AAPL and Epic: Tower Defense vs. Battle Royale

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September 1, 2020

AAPL and Epic: Tower Defense vs. Battle Royale

Epic’s legal challenge to the AAPL App Store and GOOGL Play brings to the surface a budding revolt amongst developers against policies that siphon 30% of app revenues and limit the integration of new functionality. We see this as a new chapter in an old story – companies with market power often control the ways in which other companies may engage with their ecosystem. (see The Bell System, cable boxes, AOL, pre-iPhone wireless internet, etc.) The original rationale for these restrictions may be concerns for “system integrity” or “protecting users from harm” but the ongoing effect is anti-competitive. Here, the domination of app distribution is forestalling a paradigm shift to cloud app platforms that bundle synergistic functions and operate across device platforms, keeping users within the app platform and loosening dependence on the default environment established by the device OS. While “walled garden” approaches are obviously profitable for the “gardener” and can be difficult to break, history has seen government intervention and technical innovation inevitably effective in undermining them. Epic, and other significant consumer online franchises (e.g. FB, GOOGL, AMZN, NFLX, SPOT, SNAP, MSFT, and others) look to emulate what Tencent’s WeChat has achieved in China, transcending devices to amalgamate a wide range of user engagement (e.g. messaging, shopping, payments, games, social media, and even “app” distribution) within a single “thick” app. We believe that the shift will happen, the only question is how long it will take.

  • The App Store Rules. Initially, AAPL’s tight control was a key benefit. Users enjoyed a holistic, malware-free experience that “worked”, while developers gladly paid a 30% fee to play in the emerging ecosystem. 14 years into the smartphone era, that control is an impediment to innovation and a tax on both developers and users. AAPL demands 30% of most revenues generated on iOS – e.g. fees, subscriptions, ads, and in-app purchases (physical goods are excepted) – and all updates/changes must be approved by AAPL before being pushed to users. Apps may not link to websites or other services not controlled by AAPL and must make use of specified AAPL services as default (e.g. ApplePay). GOOGL has copied much of this in its Play Store, although restrictions on developers are less onerous.
  • WeChat Envy. In China, WeChat provides an enormous range of services – messaging, gaming, communications, payments, reservations, news, customer service, even its own app store. WeChat is so dominant, that it supersedes default services offered by device platforms, greatly reducing switching costs for users. Western developers aspire to similar breadth and integration but are thwarted by App Store rules that forbid it (at least outside of China). This is the crux of Epic’s complaints against AAPL and GOOGL, which will not allow it to distribute 3rd party games within its app, accept payments on its own terms, or refer app users to its web site. Recently, FB was temporarily banned from the App Store for revealing AAPL’s 30% surcharge on tickets sold via its app. FB has joined MSFT, SPOT, and others in support of Epic, explicitly protesting the App Store rules.
  • Walled Gardens Eventually Fall. Tightly controlled ecosystems are increasingly difficult to sustain, facing both government scrutiny and competitive forces. It was nearly 100 years before the 1968 Carterfone decision ended AT&T’s prohibition on 3rd party devices. 12 years after the birth of IBM’s mainframes, a negotiated antitrust settlement allowed Amdahl to launch plug compatible gear and the PC revolution subsequently ended IBM’s dominance. AOL repackaged to internet into a walled garden for its dial-up subscribers, only to see its strength fade in a few years with the rise of residential broadband. Cable MSOs fought to protect the set top box from various technical and regulatory threats and only recently lost their iron grip on the living room TV to innovative alternatives. At the start of the millennium, wireless operators tried to restrict user mobile internet access to their curated roster of partners – the iPhone effectively killed off that policy.
  • App stores face legal/regulatory threats. Epic’s lawsuit against AAPL joins two other legal challenges, one brought by developers and another class action suit on behalf of consumers, in US courts. In addition, the FTC has an anti-trust inquiry underway while the EU is investigating the App Store and Apple Pay for possible violations of its competition policy. Of these, the EU’s cases carry the greatest risk, as European anti-trust law is far less friendly to market power. Should any of these go against AAPL, the remedies could require 3rd party distribution for apps, competition for payments, ability to replace default apps, or freedom to link app users to websites, amongst other things, all of which would erode the iOS competitive moat and threaten service revenues.
  • Cloud platforms are driving innovation. Epic, FB, and many other software companies aspire offer highly integrated virtual environments delivering entertainment, gaming, media, communications, e-commerce, and other activities to consumers with a consistent, intuitive experience across devices. While we believe competition will keep any player from building a single dominant “metaverse”, the concepts of functional integration, ubiquitous access, and critical mass offer intriguing benefits to users and ecosystem partners which may not be available in the authoritarian walled garden model.
  • GOOGL is playing both sides. While AAPL is all in on its closed device strategy, GOOGL controls Android on one hand while plying an integrated cross-device app strategy on the other. On the Android side, the Play Store apes many of the fees and restrictions of the AAPL App Store – although alternative app distribution is allowed, as are in-app links to websites – and GOOGL insists that Android licensees include many of its apps as defaults. As a developer, GOOGL pays AAPL billions to keep Search as a default, enjoys wide adoption of YouTube on iOS, and promotes its popular Maps, Chrome, and Gmail franchises as alternatives to less well-regarded AAPL default apps. A somewhat defanged version of GOOGL Assistant is also available to iOS users. Ultimately, we believe GOOGL would be willing to further loosen its control of Android if it could get similar treatment for its integrated apps on iOS.
  • We believe integrated cloud app platforms will win the long game. We have written of the advantages of the cloud-centered model vs. the device-centered approach (After Smartphones: Hold the Metaverse, the Device Assistant Era is Coming). Epic, with more than 350M registered users, may be able to catalyze consumer pressure on AAPL (and GOOGL) and raise regulatory scrutiny as it pursues legal redress. With heavy hitters like FB, MSFT, and SPOT explicitly supporting Epic (and others, like AMZN, NFLX, SNAP, DIS, etc., rooting from the sidelines), this move could accelerate the shift toward the cloud as the primary nexus of the user experience.

