Apple's App Store policies are a big mistake

Apple's App Store policies are a big mistake

The company can't explain what it's doing because it genuinely doesn't make sense

Matthew Yglesias

 Jun 16 

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(Silas Stein/picture alliance via Getty Images)

One of the non-politics things I like to follow is Apple-centric media, and it’s been kind of disconcerting to watch as the grumbling about the way the App Store works crosses the line from developers to the business press, then into the legal sphere, and then into mainstream media via Farhad Manjoo’s column denouncing “the Apple Tax.”

The basic issue here, if you haven’t been following it, is that when the iPhone was first introduced it had a small share of the cell phone market (which at the time was largely non-smart), and it introduced a paradigm for installing apps on the phones that was very different from how computers normally work. Instead of installing arbitrary software via download or physical disk, you installed software specifically sold by an Apple-controlled store. This model was actually pretty similar to how most other cell phones at the time worked, except if you wanted to install software on your Razr, you had to go to a store controlled by Verizon (or whatever carrier you used) rather than one owned by Motorola.

A big part of the early years of the iPhone was introducing a hardware product that was so appealing that it shifted the balance of power from the carriers to the hardware manufacturer. Apple had its own various motives for doing this, but a key thing to understand is that at the beginning, Apple seizing control was widely welcomed by people who make software. In part that’s because the iPhone was just so much more powerful as a computer — you could write better apps for it. And it’s also because everyone hates telecom infrastructure companies. The idea of Apple running a store was new, but Apple was a longtime player in the general market of “makes devices that run programs,” and in fact Apple was well-known for its community of independent Mac developers doing software by and for aesthetes. Apple took a 30% cut of all sales, but Apple was also the entrant into the marketplace putting the squeeze on the not-very-competitive carrier market.

A brave new app world

Today, Apple is one of two huge players that together own basically the entire phone OS market. And Apple completely dominates the high end of that market, to the extent that the majority of the money to be earned selling apps comes through the App Store. The App Store fees, in turn, have become a huge profit center, and not just as a way of defraying the cost of running of the store.

This has increasingly cast Apple as a potential antitrust villain. Medium-sized technology companies like Spotify have been increasingly aggressive in their complaints about Apple’s behavior, and Epic has taken them all the way to court in a trial that’s disclosed a lot of information about the development of the App Store over time. The small, independent developers who once saw the iPhone as the proverbial glass of freshwater in hell have become increasingly annoyed by Apple, too. In part, that’s because nobody likes handing over 30% of their revenue in commission. But also in part because the quality of Apple’s arguments is really low. Apple keeps saying in public, for example, that it’s actually a benefit to developers that they don’t allow third-party payment processing, because without it consumers wouldn’t have confidence in online payments. The 30% cut, in this view, is a well-deserved financial reward for Apple providing a valuable service. This argument may have made some sense when the iTunes store first launched in 2003, but it’s an insult to the intelligence of anyone familiar with the modern world.

I can also tell you from personal experience that Apple’s representatives do not have some better argument that they share with journalists off the record. Even worse, they specifically repeat their worst public arguments in private as if they think someone would find them persuasive. Most big companies are able to pull off a quiet “real talk” message that makes some kind of sense. Apple’s failure to do so makes it seem like either they are idiots, which seems like an implausible belief to have about the stewards of the world’s most successful company, or else they are villains.

In 1804, Napoleon sent a squad of dragoons across the Rhine River to kidnap the Duc D’Enghein and have him charged and executed on fairly flimsy charges of being part of an anti-Bonapartist conspiracy. Napoleon’s chief of police, Joseph Fouché, said “c’est pire qu’un crime; c’est une faute” — it’s worse than a crime, it’s a mistake. In other words, it ran contrary to Napoleon’s actual main strategic goals of stabilizing the domestic political situation and isolating Britain.

Apple executives aren’t idiots, but then again, neither was Napoleon. And my considered view on this is that they are making a mistake — they stumbled onto a revenue stream that they don’t want to give up, but successful companies don’t succeed over the long run by just grabbing every available penny. The refusal to exhibit any sense of grace and magnanimity about this is a huge strategic distraction, and it is now inviting regulatory and legislative crackdowns that are likely to leave everyone, including Apple, worse off than they would be if they just acted a little more high-minded.

A better argument for App Store fees

My first instinct was to infer from how terrible Apple’s arguments are that their position must be wrong. But given months and months and months of sporadically thinking about it, I decided that I should come up with a better argument for them (giant companies interest in paying me for this service should get in touch), and I think I got a good one.

Here is what I would say if I were Apple and wanted to be persuasive that that App Store commissions are good:

Like most companies, when we set the price of our product, we are balancing the fact that a high price makes the profit margins very high against the fact that a low price increases sales volume.

