours & Co., 351 U.S. 377, 395 (1956).
[44] Id.
[45] Apple, Inc. v. Psystar Corp., 586 F. Supp. 2d 1190, 1198 (N.D. Cal. 2008).
[46] Id.
[47] Id.
[48] Defendant Apple Inc.’s Opposition to Epic Games, Inc.’s Motion for a Temporary Restraining Order and Order to Show Cause Why a Preliminary Injunction Should Not Issue at 18:16-19:5, Epic Games, Inc. v. Apple Inc., 2020 WL 5073937 (N.D. Cal. Aug. 24, 2020) No. 4:20-CV-05640-YGR.
[49] Id. at 19:14-20:4.
[50] See Ohio v. American Express,138 S. Ct. 2274, 2280 (2018).
[51] Id. at 20:5-15.
[52] Id. at 22:25-23:7.
[53] Universal Analytics, Inc. v. MacNeal-Schwendler Corp., 914 F.2d 1256, 1258 (9th Cir. 1990).
[54] Opp’n. Epic Games, 2020 WL 5073937 at 21:24-22:23.
[55] Id.
[56] Apple, Inc. v. Psystar Corp., 586 F. Supp. 2d 1198 (N.D. Cal. 2008).
[57] Id. at 1200.
[58] Id. at 1194.
[59] 351 U.S. at 379.
[60] Complaint for Injunctive Relief ¶ 46, Epic Games, Inc. v. Apple Inc., 2020 WL 5073937 (N.D. Cal. Aug. 24, 2020) No. 4:20-CV-05640-YGR.
[61] Id. ¶ 181.
[62] Eastman Kodak Co. v. Image Tech. Servs., Inc., 504 U.S. 451 (1992).
[63] Id. at 477.
[64] Id.
[65] Compl. Epic Games, 2020 WL 5073937 at ¶¶ 157-158.
[66] In In re Apple iPod iTunes Antitrust Litig., 796 F. Supp. 2d 1137 (N.D. Cal. 2011), the Northern District of California held that Apple making its music files unplayable outside of its iTunes application and making non-Apple music files unplayable on Apple programs and devices was not evident of anti-competitive control because the restrictions were added in an update intended to protect Apple users from cyber security threats. This article does not address this further as it not claimed by either party that the App Store implemented an update to lock competitors out of the distribution or IAP markets, but cyber security will likely play a major role in Apple’s stance against Epic and the availability of iOS to developers.
[67] Since this article was written, the Northern District of California released a ruling on Epic’s motion for a TRO against Apple. In Epic Games, Inc. v. Apple Inc.,No. 4:20-CV-05640-YGR, 2020 WL 5073937 (N.D. Cal. Aug. 24, 2020), Judge Yvonne Gonzalez Rogers found that Epic’s attack on Apple produced self-inflicted wounds and rejected the TRO requesting Fortnite be reinstated on the App Store. However, Judge Rodgers’ opinion spoke little on Epic’s likelihood of success on the merits, only that the court could not conclude Epic had met the high burden required to satisfy the element and that serious anti-trust questions do exist. The decision was reached in reliance on the other elements of a TRO, especially irreparable harm. Id.