The Peasants are Revolting

The iOS ecosystem is the most valuable structure on in the TMT landscape, and AAPL rules it like a feudal kingdom. Serfs may farm the land but must pay Cupertino a 30% share of every harvest and adhere strictly to the dictates of the lord. Serfs must use the tools provided (e.g. Apple Pay, iMessage, etc.), cannot offer alternative distribution for digital goods, and cannot link to marketplaces outside of AAPL’s jurisdiction. If a developer finds unusually fertile ground, Apple reserves the right to make its own alternative an integrated default. Of course, certain VIPs get special treatment – AMZN pays half of the customary 30% fee for Prime Video subscriptions, the Chinese government assures homegrown developers have freedom from many AAPL policies, and so on. In contrast, cloud gaming platforms – such as MSFT’s xCloud, GOOGL’s Stadia, or NVDA’s GeForce Now – are prohibited.

Legal experts suggest that Epic is unlikely to prevail against AAPL in US courts (N.B. SPOT has lodged a complaint with the EU competition committee, a far friendlier venue), but perhaps that is not the endgame. Epic is rallying the developer community against the App Store rules – thus far, MSFT, FB, SPOT, and Valve have issued public support. More importantly, it has started appealing directly to the 350M registered Fortnite players, most of whom are well below the age of 30. Tarnish to the AAPL brand from a grass roots coalition of gamers is likely to be a far more effective weapon in this conflict than an army of lawyers.

For Epic and AAPL, this fight goes far beyond the 30% markup on Fortnite V-Bucks game currency. Epic’s guiding vision is “The Metaverse” – a sci-fi derived conception of a cloud-based world integrating a broad range of online engagement – e.g. gaming, entertainment, communications, e-commerce, social networking, collaboration, professional services, health care, and everything else – to an universal virtual environment accessible at any place, at any time, and from any device. Interestingly, AAPL wants the same thing, but without the “any device” part and that all of that activity ought to generate a significant cut specifically for AAPL. In the AAPL vision, the integration is engineered solely by AAPL and is specifically centered on AAPL devices rather than the cloud.