One factor militating in the direction of lower price (and higher volume) is that each phone sold generates ancillary revenue via App Store commissions.

Most of that commission revenue comes from free-to-play games (not the Apple community’s beloved indie developers).

Most free-to-play game revenue is derived from a minority of “whales” who get roped in and play compulsively.

Conclusion — the existence of App Store commission revenue pushes down the profit-maximizing price of an iPhone, but the majority of the App Store revenue comes from a minority of whales. Therefore, the majority of iPhone customers (non-whales) benefit from lower phone prices.

On that view, the App Store commissions are a form of price competition. Airlines’ ability to bilk price-insensitive last-minute business travelers encourages them to keep lots of planes in the sky which creates lower fares for the average leisure traveler. By the same token, bilking the whales makes phones cheaper for most of us. If you prohibited Apple from taking a cut of the action, the main beneficiaries would be the companies who make the whale-bilking games. The whales themselves might benefit from a lower price of bilking, depending on how competitive we think the bilking market is and what exactly is the psychology operating there. Sympathetic indie developers might be better off (because of lower fees) or worse off (because more expensive iPhones would create a smaller market to sell into). Realistically, they are probably going to be better off.

But policy isn’t supposed to serve the interests of developers, whether that’s developers of crappy free-to-play games or beloved indie apps. It’s supposed to serve the interests of consumers. And most people are better off with Apple taxing the whales.

I think that’s a pretty good argument. But the fact that Apple executives don’t seem to want to make this argument in public — not to me, not to tech journalists, not to Apple developers — carries some importance. Apple doesn’t want to present itself as a company that’s excited about free-to-play games duping whales into pouring unreasonable sums of money into in-app purchases. This, I think, is correct. It really cuts against Apple’s whole corporate identity as “yes our stuff is expensive but it’s the best stuff.” That identity is more important than App Store commission revenues, and they should act like it’s more important with their actual actions and policies and not just their rhetoric about the commissions.

Deadweight loss of the Apple Tax

The most intuitive thing to focus on when you pay taxes is that you now have less money whereas you’d rather have more money. But in economics, an important part of tax analysis is the taxes you don’t pay — the economic transactions that don’t occur because of the tax costs that would happen in a lower-tax or no-tax environment. That’s why there’s an especially strong case for taxes on things like pollution, traffic congestion, cigarettes, marijuana, and alcohol where high levels of consumption are undesirable.

(Saylor Academy)

And to me, the biggest problem with App Store commissions isn’t the fees that Apple collects, but the fees that Apple doesn’t collect for the sake of efficiency.

The canonical original example of this is e-books. If Amazon wants to sell books inside the Kindle App, Apple wants Amazon to pay 30% of the retail price to Apple. Amazon would rather not do that. But it’s worse than that, really. Amazon genuinely can’t pay a 30% gross commission to Apple because book retailing is just not that high-margin of a business. In other words, more than 70% of a book’s sale price goes back to the publisher. To pay Apple’s 30% fee, Amazon would either need to sell at a loss or else they’d have to persuade publishers to eat some of the cost.

Publishers aren’t going to do that, so you can’t buy a Kindle book in the Kindle app, which is inconvenient to iPhone users.

Now in theory, the point of this could be to give a competitive advantage to Apple’s digital bookstore which is not hobbled in the same way. That would be kind of underhanded if it’s what Apple was actually doing, but in fact Apple just doesn’t have a competitive product in this space. You can read a Kindle book on your iPhone or iPad but you can also read it on a Kindle — a device actually optimized for book-reading — and if you switch to another platform some day you can read it there. Apple doesn’t make a book-optimized e-reader and doesn’t seem that interested in the market. Purchasing a book on Apple Books is strictly inferior to buying it from Kindle.

Apple does at least have a competing streaming service that is advantaged by making it marginally less convenient to sign up for Netflix or Disney+ or HBO Max than it ought to be. But fundamentally, it’s the availability of content rather than ease of signup that makes or breaks a streaming service. A desire to inconvenience Netflix customers in order to sell Apple TV+ subscriptions would be scummy. But the real reason is worse than that — Apple is inconveniencing Netflix customers simply to uphold the principle of taxing in-app purchases. Not because they are hoping Netflix will give in (they obviously won’t), but because they like taxing the free-to-play game whales.

Apple’s strategy tax

When a company is new or small, its thinking about products tends to be pretty straightforward — if you can think of a way to make the product better that doesn’t cost too much, you just do it.

Older and more diverse companies wrestle with more complicated strategic considerations. The iPod initially launched as a Mac accessory, but it became a hit product.

Obviously if iPod had been a standalone company they would have immediately moved to make PC software for it. But iPod wasn’t a standalone company; it was part of Apple. So one corporate decision would have been to say “we need to keep this as Mac-only to support the Mac, our main business.” That would have been a “strategy tax” on the iPod — deliberately not improving the product in order to serve some other business strategy concept. Apple didn’t do that, which in many ways became the foundation for the company’s present-day success.

