Spotify's complaint against Apple over unfair competition could end up costing the iPhone maker billions of dollars.
The streaming music maker's allegations against Apple focus on the way Apple manages the App Store and the fees it charges developers who sell their apps and related items there. The complaint it filed with the European Commission on Wednesday increases the chances that Apple will have to lower its commission rates on app sales, warned financial analysts who cover the company.
If Apple is forced to reduce its rates, it's likely it would only have to cut them by a little, a move the company could easily swallow, said Mark Kelley, an analyst who covers the electronics giant for Nomura Instinet, in a research note on Thursday. But if Apple has to put in place a particularly large cut in its rates — which would require a "structural change" to its commission policies — the move could cost the company more than $8 billion in lost sales next year and about $1.25 a share in lost earnings, Kelley estimated.
"A structural change in Apple's take rate seems unlikely, but would prove more damaging" than a slight change in rates, he said.
App-store fees are coming under increasing scrutiny and pressure
Apple charges a 30% commission on most sales through its app store. For subscriptions charged through its store, Apple lowers its cut to 15% after the first year. Combining those two rates, the company on average gets a commission of about 27% on all the sales through the App Store, Kelley said. Google charges similar rates in its Google Play store and sees about the same overall commission rate, he said.
But the fees charged by Apple, Google, and other app store operators like Steam have been coming under increasing pressure. In recent years, both Netflix and Spotify stopped allowing customers to sign up for paid subscriptions inside their iPhone apps, instead encouraging new customers to sign up on their websites. Similarly, Epic Games has been routing around app stores with "Fortnite: Battle Royale," directing consumers on PCs and on Android smartphones to download the game from its website instead.
And now Spotify has filed a formal complaint with European regulators, asserting in part that the fees Apple charges are unfair and anticompetitive. While it had to pay a 30% fee to Apple on its subscriptions, Apple Music — the iPhone maker's rival subscription music service — has to pay no such fees, Spotify charged. To receive the same amount of revenue, Spotify says it would have to increase the cost of its subscription, which it argues harms consumers.
Spotify's complaint comes amid growing scrutiny of the business models of Apple and other tech giants. Just last week, Sen. Elizabeth Warren said that she would seek to bar such companies from both operating a platform or marketplace and offering apps or services on that marketplace that compete with those from third parties.
"With growing calls from more robust regulation, we continue to view app store pricing as an area that could see more pressure," Ben Schachter, an analyst with Macquarie Research, said in a note late Wednesday.
App-store fees are important to Apple
Apple is particularly susceptible to potential changes in app-store fee rates. The company is banking much of its future on growth in its services business. Not only has that segment been growing faster than Apple's overall hardware business, it's more profitable too.
Apple's App Store commissions make up the biggest component of its services business, accounting for about 30% of its total revenue, Kelley estimated. Consumers spent around $47 billion on apps and other items in its store last year, and the iPhone maker pulled in about $12.6 billion in revenue from those sales, Kelley estimated. Both of those figures are about double the comparable ones for Google.
A slight reduction in Apple's App Store rates won't hurt the company very much, Kelley said. If its overall commission rate falls to about 25%, Apple's store revenue next year would be about $1.4 billion less than it would be otherwise, while its earnings per share would be about 20 cents lower, he said. But those hits would represent less than 1% of the company's expected overall revenue next year and only about 1.5% of its expected per-share earnings.
But bigger cuts in its commission rates would lead to much sharper reductions in Apple's expected sales and profits, Kelley said. If its commission rate drops to 20% overall, Apple would take a $5 billion hit to its total sales next year and would see its earnings per share cut by 75 cents, or about 6%, he said. If its fee rate falls to 15%, Apple's overall revenue in 2020 would be cut by 3%, or $8 billion, and its earnings per share would be reduced $1.25, or nearly 10%.
Schachter thinks there's a chance it could fall even further than that, suggesting Apple's commission rate might drop to just 12%. That would cut its earnings before interest and taxes by 15% next year, he said.
"Pressure on [the] app distribution model [is] building," Schachter said.
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