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Now…on to the main event.
Two weeks ago, I wrote about tech layoffs and how you can’t argue that Elon Musk is the “Man in the Arena.”
Well…it looks like he’s entering a new Arena and this time, he’s up against a towering Goliath.
Apple is the closest thing to a gatekeeper when it comes to the modern internet.
For ages, they have been taking a cut through the app store on everyone that has generated revenue through an app on an iPhone.
Do they deserve a cut of every dollar generated on an iPhone? Yeah - absolutely, they made the damn thing.
But 30%…C’mon man…
Most recently, Tim Sweeney, CEO of Epic Games (created Fortnite), took this battle to court with less than spectacular results.
Now - Elon is dropping into the battle royale.
Let’s take a look at how the App store works, how the pie is sliced, and why many CEOs are up in arms about the aggressive take-rate, saying “enough is enough.”
This week, in <5 minutes, we’ll cover the battle against 30%:
The “Platform” Business Model 👉 Aggregating Eyeballs
The iPhone 👉 Pervasive, Ubiquitous
The App Store 👉 How it Works
Wars Waged 👉 Epic Games, Spotify, Twitter, Coinbase
Let’s get started!
1. The “Platform” Business Model 👉 Aggregating Eyeballs
With the proliferation of the internet and software companies, we experienced the evolution of a business model known as a “platform”. Platforms aimed to be one-stop shops where you have a landing zone of sorts with a bunch of other stuff built on top of it.
But the concept of a platform is just a fancy way of saying marketplace. An arena that connects buyers and sellers of products. To build out a successful platform you need to install the proper incentive structures in order to foster healthy growth of both the demand and supply side of the economy.
There is a virtuous flywheel inherently built into platform models. As you aggregate demand, better suppliers will come to your marketplace in order to target a very specific user base that already desires that particular solution.
Fostering an environment that is very supplier-friendly goes hand in hand with this. You need to have great actors in the system selling great products that further increase demand.
More demand = better sellers = more demand = better sellers… and so on…
At the heart of this is the concept of the Network Effect.
This makes setting the “rules of the road” extremely important in building out the early days of the platform. A lot has been said when it comes to building platforms in the debate of which you need to focus on, Demand or Supply?
This question has spawned hundreds of business and technology books and blogs. Some of the best short-form essays are from Bill Gurley which you can find here, here, and his most famous post here. Ben Thompson is also phenomenal on this subject and you can find his work here.
The Field of Dreams phrase “If you build it, they will come” comes to mind, meaning you have to build out an attractive supply-side product first for demand to even show up in the first place.
To start a platform, you have to solve a problem by building a product. People need a reason to come - whether it’s eBay to buy goods, Opentable to make a reservation, or Ticketmaster to buy tickets (sorry Swifties). You need to have supply so that demand will come.
It doesn’t have to come exclusively from proprietary sources - leaning on strategic partners in the early days to source supply is one of the most efficient ways to scale and reach critical mass.
Platforms derive their value from how large they can grow their user base (supply and demand side) and how many transactions are performed on the platform. They then make their money taking a portion of this transaction as a fee (rake or take-rate).
Once you reach a frame of inertia, you have to pay equal attention to curating and growing both demand and supply - and the most important thing is combining high volume with a fair and modest take rate.
Here is a chart of different take rates across platform companies:
The lower the take rate, the more attractive it is to come onto to platform for the supplier, the higher the take rate, the higher the value capture for the platform owner. Very powerful platforms can charge higher take rates.
These are the basic tenants of a platform.
2. The iPhone 👉 Pervasive, Ubiquitous
The greatest products in the world start by solving a very unique pain point, then manufacture demand where it didn’t previously exist. This is the edge of innovation.
The iPhone was created for the obvious use case of call and text within the original framework of what we thought cell phones were supposed to do. It wasn’t until a dude in a turtle neck with jeans told us that it could do more did we know what we were in for.
By creating an internet-enabled multi-touch screen device, Apple changed the fundamental consumer behavior behind how they would interact with cell phones. Sure Blackberry had a browser but it was clunky, ugly, and cumbersome. By eliminating a physical keyboard, Apple also gave more real estate to a more fluid display system where the keyboard disappeared when you didn’t need it.
