Epic vs. Apple Trial Features Battle Over How to Define Digital Markets

By Tim Higgins and Brent Kendall

In the high-profile court battle set to begin Monday between Apple Inc. and "Fortnite" creator Epic Games Inc., the judge will grapple with a central question: how to define a market in the digital age.

The case pits the world's most valuable publicly traded company, which helped usher in the app economy more than a decade ago, against a privately held videogame maker that wants to topple Apple's so-called walled garden.

Epic says the App Store is a monopoly because Apple is the lone distributor of apps to more than one billion iPhones and controls the only payment system for digital services in those apps. That power, Epic says, lets Apple dictate anticompetitive commissions, including a slice as high as 30% of revenue and other terms that harm developers and increase prices. Epic has filed an analyst's estimate that Apple's operating margins for the store were as high as 80% in fiscal 2019, an estimate Apple says is wrong.

Apple offers a much broader view of the marketplace, one in which its App Store is one of many ways for Epic to distribute its games, including Sony Group Corp.'s PlayStation, Google's Android software, and personal computers, if the videogame maker doesn't like Apple's terms. In that wider market, Apple says it holds nothing close to monopoly power and is merely ensuring easy and safe use of apps for its customers.

U.S. District Judge Yvonne Gonzalez Rogers, in a bench trial in Oakland, Calif., is expected to decide which view is correct. The case taps into broader concerns about online platforms and digital commerce that face scrutiny from courts, regulators and lawmakers around the world. "This is going to be a fascinating trial," the judge told lawyers during an earlier hearing.

Randy Picker, a law professor at the University of Chicago, said, "These issues are dead critical to how the digital world we live in operates, and she's going to get first crack at it." There have been past antitrust cases that have touched on so-called closed platforms, involving corporate giants such as Microsoft Corp. and Eastman Kodak Co., but in the modern digital economy, he said, "This is fresh ground."

Justice Department antitrust officials have been scrutinizing Apple's practices. And on Friday, the European Union's top antitrust enforcer brought charges against Apple, claiming the iPhone maker squeezed rival music-streaming apps by requiring them to use its in-app payment system. Apple has denied wrongdoing.

The Epic case was discussed on Capitol Hill last month when a Senate antitrust subcommittee held a hearing examining the power of app stores.

A victory for Epic in its lawsuit could disrupt a pillar of Apple's fast-growing services business, which brought in nearly $54 billion in revenue in its latest fiscal year. An Apple win could send a chill over other app developers looking to challenge Apple's terms. Either outcome could be followed by years of appeals.

Apps give other companies a way to install software on iPhones that takes advantage of the hardware and operates better than over a website. Some app makers make money selling downloads, but over time it has become far more common to offer apps free and make money selling subscriptions or digital add-ons -- like extra features in videogames -- within the apps. Apple takes a cut of all of those digital sales, a huge stream of revenue.

Since Apple launched the App Store in 2008, opening the iPhone to outside software developers, the number of apps has soared to 1.8 million from 500, helping spawn new giants such as Uber Technologies Inc. App makers have complained from early on about Apple's rules.

Epic's battle began in August when it secretly launched an in-app payment system within a software update to the company's breakout hit, "Fortnite," aiming to circumvent Apple's payment system. Apple responded by booting the game from its store. Epic, which anticipated the move, quickly filed its lawsuit, and Apple countersued.

Apple Chief Executive Officer Tim Cook and Epic co-founder and CEO Tim Sweeney both might testify in the trial, which is expected to last most of May. Mr. Sweeney is expected to sit near Epic lawyers every day in the courtroom. Each side has expert witnesses with conflicting views of the market.

Antitrust cases can be difficult for plaintiffs to win, and Apple cites recent major rulings in favor of such defendants as Qualcomm Inc. and American Express Co. as support for its position. Courts in recent decades have read the antitrust laws more narrowly than before, giving company practices more latitude, especially in fast-moving tech markets. Even if Epic's market definition carries the day, there are other issues in the case, including whether Apple's policies actually cause antitrust harm and whether consumer benefits from Apple's practices outweigh any diminishment to competition.

"Market definition is Epic's highest hurdle," said Paul Swanson, a Denver-based antitrust lawyer at Holland & Hart LLP who is following the case. "An iPhone, iOS, the App Store and in-app purchasing feel like part of one cohesive product. You can't buy one without all the others."

Epic is separately suing Alphabet Inc.'s Google on similar grounds. A trial date hasn't been set. Google has said Epic violated its app store's policies that are designed to maintain safety for users.

Together, the two companies control the market for smartphones, which "are the only platform devices owned by a majority of people around the globe," Epic said in a filing in the Apple case. "And they are the only devices that people keep with them at nearly all times."

Almost 10% of Epic's average daily players for "Fortnite" were using Apple devices, according to court records. Apple players spent almost $750 million on in-app purchases through Apple's operating system, about two-thirds from users who only ever made "Fortnite" purchases through iOS, Epic records show.

Apple's refusal to let Epic distribute apps through its own store on iOS "is the anticompetitive act at issue," Gary Bornstein, a partner at Cravath, Swaine & Moore LLP who is representing Epic, told the judge last fall.

Apple has previewed some of its defense in court filings, arguing that its fee is in line with what other platforms charge and is fair because of the value of the technology it has created for developers.

"This is the frontier fringes of antitrust law," Theodore Boutrous, a partner at Gibson, Dunn & Crutcher LLP who is representing Apple, told the judge. "They can't possibly show likelihood of success."

In pretrial proceedings, Judge Gonzalez Rogers has expressed some sympathy for Apple's arguments about the marketplace, saying walled platforms for videogames are nothing new. But she also suggested that Apple's approach to app developers might raise novel issues.

The judge added that her court was accustomed to such new questions in California. "They don't call this the Wild West for nothing," she said. "We frequently see these kinds of new issues, especially in technology."

Sarah E. Needleman contributed to this article.

Write to Tim Higgins at [e-mail] and Brent Kendall at [e-mail]

(END) Dow Jones Newswires

05-02-21 1014ET