Thus, the companies are at loggerheads. Expansive cloud-based visions like Epic’s (and AMZN’s, FB’s, MSFT’s, NFLX’s, SPOT’s, ATVI’s, Valve’s, and many others, including GOOGL’s) are hostage to AAPL’s competing philosophy. A metaverse inside the iOS walled garden would erode AAPL’s control of it, much as the ubiquity of the broadly functional WeChat has lowered switching barriers and service opportunities for the company in China. Tim Cook and company had few degrees of freedom in China, but they are not about to make it easy for a similar threat to rise elsewhere. The ambitions of rivals for gaming, social media, AI assistants, and other applications are not compatible with AAPL’s aims, and the challenge is to deliver enough proprietary innovation to the iOS ecosystem to keep users from crossing the switching barriers.

This is a considerable challenge. History has many examples of walled gardens that worked until they didn’t – IBM mainframes, AOL, cable boxes, and wireless carrier mobile internet to name just a few. We’re not sure that incremental superiority on privacy or security will be enough if cloud-based platforms enable more compelling experiences elsewhere. Ultimately, AAPL may have to choose between defending its hegemony over the developers or delighting its users. Both could have costly implications.

The Epic Future

Epic Games’ CEO Tim Sweeney is a true believer in “The Metaverse”. The concept was first articulated in Neal Stephenson’s 1992 science fiction novel “Snow Crash”, where humans interact with each other and software agents as avatars in a virtual environment that echoes the real world. For Epic, this translates to a strategy of building a world around its games, integrating social interaction, non-gaming entertainment, and commerce in an immersive experience that keeps players engaged within the platform, accessible from any place, any time, and any device, using data captured across the platform to personalize the experience for each user (Exhibit 1). In app purchases are a big piece of this – Fortnite players use V-bucks (purchased or won) as currency to buy all manner of electronic goods – with aspirations to establish a broad marketplace of third party vendors selling anything, game related or not.

V-bucks are at the center of Epic’s conflict with Apple. Under App Store rules, Epic’s iOS app MUST use Apple Pay as the basis of in-app purchases, capturing credit transaction fees in addition to assuring payment of the 30% share due Apple. Bristling under these conditions, Epic included hidden code within its most

Exh 1: High-level breakdown of the concept of “Metaverse”

Exh 2: Timeline of Apple vs. Epic Games conflict unfolding in the last 2 months

recent apps that could be activated to present users with an alternative payment method, priced 30% less with the absence of fees paid to Apple. Once activated, this violation spurred Apple to ban Fortnite from the App Store, prompting an immediate lawsuit and public relations onslaught portraying Apple as the villain in a recasting of the company’s famous 1984 ad that portrayed the Mac as the hero bringing down a dystopian future controlled by IBM (Exhibit 2). Cupertino was not amused.

Epic is also the creator of The Unreal Engine, the leading game development platform with leading edge tools for quickly programming high resolution 3D graphics, realistic physical movement and light, and libraries of common game objects. Epic monetizes the Unreal Engine by asking 5% of the revenues (after the first $1 million) from developers that use it, waiving the fee if the game is distributed on the rapidly growing Epic Games Store, where it takes a 12% cut of sales (Exhibit 3 – 7). The Epic Games Store is an integrated piece of the company’s push to “The Metaverse” and a further bone of contention with Apple, which prohibits independent app distribution on iOS.

The Tao of Steve

Apple’s strategy largely derives from the genius of Steve Jobs and centers on the integration of hardware and software in highly differentiated devices. Jobs’ experience with the Mac vs. PC battles of the ‘80’s convinced him that devices with integrated hardware and software designed closely in tandem, optimized for the user

Exh 3: Fortnite is a popular franchise worldwide – snapshot of MAU Growth

Exh 4: Fortnite Player Age Distribution – conflict hurts Apple with younger users

Exh 5: Fortnite World Cup viewership hours live-streamed on Twitch & YouTube

Exh 6: Snapshot of average weekly hours spent playing Fortnite among regulars

experience by a single organization, are inherently superior to more open architectures that allow room for variation across multiple vendors. In this philosophy, the device and the experience are inseparable parts of the whole and to the extent that outside companies participate, their role must be controlled by the creator of that perfect device. For the last 14 years, the ne plus ultra has been the iPhone, and Apple has methodically built a massive tightly controlled ecosystem of apps, peripherals, and services around the iconic OG smartphone. Apple deeply believes that this control delivers important benefits to its users – ease of use and system efficiency from integrated design, protection from malware, and vigilance for data privacy – that override any upside that might come from greater openness.