I’ll spare you the entire Apple history because you know it already but I wanted to highlight this design feature because the most important thing it did was turn a hardware device into a software device - which then birthed the app store.
As we were able to do more and more on these magic pocket computers, this expanded the use case beyond call and text to an entirely different thing - a productivity and entertainment device.
This opened the world to developers who could then create apps that performed specific functions where the possibilities were endless. The App Store was born.
3. The App Store 👉 How it Works
The App Store can best be described as a gated or closed platform with a massive install base. It’s the only way you can get access to a wealthy cohort of end users and you have to pay the toll to make money.
The iOS App Store initially launched on July 10, 2008, a day before the iPhone 3G was released. There were more than 500 apps available at launch, of which 25% were listed as free. Popular apps available at launch included Sega's Super Monkey Ball, AOL's Instant Messenger, and Apple's own Texas Hold'em.
As of 2022, there are more than 1.2B iPhone users and 1.6M apps available. In 2022, the App store brought in $72.3B in revenue for Apple, up from $38.7B in 2017. For reference, Netflix did $31B in revenue over the last 12 months.
Apps fit into a wide variety of pricing schemes. Some apps are free, while others feature a one-time cost associated with downloads. Ads support some apps, and reoccurring subscription charges or other in-app purchases support others.
The big contention here as of late is the 30% take rate on IAP (in-app purchases).
In late 2016, Apple began allowing developers to purchase advertising spots, which would show at the top of the search result page when users search for specific keywords.
Apple has strict rules surrounding how users get content from within apps and how that benefits them. Until recently, Apps purchased from the App Store, any in-app purchase, and subscriptions made within an app all had to pay a 30% cut to Apple.
This led to many apps trying to circumvent the in-app purchase model altogether.
Netflix and other entertainment apps will not let you subscribe from within the app, and some have resorted to a 30% price hike on subscriptions when done within apps rather than on a website.
App Store subscriptions were introduced in 2016 as an alternative business model that allows users to pay for new features regularly with the ability to cancel at any time. This feature came with a lower 15% cut taken from developers, as long as users stayed subscribed for over a year.
Apple made a huge move in April 2020 to allow specific entertainment apps to make sales within their apps without a 30% cut. This is similar to how shopping goods apps like Best Buy and Amazon already work but would apply to digital goods as well.
This caused companies like Spotify and Epic Games to go absolutely bezerk because it essentially was a form of favoritism with certain exemptions. More on this below.
As long as a user has a credit card on file with Amazon, they may make purchases using the in-app cart system. If not, it will defer to an in-app purchase system using the on-file Apple payment method.
In November 2020, Apple announced that developers making below one million dollars per year would pay only 15% of their income. This decision benefits many developers and gives Apple some goodwill as it continues to fight against anti-trust regulation of the App Store…
4. Wars Waged 👉 Epic Games, Spotify, Twitter, Coinbase
Although there have been many challenges over time, I’m only going to go over recent notable challenges to Apple’s 30% take-rate monopoly.
Tim Sweeney (Epic Games CEO)
Every movement needs a champion - and the battle against Apple has lately been led by Epic Games CEO, Tim Sweeney. As we know, unfortunately, Fortnite is a very popular game with around 80M active users on a monthly basis.
The main area of contention here is that Epic Games is so heavily reliant on IAP (buying Fortnite skins) and the take rate here is still 30% on mobile platforms.
The Epic Games v. Apple saga started in 2020 when Epic Games started allowing Fortnite players to make purchases directly in the app, skirting the in-app purchase rules. Apple quickly pulled the Fortnite app from the App Store, and Epic Games was ready with an antitrust lawsuit over Apple's App Store rules.
Epic Games aimed to get the court to allow for third-party app stores and alternate methods of getting apps on iOS devices, but Epic Games largely lost the lawsuit, leading it to file an appeal. Apple won the antitrust suit but was ordered to allow developers to add in-app links to outside websites where payments could be accepted.
Apple wins - GG (good game).
Daniel Ek (Spotify CEO)
This is an interesting one because Apple also has a very direct first-party competitor - Apple Music. Spotify’s statement largely speaks for itself:
“While we find their fees to be excessive and discriminatory, Apple’s tying of its own payment system to the App Store and the communications restrictions it uses to punish developers who choose not to use it, put apps like Spotify at a significant disadvantage to their own competing service. Ensuring that the market remains competitive is a critical task. We hope that regulators will ignore Apple’s ‘window dressing’ and act with urgency to protect consumer choice, ensure fair competition, and create a level playing field for all.”
