The DeanBeat: Sorting through the steamy evidence in Apple v. Epic Games

The game industry has been buzzing about the Apple v. Epic Games antitrust lawsuit since testimony in the three-week trial began on Monday. The arguments aren’t surprising, but much of the material coming out of the trial extends far beyond the battle between these two companies.

I remain interested in it for three reasons. First, I believe the case is an important conflict between a platform owner and a powerful game company that could set the rules of engagement and competition in an era that will be filled with giant tech and game companies. A lot of money is at stake here. A second reason is that a lot of details about how the game industry really works are accidentally leaking out.

Lastly, the trial has had some occasional hilarious moments, like when gamer kids took over on Monday morning — screaming as if they were in the lobby of their favorite game — when they learned their microphones for listening to the trial were live. Another moment was when I saw the 2015 email Epic Games CEO Tim Sweeney sent Tim Cook asking for iOS to be more open. Cook’s reply to his executive team was, “Is this the guy who came to one of our rehearsals?” The cluelessness of Apple’s CEO in 2015 is an indication of just how much the company appreciates the game industry.

When I sort through files available in the evidence, I never know what I’m going to find. I’m sure many companies in the secretive game industry consider the disclosures to be disastrous, but this information can surely benefit those who have been operating in the dark.

The federal court of Judge Yvonne Gonzalez Rogers of the Northern District of California in Oakland accidentally shared documents publicly that were supposed to remain private. Many documents in the file have very little to do with whether either party has the better argument in the dispute, in which Epic contends that Apple has used illegal monopoly power to close off competition in the distribution of apps and the payment systems for them. But Epic is powerful enough to challenge Apple in court, while many smaller developers wouldn’t dare.

The evidence that matters

Above: Tim Cook didn’t know who Tim Sweeney was in 2015.

Image Credit: Epic Games

Let’s start with the evidence related to the case itself. In opening statements, the lawyers laid out each side’s argument.

Epic pulled out statements referring back to former Apple CEO Steve Jobs’ intentions to “lock in” consumers within Apple’s ecosystem, in opposition to rivals such as Google.

Epic said Apple no longer earns the 30% fee it has charged since the launch of the App Store. Epic compared this to Apple getting a share of the purchase price of a car and then getting a 30% share of money paid for gas for the car every time the driver buys gas. Epic noted that Apple’s profit margin on its App Store is 78%.

Epic has also said Apple controls payments through its own payment system, even though rival payment systems work perfectly well. And it noted Apple does not uniformly enforce its policies, as it allows Uber to use a different payment system because it is in a different app category than Epic.

In testimony yesterday, an App Store executive struggled to define activities on Roblox — a platform for user-generated games — as something other than games. If Apple isn’t able to define the experiences on Roblox as other than games, that would suggest Apple treats one game maker (Epic Games) differently from the way it treats another (Roblox).

The case will live or die on how the court defines the “relevant market” for evaluating anticompetitive behavior. If that market is just the App Store, Apple could be declared an illegal monopoly. But if it is the whole games market, Epic has no case, as Apple has less than 50% of the global smartphone market and only accounts for 7% of global Fortnite revenue, compared to 46.8% for Sony’s PlayStation platform.

Above: Apple accounts for a very small share of Fortnite revenues.

Image Credit: Apple

Epic said Apple has behaved as a monopolist by erecting barriers within its App Store, freezing out other payment systems that could lead to lower prices for consumers. The company says Apple has a lock on a billion users who spend a lot of money on games and that switching costs are high enough to leave consumers effectively without much choice in the market.

Apple argues that it has plenty of rivals in the PC, Android, Sony, Microsoft, and Nintendo. And Apple notes all of those platforms erect walled gardens and charge 30% royalties. (Microsoft recently joined Epic in cutting its royalty rate to 12%.) It also said internal data showed switching costs can be as high as 26% when someone gets a new smartphone.

But Epic has a good county. Since its launch on iOS on March 16, 2018, Fortnite has generated 88 million downloads and $631 million in revenue. On Android, Fortnite has generated 80 million downloads and $47 million in revenue since August 13, 2018. That shows a huge difference in how willing iOS users are to spend money compared to Android users and means Android isn’t really that viable a competitor to the iOS App Store.

Recode’s Peter Kafka observed that it’s OK for Apple to have a monopoly on content distributed on its devices and that it should retain that in this court case, as should companies like Sony, Microsoft, and Nintendo. But he argued that Apple should not have the freedom to push developers around with rules that stop them from mentioning other retail options for things sold in Apple’s App Store. The judge could very well change the industry by ordering Apple to stop such practices — even if she ultimately rules in Apple’s favor on most matters.

I think whenever Epic argues in this case that it should gain an advantage over Apple for itself, it will lose the argument. Apple should not be forced to cut a special deal on royalties with Epic simply because Fortnite is a popular app.

Above: Did this email foretell Apple’s strategy to shut down alternative distribution to the App Store?