But that’s essentially what they are doing with the in-app purchase fees.

The iPhone would clearly be a superior device if you were able to use major digital content apps in the most logical and user-friendly way — subscribe to Netflix from the app, buy the Kindle book in the app. And the 30% fee is very plausibly high enough to deter people from trying to run modest-scale independent app businesses. The phones are just clearly a worse product than they would be without the tax and the deadweight loss. And for what? Well, for billions of dollars. But Apple’s overall revenues are just gigantic. Services, in total, represent less than 20% of the pie, and it’s not even particularly growing despite all the recent focus on it.

(Jason Snell)

And of course while App Store fees are the largest slice of the services revenue, it’s not the whole thing. Apple has their music streaming service, their TV service, their cloud storage, and their new Apple Arcade idea. To the extent that the plan is to grow services’ revenue sustainably, that’s almost certainly going to have to come from continuing the trend of developing and deploying brand new services. Taxing in-app purchases is a good way to pad the numbers on the services line, but as a growth strategy, it’s basically just a pure function of selling the phones.

The worst kind of deceptions are when you end up deceiving yourself, and muddling together a strategy to launch new, popular services with a rent-extraction strategy seems to me to likely induce loss of focus and confusion. More concretely, getting back to my actual core competence in policy analysis, it runs the risk of unleashing some legislative ideas whose implications are really bad.

Congress probably isn’t going to stand for this

Most attorneys I’ve asked about this think that Apple has a winning hand in litigation based on current legal doctrines. But that doesn’t necessarily mean that policymakers need to put up with a situation that is making everyone mad.

Recently Reps. David Cicilline and Ken Buck — the chair and ranking member of the House antitrust subcommittee — rolled out a suite of five bills intended to curtail the power and influence of the biggest tech companies. One of them, the American Innovation and Online Choice Act, addresses App Store issues. But it doesn’t address the issue I’ve been talking about here, taxing in-app purchases, at all. And I think that’s in part because writing a law that somehow says “I dunno, Apple, you’re a rich-ass company so you should cap your fees and just let people sell things” feels like a weird idea. Instead, Cicilline and Republican co-author Lance Gooden want to make a rule against platform self-preferencing.

There are a bunch of longstanding controversies about Google web search and self-preferencing that I kind of want to bracket here, because they also have a clear implication for Apple.

The big thing here is that Apple has a lot of protections in place to make sure that iPhone apps have only limited access to other parts of the system. This is different from how traditional desktop operating systems worked, and generally serves to make app installation and use much safer on iPhones than on traditional computers. You can be certain that whatever you install off the App Store won’t secretly mess your phone up. But Apple can (and does) grant itself exceptions to its own rules, building in integrations that third party companies can’t get. So AirTags do basically the same thing as the longstanding product from Tile, but they have some new features that Tile not only doesn’t have but can’t have, because third parties aren’t allowed to integrate as deeply.

As Ben Thompson writes, these integrations are only accelerating with the latest system software. To offer a somewhat trivial example, if you use the stock Photos app on iPhone and subscribe to Apple Music, then the Photo Memories function will interact with Apple Music to create soundtracks for auto-generated montages. In a world where all the streaming music services have essentially the same catalogue, that’s a reason to subscribe to Apple Music. By the same token, a new feature called “shared with you” will surface content that is shared in Messages inside the correct app — but only if it’s an Apple app like Photos, Apple Music, or Apple News.

You can see why competitors are mad at this. And for a company like Tile that is largely having a product it developed get ripped off, it genuinely sucks.

That said, unlike getting a 30% cut of every random in-app purchase from Project Makeover, doing deep integrations across software and hardware really is core to Apple’s longstanding and successful brand identity. The asymmetrical integrations are “unfair,” but they genuinely let Apple hit two different targets — a safe and secure system and deep integrations across the system — that have real benefits and real value. For Congress to cut that off in the name of competition and choice would be kind of throwing the baby out with the bathwater. Except in a weird way, you’d still have the bathwater since it doesn’t really touch the 30% cut point at all.

Phil Shiller’s “food for thought”

The litigation with Epic revealed an email from Apple executive Phil Shiller that suggested what would have been a better path forward — take a cut on the App Store at first to cover the costs, but once the revenue starts really rolling in, get more magnanimous:

From: Philip Schiller 

Subject: HTML5 Poses Threat to Flash and the App Store 

To: Eddy Cue, Steve Jobs 

Date: Thu, 28 Jul 2011 09:27:10-0700

Food for thought:

Do we think our 70/30 split will last forever? While I am a staunch supporter of the 70/30 split and keeping it simple and consistent across our stores, I don’t think that 70/30 will last that unchanged forever. I think someday we will see enough challenge from another platform or web based solutions to want to adjust our model (already Google has rolled out a web in app purchase model at 95/5).

