EPIC GAMES, INC., Plaintiff, v. APPLE INC., Defendant Court Filing, Aug 24 2020 is part of HackerNoon’s Legal PDF Series. You can jump to any part in this filing here. This is part 7 of 11.
III. ANALYSIS
3. Tying under Section 1 of the Sherman Act
a. Legal Framework
Tying arrangements under section 1 of the Sherman Act may be evaluated under either per se or rule of reason analysis.
Per se analysis allows "condemnation without inquiry into actual market conditions" based on precedent that deems certain contractual arrangements "unreasonable as a matter of law." "For a tying claim to suffer per se condemnation, a plaintiff must prove:
(1) that the defendant tied together the sale of two distinct products or services;
(2) that the defendant possesses enough economic power in the tying product market to coerce its customers into purchasing the tied product; and
(3) that the tying arrangement affects a not insubstantial volume of commerce in the tied product market."[21] Cascade Health Sols. v. PeaceHealth
To assess the first element, courts apply the purchaser demand test, which "examines direct and indirect evidence of consumer demand and whether [a] defendant[ ] foreclosed competition on the merits in a product market distinct from the market for the tying item." "Direct evidence of demand includes ‘whether, when given a choice, consumers purchase the tied good from the tying good maker, or from other firms.’ "Indirect evidence includes firm behaviors, for instance a single product is apparent if ‘competitive firms always bundle the tying and tied goods’ together." A tie requires a "condition linked to a sale."
The second element of "forcing (or coercion) is likely if the seller has power in the tying product market."
The third element asks "simply whether a total amount of business, substantial enough in terms of dollar-volume so as not to be merely de minimist, is foreclosed to competitors by the tie ...." (foreclosure of a single purchaser sufficient so long as the dollar volume of sales is "not insubstantial").
If a plaintiff fails to establish per se liability, a plaintiff must demonstrate that a defendant "violated the Sherman Act because it unreasonably restrained competition" under the rule of reason. Jefferson Parish. The rule of reason "requires courts to conduct a fact-specific assessment of ‘market power and market structure ... to assess the restraint's actual effect’ on competition." Amex , 138 S.Ct. Recent cases suggest that the rule of reason applies to any tying claim that "involves software that serves as a platform for third-party applications." Microsoft (no per se claim where "the tying product is software whose major purpose is to serve as a platform for third-party applications and the tied product is complementary software functionality").
"[T]he three-part burden-shifting test under the rule of reason is essentially the same" for section 1 as for section 2 claims. First, plaintiff has "the initial burden to prove that the challenged restraint has a substantial anticompetitive effect that harms consumers in the relevant market." That said, the Court need not "consider whether competition was in fact unreasonably restrained." Second, if "the plaintiff carries its burden, then the burden shifts to the defendant to show a procompetitive rationale for the restraint." Amex , 138 S. Ct. at 2284. Finally, "[i]f the defendant makes this showing, then the burden shifts back to the plaintiff to demonstrate that the procompetitive efficiencies could be reasonably achieved through less anticompetitive means." Id.
b. Per Se Tying Analysis
Epic Games avers that Apple ties the iOS app distribution "product," over which Apple has economic power, to a separate "product" of the IAP system. Based upon the current record, the Court concludes that Epic Games has not yet shown that the IAP system is a separate and distinct service from iOS app distribution sufficient to constitute a "tie" under antitrust law.
Where the allegedly tied product is an essential ingredient of the overall "method of business" with customers, courts view them as one product not as two tied together. Rick-Mik , 532 F.3d at 974 (quoting Will v. Comprehensive Accounting Corp. , 776 F.2d 665, 670 n.1 (7th Cir. 1985) ). That is especially true where the allegedly separate products have always been integrated. Seeid. at 975. As the Ninth Circuit has recognized, payment processing can be part of a single integrated product. See id. at 974 ("The franchise and the method of processing credit transactions are not separate products, but part of a single product (the franchise).").
Here, the IAP system appears to be integrated with the App Store and, historically, to have never been a separate product. If so, the construct of the IAP appears to reinforce the notion that the App Store is a digital marketplace where developers on the App Store are able to structure their business models however they choose.[22] Many of these developers, like Epic Games, structure these models so that the game or app is free, presumably to entice customers to download the game or app initially, and only monetize the subsequent IAPs. The IAP system does not appear to be a payment processor in the same way that Visa, Mastercard, or PayPal is a payment processor; it is more akin to a link back to the App Store whereby the transaction must occur within the digital confines of the App Store.[23] The IAP system appears to have been created, in part, to capture the value of a developer being on the digital shelf of the App Store which is owed to Apple—either on the initial download, or in subsequent IAPs.[24]
Nevertheless, Epic Games raises serious questions about the existence of separate demand for IAP-type services. Payment processing markets are ubiquitous outside of IAPs. Epic Games offers indirect evidence of separate demand through analogy to these markets, including the markets for the sale of physical goods sold through apps on the iOS platform. See Rick-Mik , 532 F.3d at 975. The experts disagree over whether the distinctions between IAP and these payment processing services actually impact consumer demand.[25] (Compare Schmalensee Decl. ¶ 49 (Dkt. No. 78) with Evans Reply Decl. ¶ 36 (Dkt. No. 88).) Moreover, Epic Games provides evidence that developers have demanded their own in-app purchase payment processing services. (See Evans Reply Decl. ¶ 45 (Dkt. No. 88).)