Image Credit: Apple/Epic

But where Apple’s decisions affect prices that consumers pay, I believe Apple will likely lose. Apple has planted the seed that Epic CEO Tim Sweeney was seeking a special deal to cut the royalties Fortnite pays to Apple, which have been stuck at 30% for big game makers. (Apple has pointed out at every opportunity that the second year of a subscription has the rate cut to 15% and that Apple recently instituted a 15% royalty rate for small business app makers.)

Sweeney pointed out that he hoped Apple would extend any discounted rate that Epic got to other developers, and he has also pointed out that Epic is suing on behalf of all developers and is not seeking damages from Apple. But oddly enough, when asked point blank if he would have taken a special deal, Sweeney said yes. That’s not exactly altruistic, as Sweeney has been positioning Epic as bringing this lawsuit on behalf of developers. And such an admission could lead both the judge and the developer community to conclude Epic’s bluster is just marketing.

At every chance it gets, Apple has pointed out that Epic is a big company. Epic recently raised $1 billion at a $28 billion valuation. (We won’t mention that Apple’s market value is $2.16 trillion). Apple has painted itself as the victim, saying Epic conducted a sneak attack by launching the antitrust suit. Sweeney testified that Epic generated gross revenue of $5.1 billion in 2020, compared to a plan (in chart below) for $3.8 billion in 2020 revenue. That compares with our own discovery that in 2019, Epic Games reported $4.2 billion in revenue and $730 million in earnings before interest, taxes, depreciation, and amortization (EBITDA, a key measure of profitability).

How the dispute started

Above: Epic takes a swing at Apple.

Image Credit: Epic Games

First, Epic asked permission to charge and advertise a lower royalty rate. It was turned down. Then it did a “hotfix,” or updated its app in the middle of the night on August 13, 2019.

Epic offered its V-bucks virtual currency (used to buy things like skins in Fortnite) for $8 on the Epic Games Store, and it enabled players to do that transaction through a link in its app. Players immediately began buying lots of V-bucks on the link to Epic’s site. After Apple learned this, it declared Epic in violation of its policy of disallowing such sideloading and shut down Fortnite on iOS. Epic did the same thing on Google Play and Google shut it down. Then Epic filed antitrust suits against both Apple and Google. It also launched a cartoon video explaining why Apple was wrong to do this, and unveiled a campaign to “Free Fortnite.”

It turns out Epic had been planning this for a long time, as the slide deck for “Project Liberty” for Epic’s entire plan was included in the court documents.

While Android allows sideloading, Apple said that it does not allow it for security reasons. Apple noted that Epic’s Android version of Fortnite had such bad results on the security front that Epic was forced to go back into the Google Play store.

Both companies have fired shots at each other here. In emails, Apple executive Phil Schiller complained to his team that Apple’s security was embarrassing, as it has had numerous security and fraud cases. But Sweeney had a moment of embarrassment in 2019 when he had to apologize to Yves Guillemot, CEO of Ubisoft, because at one point 70% of downloads of The Division 2 game on the Epic Games Store were fraudulent, forcing Epic to shut down sales.

Above: Apple says it has plenty of competition to its App Store.

Image Credit: Apple

In one email, an Epic executive Daniel Vogel said that “payment fraud is an existential threat to our store.” Apple will likely point to this as evidence that Epic isn’t capable of providing app security in a store.

Apple noted that its iOS devices accounted for only 1.72% of all malware infections, compared to 26.6% for Android and 38.9% for Windows. Epic pointed out that Apple allows sideloading on the Mac, without being as restrictive as it is on security for the iPhone.

Apple, meanwhile, noted that Epic CEO Tim Sweeney tried to enlist the help of Apple competitor Microsoft games leader Phil Spencer in a scheme to call out Apple on its alleged anticompetitive practices — before filing the lawsuit, as a kind of marketing blow against a competitor — even while he was saying in the allegations that Apple was far more powerful than all competitors and that competitors like the PC and the consoles, which Microsoft produces, do not matter.

Both Microsoft and Nvidia testified about the hoops they had to go through in order to get cloud gaming apps on the App Store. They ultimately chose to go through the Safari web browser, through the open web, because Apple put so many restrictions in place. Apple wouldn’t let them get away without paying a 30% fee per cloud game played, even though the business model for both services is to charge a monthly fee so that players can play as many games as they want.

Above: Epic Games wants to free Fortnite in Europe.

Image Credit: Epic Games

Apple’s greatest weakness in this case are the special rules that it puts in place that seem arbitrary and capricious — the actions of a company trying to preserve an illegal monopoly — according to Epic’s view. But Epic’s greatest weakness may be the twists and turns it goes through to argue that Apple has monopoly power when it clearly has competitors.

Perhaps Epic’s great hope is that the European Union, which just sued Apple after Spotify made a complaint similar to Epic’s, will rule in Epic’s favor even if the U.S. courts do not return a favorable result for Epic. Eventually, regulators may change the rules to stop Apple from throwing its power around.