If someday down the road we will be changing 70/30, then I think the question moves from “if” to “when” and “how”. I’m not suggesting we do anything differently today, only that whenever we make a change we do it from a position of strength rather than weakness. That we use any such change to our advantage if possible. And thinking about this long in advance can only help to look at an eventual change as an opportunity (with developers, press, customers, etc).

Just as one thought, once we are making over $1B a year in profit from the App Store, is that enough to then think about a model where we ratchet down from 70/30 to 75/25 or even 80/20 if we can maintain a $1B a year run rate? I know that is controversial, I just tee it up as another way to look at the size of the business, what we want to achieve, and how we stay competitive. Again, just food for thought.

https://www.wsj.com/articles/BL-TEB-2920

This is not that fleshed out in the details, but I think it paints an attractive vision of what would have been a better path forward for Apple.

If Apple targeted a $1 billion per year return on the App Store, many things could be different. You could have a lower Apple cut than 30%. And it could have a progressive rate structure so that brand new apps could sell tax-free, and only pay into the system when proven successful. And there could be an option for companies like Amazon and Netflix and Spotify to just pay a flat fee and then let customers sign up untaxed — with the nature of the $1 billion target meaning that the flat fee from Amazon goes to subsidize small developers. Apple, in that case, would retain its ability to “favor” its own services with integrations, but it would be seen by users and developers alike as much more of a benevolent steward of an ecosystem than a rent-extractor. Of course, Apple wouldn’t be behaving purely altruistically in Shiller’s vision. It’s just that Apple’s goal with the App Store would be to make customers happy and thus sell more phones, rather than to grab every available dollar.

Then another aspect of this is that if Apple weren’t making so much revenue off of shitty free-to-play games trying to con people into making compulsive purchases, then they might see more clearly that this actually isn’t an attractive line of business to be in.

My kid is getting to the age where he’s interested in some casual gaming on the iPad, which is fine, and I’m happy to pay good money for a few appropriate games. But the bombardment with little prompts to buy more coins or more gems or more whatever is very unappealing. And though providing parental controls that prevent kids from going rogue is fine, it’s not a real solution to the problem of this being a tacky business model that a responsible platform steward would try to nudge people away from.

“The bloody ROI”

I would contrast Apple’s handling of the whole App Store situation with a famous moment years ago when, at a shareholder meeting, Tim Cook got a question of whether the return on investment of Apple’s focus on making its devices friendly to vision-impaired users really made sense.

Cook, rather than answering the question, said: “When we work on making our devices accessible by the blind, I don’t consider the bloody ROI. When I think about doing the right thing, I don’t think about an ROI. If that’s a hard line for you, then you should get out of the stock.”

Now obviously, if you think about it for a minute, this can’t possibly be true. Apple does invest significant resources into accessibility, but it’s a finite investment. There is some point where the ROI isn’t there and they don’t do it. But what I do believe is true is that Cook doesn’t make the people who work on this stuff justify everything they do in terms of incremental sales benefit. It’s a cultural commitment of the company. It has some value in selling phones. It has some value as a discipline for everyone — lots of people who are not “blind” nonetheless suffer some form or another of impaired vision at some point in their life, and well-designed features are better for everyone. It also has value in employee retention and recruitment. Smart, hard-working people want to feel like they’re doing something worthwhile with their time, and knowing that the products you work on are considered especially useful by people with certain needs gives everyone a nice feeling of worthwhileness whether or not they are directly involved in accessibility work.

I think that is the right spirit with which to approach to App Store issue. Apple is not a bootstrapping startup that needs that money to finance its next round of investments. At the margin, extra Apple revenue goes to dividends and share repurchases because Apple’s profits far exceed their set of desired investments, even though they spend a ton on investment.

This particular source of revenue is giving them legal problems, it’s giving them regulatory headaches in Congress, it’s getting them denounced in New York Times columns, it’s alienating developers who generally benefit from Apple’s success, it’s antagonizing other big companies, and it annoys Apple’s highest-information users. It also just fundamentally distracts from the actual challenge of building a growing services business which is, like, making Apple Arcade better or continuing to add features to Apple Music. Long story short, Shiller had this right ten years ago — the launch of the App Store complete with the 30% cut was a big success, but taxing every store transaction at that rate was not a great long-term business idea.

This Cicilline/Buck legislation seems misguided to me, and the idea of direct government regulation of App Store pricing is not that appealing either. But I hope the specter of a legislative crackdown inspires the company to rethink what they are doing here. The launch a few months ago of the Small Developer Initiative suggests that the decision-makers are not blind to the fact that it would be in their interests to make everyone less mad. But they should take that idea seriously and make big, non-superficial changes to address it.

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