Apple and Google’s app stores face regulatory, developer presssure

Tim Cook, CEO of Apple,
whose App Store has become a big money maker.
AP

• Apple and Google earn big money through the commissions
  they charge of sales made through their smartphone app
  stores.
• Right now, they take a 30% cut of most sales made
  through their stores.
• But that rate could soon plunge, Macquarie analyst Ben
  Schachter said in a research note.
• The companies face regulatory and legal challenges over
  the rates they charge, as well as growing pushback from
  developers, Schachter noted.
• If Apple and Google were forced to cut their rates, the
  move could cost them billions of dollars in revenue and
  operating profits, he estimated.

For years now, Apple and Google, in addition to their main
businesses, have had a growing and profitable side gig going
charging developers hefty commissions when the developers sell
apps, subscriptions, and other items through their app
stores. 

But maybe not for much longer.

Apple and Google face regulatory threats and pushback from
developers that could hamper their app store businesses and force
them to reduce the cut they take from each sale, Ben Schachter, a
financial analyst with Macquarie Research, said in a research
note Monday. Even though the companies’ app stores are just
sideshows to both companies’ main businesses, they could both
take a significant hit to their financial results if they are
forced to reduce rates, he said.

Apple, for example, could take a $16 billion hit to its adjusted
earnings if its forced to take a major cut to its App Store
commission rates, he said in the note.

“We believe that the traditional … commission rates for app
distribution may come under pressure,” Schachter said in the
note. He continued: “Changes in the commission rates would
meaningfully impact profits.”

Apple started taking a 30% cut when it launched the App Store

Both Apple and Google charge a 30% commission on purchases made
through their app stores, including on buying apps, subscription
sign-ups, and in-app purchases of digital goods. Both companies
also now charge 15% on subscription charges after the first year;
a reduction to entice developers to focus on subscription-based
business models. 

Tim
Sweeney, CEO of Epic Games, which announced earlier this month
that it won’t distribute “Fortnite” Google
Play.
Epic

Although the basic 30% commission has been the norm since Apple
launched the iPhone App Store 10 years ago, it’s starting to come
under increasing scrutiny. Earlier this month, Epic Games
announced that it would distribute the Android version of its
megapopular game “Fortnite”
through its website rather than through the Google Play app
store. It opted out of Google Play specifically because it didn’t
want to pay the search giant a commission on in-app purchases,
which is the main way it makes money off “Fortnite.”

Epic’s move drew widespread publicity,
because it was so unusual for a developer to opt out of one
of the two major global smartphone app stores. But it may soon be
followed by others, Schachter said.

“We’ve had behind closed door discussions with game developers
who claim that [Apple] and [Google’s] commission structure is
unfair, and that they may take a more public role in pushing back
against the business model,” he said.

Developers are starting to push back against those commissions

And it’s not just game makers who are getting fed up. Spotify, in
a recent regulatory filing with the Security and Exchange
Commission called out Apple and Google for charging it
commissions that aren’t applied to their rival subscription music
services. The statement was only the latest move by Spotify to
bring the issue to the attention of consumers and regulators,
noted Schachter.

Daniel
Ek, CEO of Spotify, which has repeatedly criticized Apple and
Google for the commissions they charge in their app
stores.
Greg Sandoval/Business
Insider

Like Epic Games, Spotify has essentially opted out of that model.
Although iPhone users can download Spotify from the App Store,
they can’t sign up for its premium subscription service through
it. Instead, they have to do that through its website.

Apple and Google could also see pushback from other developers,
particular from streaming video providers such as Netflix,
Schachter said. As that market starts to mature, and the players
become less focused on signing up new users, they may start to
become more concerned about the commissions they’re paying to
Google and Apple, he said. Those concerns might be heightened as
the two giants rev up their respective video services, he said.

Already, Netflix is testing directing smartphone users to sign up
for a subscription to its service via their web browsers, rather
than through its app, Engadget
reported Tuesday.

“As [Google] and [Apple] continue to add more services and
directly compete with app developers, we suspect some of these
voices from the music, video, game business, and others may
become louder,” he said.

Apple and Google also face increased regulatory and legal
pressure

But the app store commissions are likely to come under pressure
from other places besides developers, most notably from the legal
and regulatory arena, Schachter said.

In the next year, the US Supreme Court is scheduled to hear an
appeal of an antitrust lawsuit by consumers filed against Apple
that targets its commission fees directly. The consumers charge
that Apple’s monopoly over the distribution of apps on the iPhone
means that developers have no choice but to pay its commissions,
which the developers then pass on to their customers in the form
of inflated prices. Should the court allow the case to continue,
it could eventually upset the whole business model of the App
Store.

Margrethe Vestager, the European Commissioner for
Competition, recently hit Google with a $5 billion fine for
abusing its dominance of Android.
Reuters

Meanwhile, Google’s business practices have been under scrutiny
for years now by European competition regulators. Last month,
they
hit the company with a $5 billion euro fine for forcing
smartphone makers to install its apps.

Such regulatory scrutiny may only increase, Schachter said.
Developers such as Spotify are complaining directly to
regulators, he noted. With the market big and growing rapidly —
global app sales hit $86 billion last year — and with Apple and
Google offering increasing numbers of services that compete with
those of leading app makers — their commissions and app stores
will also be increasingly likely to draw regulators’ attention,
he said, referring to the companies by their ticker symbols.

“We are concerned that given AAPL and GOOG’s dominance of mobile
[operating systems] combined with their growing efforts to add
value and services to customers using those OSs, it will draw
regulatory and legal attention,” Schachter said. He continued:
“We are particularly concerned that as AAPL and GOOG add more
features and offerings such as voice assistants, Apple Music,
YouTube Red, a potential video service from AAPL, and more, that
competing developers will claim that AAPL and GOOG’s position as
owners of the platforms may give them ‘unfair competitive
advantages.”

Apple and Google could take a big hit to sales and profits

Should all this pressure on the app store commissions lead to
decreased prices, the two giants could take a big hit, Schachter
said. Over the last year, 14% of Apple’s total revenue came from
its services business, much of which is derived from commissions
on App Store sales. 

If nothing changes with commission rates, Apple should see an
average commission rate of about 27% on such sales in its 2020
fiscal year, he estimated, taking into account the 15% rate it
charges on ongoing subscriptions. The company’s App Store revenue
would be about $20.1 billion that year, while its total company
earnings before interest and taxes (EBIT) would be about $78.6
billion, he said.

Sundar Pichai, CEO of
Google, which has generally followed Apple’s lead in terms of
app-store commission rates.
Getty

But if Apple is forced to slash its average commission rate to
15%, its App Store sales would fall to $11.2 billion in fiscal
2020, and its total company EBIT for the year would drop to $69.7
billion. If it has to cut commissions way down to 5% on average,
its App Store revenue would be just $3.7 billion, and its
company-wide EBIT — essentially its operating profit — would be
$62.2 billion.

Those estimates “highlight just how levered operating profit is
to the high-margin dollars of the App Store,” Schachter said.

Google could see a similar hit if it is forced to slash Google
Play commissions, he said. Assuming everything stays the same as
it is now and the company continues to get an estimated average
commission of 27% on app store sales, Google will pull in $10
billion in such revenue in 2020 and its company-wide EBIT will be
about $40.2 billion.

But if its rates are cut to 15%, Google’s app store revenue would
be just $5.6 billion that year and its EBIT for the year would be
$35.8 billion, he said. If rates plunge to just 5%, its app store
revenue would be about $1.9 billion, and its total EBIT would be
$32 billion.