Apple makes money in three ways from its iOS franchise. First and foremost, it designs and manufactures (with stunning efficiency) extraordinary devices, including peripherals, featuring proprietary software functionality built to be intuitive and as frictionless as possible, and sells them at significant premiums. Second, it allows 3rd parties to develop apps for the iOS platform with the App Store as the sole distribution point taking 30% of most revenues – i.e. upfront payments, subscription fees (drops to 15% after year one), advertising revenues, in app sales of electronic goods (physical goods and services are excluded) – and enforcing strict requirements, which include the exclusive use of Apple Pay for payments. Third, it develops its own paid services – e.g. Apple Music, iCloud, Apple News, Apple TV+, etc. – integrates them into the iOS platform, privileging them relative to would-be competitors. Of course, the second two proceed from the first.

The rise of broad, cross-platform, integrated cloud-based applications is a major challenge to Apple’s device centered philosophy. The success of WeChat in China is the salient example of the tension between a

Exh 7: Avg. per player spend on Fortnite virtual goods – gaming ARPUs are high

Exh 8: Avg. no. of games downloaded each week – only growing post pandemic

Exh 9: Estimated spending inside of Mobile App Stores, 2Q2020 – gaming spend could be threatened if Apple continues leading franchise purge

Exh 10: Est. player spending on in-app virtual items including skins and lootboxes

Exh 11: Analyst estimates for gaming market project 10% growth in 2020 – we think the estimates are overly conservative

Exh 12: Next frontier from gaming demands ubiquitous intelligence and data sharing and cannot be contained within Apple’s tightly defined parameters

“thick” app approach and Apple (Exhibit 12). Chinese consumers swap between device brands readily, as most of their activity is tied to WeChat rather than the default functions of the smartphone. Messaging? WeChat, not iMessage. Payments? WeChat Pay, not Apple Pay. Games? WeChat, not Apple Arcade. WeChat Photos, not Apple Photos. WeChat Apps instead of the App Store. Relatively late entry into China and the muscular industrial policy of the Chinese government favoring indigenous champions like Tencent left Apple with little choice but to accept the loosening of control over the iPhone user experience if they wanted to play in that market.

Thus, the impasse with developers looking to bring their vision of integrated cloud apps to the iPhone. The 30% fee is non-negotiable – unless you happen to be an essential app, like Amazon Shopping, Netflix, Facebook, or Google Search, that might prompt a user revolt if excluded from the platform (Exhibit 13). Even then, Apple is not amenable to using those apps as platforms to deliver a broader suite of services, and where applicable, even these mega apps must typically defer to most of the App Store rules. For example, Netflix doesn’t have to share subscription revenue with Apple, but you will have to create your account elsewhere – if you download the Netflix App, the open screen asks for your login but gives you no options to sign up within the app. From the developer’s perspective all of this seems petty, greedy or even abusive, but from Apple’s perspective it is necessary to protect the integrity of integrated iPhone experience from apps that might push it to the background (and, of course, to protect the significant and highly profitable revenue flow from the App Store).

Exh 13: Snapshot of active users across leading internet platforms

Friends of Epic

Epic is not the only company with an axe to grind against Apple. In March of last year, Spotify lodged a complaint against the App Store with the EU Competition Committee, which had previously levied $10B in fines on Google and required business model changes after ruling that several of its practices were anticompetitive. The committee recently announced a formal investigation. Shortly after Spotify’s filing, two small developers launched a class action suit in the US alleging that the App Store rules were anti-competitive. Spotify, Microsoft, and Facebook have all issued statements of support for Epic’s move, with numerous other parties having obvious skin in the game as well.