Other surprising facts leaking out

Above: Epic’s once-secret revenues have been disclosed in court papers.

Image Credit: Epic Games

Now let’s consider the things that aren’t so relevant to the case. One category I would call “collateral damage,” where a partner of Epic’s gets splashed with damage. Sony is friendly to Epic, having invested hundreds of millions of dollars in Epic. But under questioning, Epic’s Sweeney confirmed that Sony is the only platform owner that requires Epic to pay compensation for crossplay, or enabling games so friends can play with their friends, no matter what platform they are using to play a game like Fortnite. Sony extracted a payment from Epic, while other companies did not. That’s pretty anti-competitive and anti-consumer.

But so long as Sony has competition, it’s not a monopoly. And so long as it is not a monopoly, it can play with bare-knuckle rules like any capitalist. Apple, on the other hand, has to hold back because it is so much bigger, and its actions can be interpreted as antitrust violations.

Another thing that spilled out was a complete list of the games that Epic Games made available for free in its Epic Games Store, and how much Epic paid to developers for the right to have their games exclusive and available to increase the number of accounts on the Epic Games Store.

Simon Carless of GameDiscoverCo found documents that mentioned the details of Epic’s game giveaways in 2018 and 2019. Subnautica had more than 804,000 users when Epic Games gave away the game on its then-new Epic Games Store. Epic gave the developers $1.4 million, and roughly 17% of the players were new to the Epic store. That means the giveaways were a relatively inexpensive way to acquire new users.

Above: Epic Games Store deals

Image Credit: Epic Games

For Borderlands 3, Epic paid $146 million in advances to have the game as an exclusive on the PC. Epic recouped the $80 million minimum guaranteed fee of $80 million for marketing, bundle deals, and fees. And it got more than 1.56 million players. Of those, half were new to the store. Epic lost around $181 million on the Epic Games Store in 2019, and it projected it would lose around $273 million in 2020.

With this evidence, perhaps Apple could point out how hypocritical Epic Games is. Epic is buying market share, and rivals like Steam could claim this is anti-competitive. Epic’s answer is that Steam could lower its royalties from 30% to 12%, as Epic has done, and Epic would stop doing this. Again, Epic can do this because it doesn’t have a monopoly.

Apple complained that Epic surprised it by naming Lori Wright, vice president of business development at Microsoft, as a witness. One of Wright’s comments got picked up around the world as she articulated a well-known but never disclosed fact: Microsoft loses money on every console that it sells.

She was there to testify about Microsoft’s well-known attempt to launch a cloud gaming app, Project xCloud, on the iOS store. She confirmed that Microsoft sells its Xbox consoles at a loss. (Microsoft use a “razor and razor blades model,” where it loses money on the razors and makes money on the blades; the console is the razor, and the blades are the games.)

An Epic Games lawyer asked, “Does Microsoft ever earn a profit on the sale of an Xbox console?”

She replied, “no.”

Above: Steve Jobs wrote this memo in 2010.

Image Credit: Epic Games

The documents also show Fortnite’s budget in 2017, how much Epic paid various vendors for outsourcing tasks, and a redacted copy of Epic’s agreement with Microsoft to publish Fortnite on the Xbox One game console.

Epic Games went through great pains to enable crossplay on Fortnite across all platforms. It succeeded, but its documents showed that Epic pays money to Sony for allowing crossplay, while Epic doesn’t pay any money for that purpose to others.

According to a presentation in June 2020, Fortnite had 81 million monthly active users, the Epic Games Store had 45 million monthly active users, and Epic’s Unreal Engine had 540,000 monthly active users. Epic is under no obligation to disclose these numbers as a private company, but now those numbers are out in the open.

Sweeney testified that Fortnite transcends gaming, with special entertainment features such as concerts and films, and he believes it is a contender to be a metaverse, the universe of virtual worlds that are all interconnected, like in novels such as Snow Crash and Ready Player One. He said Apple’s actions stand in the way of Epic’s goal of creating a true metaverse.

More funny moments

Above: Epic Games launched the Free Fortnite Cup with Apple as the villain.

Image Credit: Epic Games

The court has game consoles in the courtroom for demo purposes. Sweeney was asked to assemble a Switch and its Joy-Con controller. He failed. He admitted, “As you can see, I’m not a Switch player.”

Gonzalez Rogers, the judge, replied, “Well, now the world knows.”

The companies are treating this as a kind of life-or-death battle when it comes to the future of the game industry, the rights of game and app developers, and the freedom to innovate. But let’s hope that the three weeks of the trial produces more funny moments, like when a lawyer asked Sweeney, who has many important things to do, “What is a game console?”

I don’t know if the judge, who will decide this case rather than a jury, really needs that kind of elementary background. But it’s a bit mind numbing as we wait for more exciting testimony to surface. I’m looking forward to watching Apple executives take the stand soon, and the whole world will be watching.

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