Epic Games further points to evidence in the record demonstrating that some customers chose to use Epic Games’ payment processing service when given the choice with IAP. The trouble with this argument is that it conflates competition on the merits with Epic Games’ goal of avoiding Apple's 30%. It is not surprising that some customers would choose competing payment services if they provided lower prices offered only because of this non-payment. This does not evidence separate demand for payment processing services, as much as a demand for alternatives to Apple's "integrated services" of iOS app distribution. When framed in this way, Epic Games’ argument is no more than a collateral attack on Apple's App Store model, not a demonstration of separate demand. In this respect, Epic Games’ strongest argument—left woefully underexplored in the record—lies with competition on other features provided by IAP, such as customer service, parental controls, and security.[26] This evidence suggests that a more fully developed record could plausibly show demand for a separate product.
Should Epic Games satisfy the "purchaser demand" test for finding distinct products, it may prevail on the remaining elements under the per se tying analysis. While Apple claims that it does not "tie" IAP to iOS app distribution because developers may choose other business models, it does not dispute that its App Store Review Guidelines require the IAP system's use for IAPs as a condition of app distribution. (See Schiller Decl. ¶¶ 5, 7, 33, 41 (Dkt. No. 74).) This requirement manifests the coercion, that is, developers who offer IAP must do so on Apple's terms. Apple also does not dispute that it holds market power in the iOS app distribution market and that the alleged tie affects a substantial volume of commerce in in-app payment processing. Accordingly, Epic Games raises serious questions with regard to per se tying, but fails to demonstrate the likelihood of success due to lack of evidence of "purchaser demand" for IAP processing service separate from the "integrated service" of app distribution.[27]
c. Rule of Reason Analysis
The rule of reason analysis is more fact specific than the per se analysis. Here, the first element focuses on the harm to competition and consumers. Epic Games errs by focusing on harm to competitors, and for that reason has not sustained its burden at this juncture.[28] Even if it had, Apple, of course, offers a procompetitive justification consistent with step two of the three-part burden shifting analysis. Apple claims that the IAP provides the business mechanism for it to be paid for the App Store given its support of 1.8 million apps, of which 84 percent are free, to 1.5 billion Apple devices and 900 million iPhone users. Apple claims that IAP also provides: (1) a "centralized, convenient way" to transact online, (2) security and fraud protection, (3) refunds and customer support from Apple, (4) parental controls, and (5) comprehensive list of purchases," all of which are facially reasonable. (Schiller Decl. ¶ 36 (Dkt. No. 74); see also Schmalensee Decl. ¶ 29 (Dkt. No. 78).) That developers may not want to pay a commission or licensing fee does not necessarily translate to antitrust behavior.
Under a rule of reason analysis, the burden shifts back to Epic Games to demonstrate that the "procompetitive efficiencies could be reasonably achieved through less anticompetitive means." Here, the record is not fully developed, and mixed, at best. Competitors could conceivably provide equal or superior services. Indeed, it is entirely plausible that app developers could provide better refunds and customer support for goods purchased through their own apps than can Apple, or not. As noted, the sale of physical goods sold on the iOS already uses separate payment processors or mechanisms outside of the Apple IAP system. On the other hand, Apple has produced evidence that its security features are more effective than its competitors, a basis on which it competes. Thus, the dispute likely comes down to whether these features and Apple's monetization can be achieved through less anti-competitive means. The record on these issues is thin, as is any briefing on the method of proof given the frontier on which the questions sit.
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[20] Section 1 of the Sherman Act broadly prohibits "[e]very contract, combination ..., or conspiracy, in restraint of trade or commerce among the several States." 15 U.S.C. § 1. The term "restraint of trade" has been limited to "undue" (unreasonable) restrains. Amex , 138 S.Ct. at 2283.
[21] As explained in Jefferson Parish , "the essential characteristic of an invalid tying arrangement lies in the seller's exploitation of its control over the tying product to force the buyer into the purchase of a tied product that the buyer either did not want at all, or might have preferred to purchase elsewhere on different terms." 466 U.S. at 12, 104 S.Ct. 1551. Per se condemnation is only appropriate where such forcing is "probable." Id. at 15, 104 S.Ct. 1551.
