How Apple’s 30% app store cut became a boon and a headache

Twelve years ago, Apple introduced the App Store, a peculiar online marketplace for the year-old iPhone. It had 500 offerings. Apple told app makers it would take a 30% cut of their sales, and few complained.

Today, the App Store is one of the world’s largest centres of commerce, facilitating half a trillion dollars in sales last year alone. And Apple still takes 30% of many apps’ sales.

That commission has proved hugely consequential for Apple. It has been the primary driver of growth in recent years for a company that has nearly $275 billion in annual sales. And it has created some of Apple’s biggest headaches, drawing antitrust scrutiny, fury from app makers and lawsuits from consumers and partners.

The headaches intensified this week when Epic Games, the maker of “Fortnite,” arguably the world’s most popular video game, sued both Apple and Google, accusing the companies of breaking antitrust laws by forcing app makers to pay their 30% fees. The lawsuits followed Apple and Google’s removal of “Fortnite” from their app stores because Epic encouraged users to pay it directly, rather than through Apple or Google, to avoid their fees.

“I think we’re realizing that 30% is way too much,” said Phillip Shoemaker, a former senior App Store executive, who left Apple in 2016. Credit card companies charge roughly 3% to process payments. “It should be closer to that,” he said.

That is the rising sentiment among app developers, consumers and regulators. Apple and Google, which together are worth more than $3 trillion, make the software that backs virtually all of the world’s smartphones. That dominance has allowed them to keep their commissions high.

But now that the tech giants’ smartphones have become the only way other businesses reach millions of people, those businesses are increasingly pleading: Do you really need a third of my sales?

“There are very few companies out there that have a 30% profit margin,” said Andy Yen, the chief executive of ProtonMail, an email service. “The only way we can support this fee is bypassing that cost on to customers.” ProtonMail charges 30% less for subscriptions purchased on its website, but when the company advertised that to its iPhone users, Apple restricted its app.

Likewise, Spotify increased its monthly subscription to $13 from $10 in 2014 to account for Apple’s fee. A year later, Apple introduced a competing music service — priced at $10. To compete, Spotify opted out of Apple’s payment system, enabling it to avoid the commission. Now customers can still use Spotify’s app, but they must subscribe on Spotify’s website. Yet Apple bars Spotify from saying that in its iPhone app.

“Either we lose because we have to pay them a 30% tax just to operate and raise our prices for consumers as a result, or we lose because it becomes much more expensive to convert users from free to premium,” Horacio Gutierrez, Spotify’s chief legal officer, told reporters in June after European regulators opened an antitrust investigation into Apple based on Spotify’s complaint.

Even consumers have spoken up. An enormous class-action lawsuit accuses Apple of breaking antitrust laws to enforce its commission, inflating app prices for iPhone users. The Supreme Court ruled last year the lawsuit could proceed.

On Friday, Facebook chimed in, complaining that Apple is collecting 30% of sales on its new live-events service, where people can sell expert talks, fitness classes and cooking tutorials on Facebook’s app. Facebook said it wanted to process the payments itself so it could pass on 100% of the sales to the small businesses selling the talks and classes, but Apple declined.

Apple argues that it has actually cut software developers a break. Tim Cook, Apple’s chief executive, suggested to Congress last month that when the software was still sold in brick-and-mortar stores, 50% to 70% of the retail price went to middlemen.

“In the more than a decade since the App Store debuted, we have never raised the commission or added a single fee,” he told lawmakers. “The App Store evolves with the times, and every change we have made has been in the direction of providing a better experience for our users and a compelling business opportunity for developers.”

For Google, the stakes are lower. It allows people to download apps from outside its Android app store, meaning app makers like Epic have ample ways to still reach consumers using Android devices. And Google’s vast online advertising business makes its app store a much smaller portion of its overall business.

Over the past year, Apple has collected $19 billion of the $63.4 billion in sales of digital goods and services on iPhone and iPad apps, according to Sensor Tower, an app analytics firm. Google collected $10 billion of the $33.8 billion in similar spending on its app store, Sensor Tower said.

Before Cook’s testimony to Congress, at a House hearing focused on the power of Big Tech, Apple commissioned a study that showed its cut was in line with what many other platforms charged for similar distribution, including the app stores from Google, Microsoft and Samsung, and the game stores from Nintendo, Sony’s PlayStation and Microsoft’s Xbox.

Amazon’s Twitch gaming platform collects 50%, according to the study. By comparison, Amazon, eBay and Walmart charge 6% to 17% for sales of goods on their websites, the study said.

What the study didn’t note: Apple popularized the 30% cut.

It applied that rate on any purchases of an app in 2008, and then a year later on any transactions inside of apps for digital goods and services, such as a virtual currency in a game or a subscription to music, TV or dating app. Apple does not take a cut of apps’ sales of advertising or physicals goods, and thus most apps don’t pay a fee.

So how did Apple arrive at 30%?

There was some precedent; Apple had been charging roughly the same commission on music sales on its iTunes software. For each 99-cent song it sold, Apple passed on 72 cents to major music labels and 62 cents to independent labels, according to The Wall Street Journal in 2007.

When Apple began setting rules for the App Store, “30% was just kind of a no-brainer,” said Shoemaker, who joined the company in early 2009. “It was, ‘Of course that’s what we’re going to use.’ Nobody questioned it.”

In 2008, when Apple introduced the App Store, the company’s co-founder Steve Jobs told The New York Times: “We are not trying to be business partners” with app developers. Rather, he added, Apple wanted to “sell more iPhones.”

At the time, there was far less pushback from app developers, in part because the App Store was so nascent and the digital transactions were complicated without Apple’s help.

With Apple, “it was pretty much one click and that was revolutionary,” Shoemaker said. “So people were willing to bite that 30%. But now, those kinds of tools are a dime a dozen.”

Indeed, many companies now protesting Apple’s fee seem willing to pay something, just not 30%.

Epic made $1.8 billion on “Fortnite” last year, in large part by selling the digital currency that players need to buy new features inside the game. The game itself is free.

On Thursday, Epic started its confrontation with the tech giants by allowing “Fortnite” users to pay it directly in its iPhone and Android apps, rather than via Apple or Google’s payment systems.

Epic also offered a 20% discount on all purchases that used its payment system. That meant that if Apple and Google charged a 10% commission, their price would be about the same as the one Epic was offering its customers.

Epic has also shown that running a profitable app store is possible with a lower commission. It runs its own online marketplace for other developers to distribute their games on desktop computers. In that store, it takes 12% of sales — and still makes a profit of 5% to 7%, the company said.

Yet at Apple, the discussion has long been about how to maximize profits. In 2011, Apple executives were discussing how much to charge content providers like Hulu and the NBA for new customers who signed up via Apple TV, according to internal emails provided to House lawmakers investigating Apple.

Jai Chulani, one Apple executive, said in an email to colleagues that he worried that if Apple charged 30% of the first year of a subscription “we may be leaving money on the table.”

Eddy Cue, one of Apple’s most senior executives, responded with a better idea: “For recurring subscriptions, we should ask for 40%.”