Tencent may be the furthest along in delivering “The Metaverse”. The company’s WeChat is dominant in China, combining social networking, messaging, games, communications, commerce, reservations, payments, news distribution, streaming media, communications, customer service and even the distribution of other apps into a single, nearly ubiquitous (in China) platform with more than 1.2B monthly active users. Many Chinese keep the app open at all times, completely fronting the underlying OS of their smartphones and eliminating switching costs.

Facebook’s Mark Zuckerberg is also a “The Metaverse” true believer, at one time providing a copy of “Snow Crash” to every new employee. Facebook’s push to integration is obvious – the eponymous social networking site is tightly linked to the other properties, Instagram, and WhatsApp, each of which provides a different angle on the company’s stated mission to give people the power to build community and bring the world closer together. The company would like that happen without ever logging out of the Facebook franchises, regardless of the device you happen to be using. Beyond ad supported social networking, Facebook aspires to e-commerce and gaming, with a recent agreement with Shopify to push Facebook Shops for merchants, the 2014 acquisition of VR gaming pioneer Oculus and the cybercurrency initiative Libra are clear steps toward establishing a “Metaverse” of its own.

Amazon CEO Jeff Bezos also identifies “The Metaverse” as an important influence. The company has been relentless in its integration of new businesses to its platform. Prime Video offers streaming programming on demand, including live events/sports. Amazon Music is a rival to Spotify and Apple Music. Prime Gaming combines the Twitch live stream/e-sports platform with game distribution. Prime Reading offers an electronic library with thousands of books plus a monthly free read from a selection of recent releases. Amazon photos offers free storage and shipping for photo books and prints. The Prime Rewards Visa offers 5% cash back for Amazon and Whole Foods Purchases, 2% back at restaurants, gas stations and drug stores, and 1% back on everything else. More than 40M households use Amazon’s Fire TV to manage their video streaming. There are more than 60M Amazon Echo smart speakers connecting users to the Alexa AI assistant which offers an easy gateway into Amazon’s other services. And of course, there is the shopping. All of this is intended to keep Prime members happy and engaged with the world of Amazon.

Alphabet founders Larry Page and Sergei Brin have cited the computer on Star Trek – always available and able to intuit the meaning of spoken commands and queries – as their biggest inspiration. (N.B. both Bill Gates and Steve Jobs acknowledged the influence of that seminal sci fi series on their respective businesses) While we have written of the differences in Google’s vision of “ambient computing” from “the metaverse” concept (After Smartphones: Hold the Metaverse, the Device Assistant Era is Coming), both ideas rest on highly integrated, ubiquitous app environments. In Alphabet’s case, Search, Maps, Gmail, Chrome, Photos, YouTube, Shopping, Assistant, Stadia Gaming, and other apps are tied together, levering the company’s extraordinary reach and its technical leadership in AI and hyperscale datacenter technologies. The 2 billion user Android franchise gives it an obvious venue to press its advantages, but the strategy is explicitly designed to overarch all manner of access devices in search of seamless ubiquity.

Microsoft has greater consumer aspirations than most investors suppose. There are 90M paying subscribers to the company’s Xbox Live networked gaming platform and great hopes for the recently launched xCloud streaming game service. The rumored negotiations for TikTok’s US business would mesh nicely with this youth-centered franchise. Perhaps more important are Microsoft’s aspirations to dominate streaming game

Exh 14: Highlight of recent conflicts Apple has entered over App Store policies

hosting with its Azure cloud platform. In addition to the aforementioned xCloud, Microsoft will also host a streaming games service from Sony, its primary console rival. Nintendo is rumored to be considering Azure for its own future streaming plans, while Electronic Arts is already up and running. We note that streaming gaming platform apps, like xCloud, have been banned from the Apple App Store (Exhibit 14).

Other significant consumer app companies are also weighing options for integrating new businesses into their platforms. Spotify has added podcasting. Snap is shifting into e-commerce. Netflix has been much more static from a product standpoint, denying interest in live video, advertising, pay-per-view, or integrated e-commerce. Nonetheless, all of those and more remain options given the platform’s formidable reach and engagement. As noted, most gaming companies – e.g. Sony, Nintendo, Electronic Arts, Activision Blizzard, UbiSoft, Riot, and others – also aspire to “metaverse” like engagement with their user bases. A wildcard is the privately held and rapidly growing Discord, which boasts more than 100 million MAUs (up 50% YTD) on its group chat (voice, video, and text) platform and is branching away from its gaming heavy heritage. It would seem a matter of time before it too would be looking at synergistic directions to expand its business.