[22] Epic Games’ Best Buy and QuickBooks analogy misses the mark. Epic Games stated:
[W]hat Apple wants to do is to have the consumer go in to Best Buy, buy the Quick[B]ooks ... pay for it there, that's fine. That's the app distribution. But then take it home, and every time you do your taxes or every time you close your books using Quick[B]ooks, after you have the product, to keep paying Best Buy every single time another 30 percent. They are reaching into subsequent transactions."
(Dkt. No. 50 at 50-51.) With respect to video games, however, at least two significant distinctions exist. First, at a brick-and-mortar store, games were not distributed for free; that is, free-to-play games likeFortnitedid not exist. In the digital context, consumers can obtain some games for free, and, under the license, no payment from Epic Games to Apple is due in that transaction.Second, an analogous pre-digital marketplace transaction exists: namely, the sale of expansion packs, which could unlock additional content for base version of games, including new gameplay mechanics and functions. Consumers would initially purchase the base game from a brick-and-mortar store. Assuming the expansion pack was not available at the time of purchase of the base game, consumers were thereafter required to return to a store to purchase in a separate transaction the expansion pack—thereby unlocking this additional content in the base game.IAP appears to operate analogously: the base version of a game is required to play, but IAP similarly unlocks additional content including new gameplay mechanics and functions. These analogous pre-digital transactions suggest that IAP is not merely a payment processor, as Epic Games contends, but rather an integrated part of the digital marketplace, permitting a prior historical business model in the gaming industry. The Court highlights that neither party discusses these analogous transactions, but the Court discloses that this conceptual similarity further colors the Court's analysis, including the need for a more complete record.See also Amex , 138 S. Ct. at 2286-87(discussing a transaction platform like the App Store, noting that it "facilitate[s] a single, simultaneous transaction between" two parties).
[23] Indeed, it is the Court's understanding that all video game digital distribution marketplaces require a consumer to similarly return to the marketplace to complete an IAP.
[24] The Court notes that the conceptualization of the IAP system as integrated within the App Store may generally defeat a per se analysis. Microsoft suggests that perhaps the appropriate lens to view a tying claim involving innovative technological business models is under the rule of reason analysis, not under a per se tying analysis. See Microsoft , 253 F.3d 34 at 89-95.
[25] The question of perspective underlies the tying claim as much as the monopolization claim. In Rick-Mik , the court found that "[t]he relevant ‘purchaser’ is the franchisee (not the general consumer)" for purposes of separate demand for credit card processing services. 532 F.3d at 975. Here, the equivalent of the franchisee is the developer, which may demonstrate stronger "separate demand" for payment processing services than the user who makes the purchases.
[26] Epic Games shows that at least some developers have demanded separate payment processing services based on these features, independent of Apple's 30%. For example, Epic Games claims the CEO of the company "Hey," which provides email service, made the following statement months before Epic Games’ motion:
[A]s the owner of a business, this isn't just about money. Money grabs the headlines, but there's a far more elemental story here. It's about the absence of choice, and how Apple forcibly inserts themselves between your company and your customer....When Apple forces companies to offer In App Purchases in order to be on their platform, they also dictate the limits to which you can help your customer. This has a detrimental impact on the customer experience, and your relationship with your customer. It can flat out ruin an interaction, damage your reputation, and it can literally cost you customers. It prevents us from providing exceptional customer service when someone who uses our product needs help.
(Evans Reply Decl. ¶ 45 & n.40 (Dkt. No. 88).) This statement suggests that the IAP dispute is not simply about Apple's fee, but also about whether "the world's largest company [gets] to decide how millions of other businesses can interact with their own customers."See Jason Fried, "Our CEO's take on Apple's App Store payment policies, and their impact on our relationship with our customers," HEY (June 19, 2020), available at https://hey.com/apple/iap/.
[27] Commentators have suggested that separate demand is a "threshold requirement" for separate products, following which defendant may show that the products are nevertheless a single product due to their being an "integrated service." See Philip E. Areeda & Herbert Hovenkamp, Antitrust Law: An Analysis of Antitrust Principles and Their Application ¶ 1743 (4th Ed. 2020). United States v. Microsoft Corp. , 147 F.3d 935, 948-49 (D.C. Cir. 1998), lays out the general requirements for an integrated service.
[28] Nevertheless, for the same reasons as described for separate demand under the per se analysis, the Court can envision a plausible case for anticompetitive effect given the serious questions referenced above regarding Apple's IAP restrictions and whether they reduce consumer choice or increase price due to exclusionary conduct. See Qualcomm , 969 F.3d at 990. Competitors could conceivably provide equal or superior services than IAP—better security, better customer service, and better parental controls. Moreover, Epic Games may be able to prove anticompetitive effects even if it cannot show separate products: Microsoft suggests that the separate-products test "is a rough proxy for whether a tying arrangement may [be] ... unsuited to per se condemnation," not a determination of ultimate efficiency. 253 F.3d at 87.
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