Apple's surprise defeat in the Supreme Court is bad news for Tim Cook's turnaround plan (AAPL, SPOT)
- Apple's loss at the Supreme Court could ultimately hobble its services business.
- The court ruled that a case over the fees Apple charges on app sales could go forward, a move that could eventually force Apple to reduce them.
- Those fees comprise the biggest portion of Apple's services business — and a significant chunk of its total gross profit.
- Apple has been touting its services business as the engine of its future growth.
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Thanks to the Supreme Court, Apple now has a big problem with its attempt to re-invent itself as a company that sells services.
The court on Monday ruled that an antitrust case against the iPhone maker involving the commissions it charges on apps sold through its app store could proceed, rejecting Apple's efforts to dismiss the suit. The ruling increases the likelihood that Apple will lose the long-running case or ultimately be forced to settle it on unfavorable terms. In either case, the Supreme Court's decision makes it more likely that Apple is ultimately going to have to reduce its App Store fees.
Unfortunately for Apple, the App Store is a linchpin of the services business that CEO Tim Cook is betting the company's future on.
As Apple's iPhone sales have started to decline, it's been touting its services as the driver of its future growth. These services include its iCloud storage service, its deal with Google that makes the tech giant's search engine the default one on the iPhone, and Apple Music. And in March, the company unveiled a slew of new offerings, including a new streaming video service and a subscription game service.
The court ruling endangers Apple's App Store cash cow
Despite this growing catalog of service offerings, Apple's App Store remains the biggest part of its services business, providing about a third of that businesses' revenue, according to Wall Street analysts. What's more, Apple's App Store alone will account for 12% of the company's total gross profit this year, KeyBanc Capital Markets forecast in March. That's a remarkable figure, given that Apple's entire services business accounted for just 16% of the company's total sales in the first six months of its current fiscal year and attests to just how profitable the App Store is for the company.
But the Supreme Court ruling puts that cash cow at risk of being slaughtered.
The case revolves around how consumers get apps on their iPhones and the fees Apple charges for sales through its App Store. Apple has designed the iPhone so that, basically, the only way to get apps for it is to go through its App Store. The company charges a 30% commission on most app store sales; for apps that charge subscriptions, Apple takes a 15% cut after the first year.
The plaintiffs in the case allege that those commission rates are higher than they would be in a competitive market. They say that they and other consumers have overpaid for their apps as a result, because those fees get passed on to them in the form of inflated prices.
The case isn't the only threat to Apple's App Store fees
The court's ruling was narrow. The justices didn't decide whether Apple had a monopoly, whether it was abusing it, or what the penalty would be for doing so; instead, they simply ruled the consumers had a right to sue Apple and their case could proceed.
But that ruling is a significant setback to Apple, because it increases the likelihood that the case will actually go to trial. And it's not hard to see how that could be a big problem for Apple.
It shouldn't be too hard for the plaintiffs to show that Apple has a monopoly on the distribution of iPhone apps. It also shouldn't be too difficult for them to show that the fees Apple charges makes those apps pricier than they would otherwise be. One has to look no farther than Spotify, which charged $3 more to customers who signed up for its service through Apple's app store than those who subscribed through its website. Spotify has said it did that to cover the cost of Apple's fees. And Spotify isn't the only company plaintiffs can point to that had similar pricing practices.
In other words, there's a good chance that Apple will lose the case on its merits.
But even if it doesn't, the company's app store fees are already coming under pressure. Spotify filed a complaint against Apple with European Union's competition regulators, making similar charges. Meanwhile, it and a growing number of app developers have decided to opt out of Apple's fees entirely by directing customers to sign up for subscriptions through their own websites.
All this could well mean that Apple is going to have to reduce its app store fees in a significant way sooner or later. Such a move would reduce its revenue and profits. Worse, though, it would likely sully its services story.
- Read more:
- Apple's new services 'aren't hobbies,' a testy Tim Cook told analysts
- Spotify just painted a big target on Apple's back, and the iPhone maker should worry if antitrust regulators start aiming at it
- A longtime Apple analyst thinks a $10-per-month service for doctors will unlock the Apple Watch's true potential
- The 'clock has struck midnight' for Apple: It needs to buy a major Hollywood studio this year or lose the streaming war to Netflix and Amazon
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