Exh 15: Highlight of mounting threats to Apple’s walled-garden approach

Walled Gardens Eventually Fall

History has many examples of companies that built tightly controlled ecosystems on the altar of delivering a better user experience, only to see that control challenged by outsiders. Sometimes, the change agent is a legal challenge or government regulation. The obvious example here is AT&T. For years, The Bell System refused to allow 3rd party equipment to attach to its network – all home phones, modems, and other connected devices were designed and manufactured by its Western Electric subsidiary – claiming that rogue tech could damage the core networks. In 1965, a company called Carterfone debuted a device that could connect two-way radio conversations to a telephone call. AT&T immediately banned the device but Carterfone appealed to the FCC, which in 1968 ruled in its favor. After this, Ma Bell would have to demonstrate the risk to its network before prohibiting a device from connecting. This opened the floodgates for all manner of new devices, from home answering machines to faxes.

IBM had a similar tack with its dominant System360 mainframe computers, launched in 1964. All of the terminals, front-end-processors, storage systems, and other gear would need to be bought from Big Blue. The Carterfone decision was a harsh wake-up call. In 1975, IBM entered into a settlement with the US Department of Justice, which had been investigating the company for antitrust, to sanction 3rd parties to sell equipment that was plug compatible with its computers. Thus, Amdahl Computers, founded by a former IBM engineer, gained new life. Later on, IBM’s attempt to create a PC architecture that it could dominate without falling afoul of its regulators ended up driving a stake right through the company’s crown jewels. Oops (Exhibit 15, 16).

AOL was founded in 1983 as a service to let home computer owners download games, morphing through several iterations before settling on a strategy to offer a turnkey bundled internet service to consumers. In the ‘90’s, the Internet was an exotic thing to most users and AOL made it simple, offering up a tightly

Exh 16: Summary of similar walled gardens corrupted by innovation or regulation

curated package of information, entertainment, games, and communications. AOL maintained its dominance in the consumer internet past its 2001 merger with Time Warner, showing relative resilience in the face of the concurrent bursting of the internet bubble. However, the combination of “always on” broadband (vs. AOL’s primarily dial-up base), Google Search, and easy to use browsers rendered the AOL walled garden superfluous and users began bailing in droves, leaving the merged AOL Time Warner the punchline of many a Wall Street joke.

As AOL Time Warner was taking its punishment, the mobile phone boom was in full tilt. Connection speeds on the 2G networks of the early millennium topped out at 40Kbps and even the simple websites of the day couldn’t be rendered on the tiny low-resolution screens. Carriers saw an opportunity to establish control of the mobile internet, building walled gardens with greatly simplified, largely text content that could be supported on mobile devices. Each carrier signed on a roster of content partners who would reformat exclusively for their proprietary platform, and subscribers had to ante up for the package at a hefty monthly fee. With the advent of 3G mid-decade, speeds increased by a factor of 100, enabling a much more palatable experience, but carriers still limited access to their curated (and lucrative) walled gardens. It was the entry of the iPhone in 2007 that marked the end of carrier restricted mobile internet. AT&T was on its heels, having had to make an enormously expensive and disruptive technology transition from the dead-end US only IS-136 standard to the global GSM. Hemorrhaging market share, it struck a deal with the devil, agreeing to drop any control of its mobile internet to get an Apple exclusive. The rest is history.

Through the ‘90’s and into the ‘00’s cable operators established dominion over the residential living room. Televisions of the day were largely defined by a single input and the set-top box rented from the cable company for a stiff monthly fee was permanently ensconced in that port. Even when TV OEMs began adding additional ports – generally used for VCRs back in the day – switching from one input to another was a serious annoyance. Legal and regulatory challenges to forced set-top box rental yielded toothless remedies, like the Cable Card fostered by the Telecommunications Act of 1996 that was intended to package all of the anti-piracy tech of a set-top box into a cheap module which would then let 3rd party equipment in the game. That “solution” was essentially still born. It wasn’t until the rise of Streaming Video over the last decade that the Pay TV industry’s hold on HDMI input 1 began to weaken as smart TVs, connected TV devices (e.g. Roku, Chromecast, Fire TV, and others), and gaming consoles proliferated. Late in the game, cable MSOs began to enable streaming services like Netflix to operate through their cable boxes, but we believe that Pay TV is now on an irreversible (and likely many years long) glide path to irrelevance.