However, Spotify just makes people go to their website to sign up for subscriptions instead of through the App Store, and Spotify relies less on IAP and more on subscriptions so it’s not as large of an impact.
Elon Musk (Twitter)
I think this one has the potential to get very interesting. The pre-musk era of Twitter was so incredibly boring as there were no major changes to revenue streams, essentially no change in the underlying product, and little/no innovation at the company going on whatsoever.
Elon is now coming in and introducing subscription tiers ($8/month verification), as well as talking about building a payment layer on top of Twitter. This comes from his background of building out Paypal. In a sit-down interview, Elon postulated that North America has no WeChat equivalent. For those unfamiliar, WeChat is an “everything” app in China that is chat, social, and payments all wrapped into one.
He thinks Twitter might be able to do this.
But first - he has to make sure Twitter’s only existing revenue stream (ads) stays healthy because recently, a lot of advertisers pulled spending off the platform as concerns about the reorganization surfaced.
It looks like he smoothed it out with Tim for now, but adding a payment layer while operating in the App Store ecosystem will be extremely challenging.
Coinbase
Coinbase has accused Apple of forcing it to remove NFT transfers from its Wallet app on iOS. On Thursday, Coinbase tweeted that Apple “blocked our last app release until we disabled the feature” because the iPhone maker wanted the blockchain fees associated with an NFT transfer to go through its in-app purchase system, giving it a 30 percent cut.
I find this pretty timely - NFTs are down 90% from peaks, exchanges are falling as we see that many are a house of cards, and Apple still says, “give me 30%”. It’s also quite ironic that Coinbase is at the center of this whole DeFi movement (while it itself is a centralized institute, but I digress…) and Apple can STILL come after fees.
Wrapping Up…
The battle for the App store isn’t some cutesy isolated issue. It is a hundreds-of-billions-of-dollars per year type of fight. It is a focal point of the distribution model of how we are entertained, how we become more productive, and how we interact with each other on a daily basis.
On one hand - Apple has earned the right to charge whatever they want. They manufactured, marketed, and distributed the single greatest consumer good arguably of all time. An incredibly difficult thing to do. If you don’t like it, go somewhere else.
On the other hand, the power they possess is enormous because of their existing install base, and unchecked power can lead to uneven value capture tilted to one side.
What do you think?
Is 30% too much?
Until next time. Always Yours. Incessantly Chasing ROI,
-Genevieve Roch-Decter, CFA
P.S. Have you checked our new ALTS and CRYPTO newsletters? Subscribe for free!
What else we Grittin’ On?
CHINA. Protests spread across cities in China over Covid restrictions. The country has seen a spike in cases.
HOUSING. Pending home sales fell for the 5th consecutive month. The annual drop is the worst on record.
IPOs. The 2023 IPO outlook, in one word, according to Financial Times. Hint: it's "pain".
OPEC. OPEC+ agreed to keep production unchanged. The group has only just started implementing its previous production cut.
INVERSION. The yield curve inversion is at new extremes. The inversion is at its deepest in decades.
Sources:
https://abovethecrowd.com/2003/02/10/software-in-a-box-the-comeback-of-the-hardware-based-business-model/
https://abovethecrowd.com/2003/07/16/the-comeback-of-the-mobile-internet/
https://abovethecrowd.com/2013/04/18/a-rake-too-far-optimal-platformpricing-strategy/
https://stratechery.com/concept/aggregation-theory/platforms-vs-aggregators/
https://appleinsider.com/inside/app-store#:~:text=The%20App%20Store%20is%20Apple's%20digital%20distribution%20platform%20used%20for,apps%20directly%20from%20the%20web.
https://www.theverge.com/2022/12/1/23488448/coinbase-ios-wallet-app-apple-nft-fees-in-app-purchase-store
https://www.macrumors.com/2022/11/14/epic-games-apple-appeals-court/#:~:text=Apple%20saga%20started%20way%20back,over%20Apple's%20%E2%80%8CApp%20Store%E2%80%8C%20rules.
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