The Capital Note

Apple on Trial

Fortnite creator and Epic Games’ Chief Executive Tim Sweeney (L) leaves the federal courthouse after the first day of a weeks-long antitrust trial at a federal court in Oakland, Calif., May 3, 2021. (Brittany Hosea-Small/Reuters)

Welcome to the Capital Note, a newsletter about business, finance, and economics. On the menu today: Epic Games v. Apple, Alec Gores’s SPAC Machine, Walmart’s secret gaming service, and Clay Christensen’s early take on the iPhone. To sign up for the Capital Note, follow this link.

Epic Games v. Apple
A much-anticipated trial between Apple and Epic Games, the maker of blockbuster video-game Fortnite, commenced yesterday in Oakland, Calif. At issue is Apple’s 30 percent App Store commission, levied on app sales and content sold in-app.

Long a point of contention with app developers, the App Store has come under increasing pressure recently by a number of developers, including Spotify and Tile. Epic Games took the boldest measure yet when it attempted to circumvent the fees by offering an alternative payments system to its iPhone users. Apple promptly removed Epic from its platform, setting off a tense legal battle that will culminate with the testimonies of both companies’ CEOs this month.

The lawsuit targets a central pillar of Apple’s business model: its fully integrated operating system, which gives the company end-to-end control over the user experience. Unlike competing computers or smartphones, such as the Android, Apple’s operating system is a “walled garden” where all third-party software must be approved by Apple and downloaded in the App Store.

In Apple’s early days, tech analysts questioned the integrated approach, with many claiming it would make iPhones and Macs less attractive than competing devices that made use of open-source software. Jobs’s vision has no doubt been vindicated: Apple collected $15 billion in App Store commissions last year. But developers argue that Apple uses its walled garden to take unfair advantage of app developers. “The most prevalent flower in the walled garden is the Venus fly trap,” said an attorney for Epic. The company is petitioning the court to require Apple to allow third-party app stores on its platform.

Apple does appear to be tightening its grip on the App Store, as Stratechery’s Ben Thompson points out:

Last year, for example, the company required that apps that utilize third-party login services also utilize “Sign in with Apple”. This, by extension, meant that cross-platform apps and services had to integrate “Sign in with Apple” into their Android and web apps. This was in part a further assumption of customer management, and also an extension of control beyond the iPhone.

Apple’s control of the customer relationship has also helped sustain its control of payment processing; after Amazon advertised that Kindle books were available on all platforms Apple forced the bookseller to stop selling books in its app. Moreover, Amazon couldn’t even tell users to visit Amazon.com, much less offer a link or, as Android allows, a webview of the store.

But that is unlikely to result in a ruling against Apple. The iPhone maker argues that its fees are compensation for building out the iOS app ecosystem and providing developers access to its users, and that the smartphone market remains competitive. Proving that Apple has monopoly power will be an uphill battle for Epic. Regardless of the outcome, though, Apple will have to contend with continued pressure from governments as well as businesses. The European Commission initiated a probe into the App Store last week, spurred by the complaints of music-streaming service Spotify.

“It appears that Apple obtained a ‘gatekeeper’ role when it comes to the distribution of apps and content to users of Apple’s popular devices,” argued an EU official in charge of competition policy. “We need to ensure that Apple’s rules do not distort competition in markets where Apple is competing with other app developers, for example with its music streaming service Apple Music or with Apple Books.”

And a critical mass of U.S. lawmakers appears poised to go after Apple, too, if a recent congressional hearing is any indication. Whatever the result of the Epic trial, Congress could write laws that pertain specifically to the App Store or broad-based legislation reducing the heft of Big Tech firms. The California trial is unlikely to thwart Apple, but it’s the starkest display of antagonism against a tech firm yet.

Around the Web
Alec Gores, SPAC machine

The billionaire investor, who first tried his hand at the unconventional reverse-merger IPO process in 2015, has watched the market for SPACs reach a fever pitch over the last two years. As the market swelled, he became a serial SPAC backer. He has methodically created 13 special-purpose acquisition companies, more than any other single investor, according to data provider SPACInsider.

Mr. Gores is a veteran when measured in SPAC years. He believes in the process, which had been criticized as an avenue to take sketchy companies public. His firm, Gores Group, opens its own checkbook for every deal—unlike many other SPAC investors—and sometimes even lands deals despite underbidding his competitors, he says.

Epic Games v. Apple court filings uncover Walmart’s undisclosed gaming service

Walmart’s unannounced cloud gaming service, codenamed Project Storm, has been detailed in new confidential emails. An exhibit in the Epic Games v. Apple trial reveals Walmart’s efforts to pitch its cloud gaming service to Epic Games and get Fortnite on board.

A presentation attached to the emails shows how Walmart had been pitching its cloud gaming service to publishers like Epic Games. The company was planning to run the service on Windows, with third-party game launchers like Steam, Uplay, Origin, Epic Games Store, Battle.net, and Bethesda Launcher supported.

Bill and Melinda Gates announce their divorce

Bill Gates and Melinda Gates are getting a divorce after 27 years of marriage, the billionaire philanthropists announced on Monday.

“After a great deal of thought and a lot of work on our relationship, we have made the decision to end our marriage,” said Bill Gates, the co-founder of Microsoft, in a tweet Monday afternoon.

Random Walk
In light of the backlash against Apple’s integrated operating system, I revisited an old Stratechery post highlighting criticisms of the walled garden approach by tech guru Clay Christensen. This excerpt in from 2006:

Q: Can Apple keep it up?

Christensen: I don’t think so. Look at any industry — not just computers and MP3 players. You also see it in aircrafts and software, and medical devices, and over and over. During the early stages of an industry, when the functionality and reliability of a product isn’t yet adequate to meet customer’s needs, a proprietary solution is almost always the right solution — because it allows you to knit all the pieces together in an optimized way.

But once the technology matures and becomes good enough, industry standards emerge. That leads to the standardization of interfaces, which lets companies specialize on pieces of the overall system, and the product becomes modular. At that point, the competitive advantage of the early leader dissipates, and the ability to make money migrates to whoever controls the performance-defining subsystem.

When the iPhone came out the following years, Christensen expressed doubt:

The iPhone is a sustaining technology relative to Nokia. In other words, Apple is leaping ahead on the sustaining curve [by building a better phone]. But the prediction of the theory would be that Apple won’t succeed with the iPhone. They’ve launched an innovation that the existing players in the industry are heavily motivated to beat: It’s not [truly] disruptive. History speaks pretty loudly on that, that the probability of success is going to be limited.

A rare incorrect prediction by Christensen.

— D.T.

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