The Coolest Kid in the Room

Many legal commentators have asserted that US antitrust law will make it difficult for Epic to prove its allegations of Apple market power given the strength of Android as an alternative and precedent that supports a company’s right to choose with whom it does business. While we are not certain that Epic would not win its case, it is clear that any resolution in US courts will take years to play out, in which time the point

Exh 17: AAPL services segment revenue will be threatened if revolt leads to action

Exh 18: High-level overview of differences between EU and US anti-trust laws

could be made moot. The EU investigation, at the behest of Spotify, seems more threatening to Apple’s App Store policies (Exhibit 17, 18). The competition commission has the power to pass judgement quickly and unilaterally, and while the findings and remedies can be appealed to EU courts, European laws have much lower hurdles for finding market power. Still, it seems more likely than not that Apple’s basic policies on app distribution would remain largely intact.

The bigger threats are competitive. First, Apple’s public image as an underdog fighting the entrenched system has been an important aspect of its brand. From the iconic 1984 Superbowl ad, to the ‘90’s “Think Different” tagline, to the post-millennial “I’m a Mac, I’m a PC” campaign, and the “Hello” ads that launched the iPhone, Apple products have been portrayed as hip, edgy and innovative. This cool factor has been so baked into its mystique that the Occupy Wall Street protest against capitalism took a break from their chants and drum circles to hold a silent candlelight vigil on the night of Steve Jobs death, an oddity given Jobs’ wealth, power, and distain for charity.

In a turnabout, Epic has launched a PR offensive portraying Apple as a greedy behemoth, casting the company as the oppressive power in a 1984 ad of its own and running anti-Apple events for its fervent audience of gamers. Playing the same note, Facebook recently confronted Apple directly over the 30% surcharge added to event ticket sales on its app (Facebook was selling them at face value and passing the revenue directly to event organizers). It added a disclaimer revealing the existence of the markup, earning it an immediate App Store ban, with Apple claiming that the information was “irrelevant” and thus, inappropriate to communicate to users. Facebook could be testing the waters for a more direct appeal to its nearly 3 billion regular users over its broader concerns with Apple’s policies. This would be a magnitude more threatening than Epic’s campaign.

Exh 19: Major innovations in technology are converging to drive paradigm shift

Apple also faces growing political and media criticism of its cozy relationship with China, with questions about the treatment of workers in the manufacturing chain, cooperation with the Chinese government in removing apps supporting protests in Hong Kong, and double standards on privacy when dealing with the Chinese state. Historically, the media has been an ally for Apple, but the mood in newsrooms may be changing. Arguably, Apple has been the coolest brand in the world for nearly two decades – it’s a hard title to keep.

The Developers Strike Back

Second, Apple has tried to cultivate an image as supportive of developers, emphasizing the tens of billions of dollars in revenues that 3rd party apps have generated from the iOS ecosystem. Epic is agitating for an alternative characterization of Apple as a bully that keeps developers on a tight leash, reining in their creativity with strict rules and siphoning an unfair share of their revenues. As noted, Facebook has turned up the heat with its own protest over the required 30% markup on event ticket sales. Apple suffered a self-inflicted wound when it temporarily banned the non-profit, open source, WordPress app, demanding that it implement in-app purchases, despite the fact that the organization that publishes it doesn’t actually sell anything. This created quite a stir within the broader developer community. If other developers with strong user bases of their own follow Epic and Facebook’s lead flouting the rules and daring Apple to ban them from the App Store, the situation could get messy enough to erode the utility of the platform, particularly if Alphabet decides to further soften its own stance on its Play Store. This also has knock on effects. The market for engineering talent is extremely competitive, with Apple viewed as a top destination for programmers. This could change with a bloody war against developers.

