Will Apple’s Services Momentum Be Blunted by New Epic App Store Ruling?

For several years, Apple has been leveraging its hardware and services to forge an ecosystem, as phones, tablets and computers are an on-ramp to higher margin subscriptions, streaming and apps.

This week, the company posted earnings that showed headwinds to its top-line growth (to 5% on a consolidated basis). The services businesses grew by 11.6%, to $26.6 billion, outpacing the 2.6% gains seen in the product segment. But the services line slowed from 14% growth logged in the fourth quarter as measured year on year. On an absolute dollar basis, the services operations posted record revenues.

The company’s financial statements indicate that the cost of the service sales is a bit more than 24%, which translates to a roughly 75% gross margin, compared to a company-wide 47%. It’s rather safe to assume that a significant slice of that gross profit falls directly to the operating income line, given the fact that that the non-hardware parts of the Apple ecosystem are inherently high margin.

Though the company does not break out the individual components of the services, there are some indications that fundamental changes to the App Store business model may have a dampening effect on those high-margin revenue contributions.

The Epic Ruling

As reported this week, a federal judge ruled that Apple had been in “willful violation” of a 2021 injunction stemming from the Epic Games lawsuit. The court had previously ordered Apple to let users pay App Store developers directly through a third-party link to avoid the 30% commission Apple charges developers. But the ruling noted that the company assessed a 27% commission to app developers for external sales. The order now states that the tech giant cannot collect commissions outside the App Store.

Again, the financial impact is tough to quantify, as it remains to be seen whether Epic and other firms (like Spotify) will be able to move Apple customers to transact with them directly. In the meantime, Apple faces battles in Europe tied to the App Store, as it has been fined by the European to the tune of $566 million, as a result of what the EU said were restrictions that prevented app developers from informing customers of the App Store that they could transact outside the App Store.

The Epic Games-related ruling details that “Apple estimated a revenue impact of hundreds of millions to billions under the no-commission model for customer [developer] adoption ranging from 10% of 25%.”

In a statement emailed to PYMNTS on Friday, Spotify said that Apple has approved the latest Spotify app for U.S. consumers, which the company said via spokesperson Jeanne Moran “finally allow us to freely show clear pricing information and links to purchase, fostering transparency and choice for US consumers.”

In another example of how big this business is, Apple said that App Store developer billings were $1.1 trillion in 2022, and said that more than 90% of that accrued to the developers “without any commission paid to Apple.” The remaining 10%, then — at $100 billion — seems to have at least some connection to Apple, and would have been subject to some commission. The new ruling means developers will keep all the revenue garnered from transactions that occur outside the App Store.

The battle’s not over, it seems, given the fact that Apple CEO Tim Cook said on the call yesterday that the company will appeal the ruling. But the status quo — the commission-based model that has been in place — is bumping up against uncertainty.