Exh 20: Converging technologies are enabling extraordinary new use cases

No Monopoly on Innovation

Third, and most importantly, Apple’s device-first, walled garden approach presumes that the best innovations will come from its own labs, built on the idea of integrating hardware and software as a single system. Cloud resources, including apps, are viewed as subordinate to the device, keeping user data and many functions as local as possible. This approach maximizes responsiveness and security but sacrifices processing power, storage, and integration of the experience across devices and users. In contrast, the rest of the industry has shifted focus to the cloud to lever the enormous capabilities of hyperscale datacenters and CDNs, including specialized processing for AI, functionally limitless storage, easy support for multiuser group interaction, and seamless portability across devices and venues, while more vulnerable to RTT delays effecting responsiveness and security threats (Exhibit 19, 20).

Most of the concepts inherent in “The Metaverse” and Google’s Ambient Computing rest on the cloud. AI-powered virtual assistants, such as Amazon’s Alexa and Google’s Assistant, are obvious examples (Exhibit 21, 22). Alexa and Assistant follow you from device to device – the Google Home in the kitchen knows the recipe that you found online from your PC and can play the YouTube video you were watching on your phone. In contrast, the Siri on your iPhone is a separate entity from the Siri on your Mac or iPad, able to share only the information that has been explicitly uploaded to iCloud. Kludgy, at best. Given Apple’s insistence on holding almost all of its own software and cloud services proprietary, even if it did shift its focus to cross-device integration, the value of that to a user would be dependent on the homogeneity of their technology use. While Apple users are often rabid fans, very few have committed to the exclusive use of its product – note the relative penetration of Homepods and Apple TV boxes relative to iPhones.

Exh 21: Mobile centered Design Paradigm is giving way for Ubiquitous Intelligence

Exh 22: Global Smart Speaker Installed Base Forecast – device footing outside the purview of traditional app stores is going strong

5G, the arrival of which we believe has been delayed by the pandemic (5G: The Heat is Off), will be a significant factor for technology use in the intermediate future. The biggest benefit to users will be a dramatic improvement in the responsiveness of network apps, due to lower network latency and the facility for CDN-like edge servers geographically close to users. This will greatly increase the performance of cloud-

Exh 23: Top line growth for innovative consumer services franchises holds strong

Exh 24: While top-line growth for device-first players is showing signs of weakness

Exh 25: Snapshot of consensus sales estimates for Apple, FY2018 – FY2024

hosted apps on mobile devices, trimming the benefit in responsiveness that Apple’s device-focused approach has delivered to its customers. For example, in an application space like augmented reality, a 5G connection to the cloud could be a breakthrough, given the enormous storage and processing requirements and intolerance to delay inherent to the technology. Given that Apple seems to be concentrating its AR development on localized solutions, this could be an enormous risk to its aspirations.

How Will this Play Out?

While we see significant long-term risks to Apple’s walled garden, device centered strategy, we do not believe that it could be many quarters before they show meaningful impact on the company’s performance. We also place the odds on meaningful legal, regulatory, or legislative intervention as low, and certainly very unlikely over the next few years. Still, global economic conditions may make it difficult to achieve consensus expectations of better than 12% YoY growth for FY21 despite the company’s extraordinary operational execution (Exhibit 25). The worldwide smartphone market has been stagnant for four years and we are not convinced that the first 5G iPhones will be sufficient to drive the “supercycle” that many analysts are anticipating.

The bigger threat will more likely play out over 5-10 years, as the benefits of cloud-based device agnostic “mega-apps” becomes more obvious and as the low latency, fast round-trip-time functionality of 5G

Exh 26: Summary of Winners and Losers in the battle for open ecosystems

becomes more widely available. Then, Apple will find itself playing defense against broad platforms from Facebook, Amazon, Alphabet, Microsoft, Epic and others, either dramatically loosening its hold over its ecosystem to accommodate them or willfully blocking them and daring its customer base to go elsewhere. We do not believe that the status quo is a stable long-term equilibrium.

In this context, we’d rather own the innovators than the defender (Exhibit 26).


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