Apple and Google's app-store businesses are coming under pressure — and the companies could end up losing billions of dollars (AAPL, GOOGL, NFLX, SPOT)

Tim Cook Apple App Store

Apple and Google earn big money through the commissions they charge for sales made through their smartphone app stores.
Right now, they take a 30% cut of most sales made through their stores.
But that rate could soon plunge, the Macquarie analyst Ben Schachter said in a research note.
The companies face regulatory and legal challenges over the rates they charge, as well as growing pushback from developers, Schachter noted.
If Apple and Google were forced to cut their rates, it could cost them billions of dollars in revenue and operating profits, he estimated.

For years now, Apple and Google, in addition to their main businesses, have had a growing and profitable side gig in charging developers hefty commissions when those developers sell apps, subscriptions, and other items through their app stores.

But maybe not for much longer.

Apple and Google face regulatory threats and pushback from developers that could hamper their app-store businesses and force them to reduce the cut they take from each sale, Ben Schachter, a financial analyst with Macquarie Research, said in a research note Monday. Though the companies' app stores are just sideshows to their main businesses, they could both take a significant hit to their financial results if they are forced to reduce rates, he said.

Apple, for example, could take a $16 billion hit to its adjusted earnings if it's forced to make a major cut to its App Store commission rates, he said in the note.

"We believe that the traditional ... commission rates for app distribution may come under pressure," Schachter said in the note, adding, "Changes in the commission rates would meaningfully impact profits."

Apple started taking a 30% cut when it launched the App Store

Both Apple and Google charge a 30% commission on purchases made through their app stores, including app purchases, subscription sign-ups, and in-app purchases of digital goods. Both companies also now charge 15% on subscription charges after the first year, a reduction to entice developers to focus on subscription-based business models.

tim sweeney epic Though the basic 30% commission has been the norm since Apple launched the iPhone App Store 10 years ago, it's increasingly coming under scrutiny. Earlier this month, Epic Games announced it would distribute the Android version of its megapopular game "Fortnite" through its website rather than through the Google Play app store. It opted out specifically because it didn't want to pay the search giant a commission on in-app purchases, which is the main way it makes money off "Fortnite."

Epic's move drew widespread publicity because it was so unusual for a developer to opt out of one of the two major global smartphone app stores. But it may soon be followed by others, Schachter said.

"We've had behind-closed-door discussions with game developers who claim that [Apple's] and [Google's] commission structure is unfair and that they may take a more public role in pushing back against the business model," he said.

Developers are starting to push back against those commissions

And it's not just game-makers who are getting fed up. Spotify, in a recent regulatory filing with the Security and Exchange Commission, called out Apple and Google for charging it commissions that aren't applied to rival music-subscription services. The statement was the latest move by Spotify to bring the issue to the attention of consumers and regulators, Schachter said.

Daniel Ek Like Epic Games, Spotify has essentially opted out of that model. Though iPhone users can download Spotify from the App Store, they can't sign up for its premium subscription service through it. Instead, they have to do that through its website.

Apple and Google could also see pushback from other developers, particular from streaming-video providers such as Netflix, Schachter said. As that market starts to mature and the players become less focused on signing up new users, they may start to become more concerned about the commissions they're paying to Google and Apple, he said, adding that those concerns may heighten as the two giants rev up their respective video services.

Already, Netflix is testing directing smartphone users to sign up for a subscription to its service via their web browsers rather than through its app, Engadget reported Tuesday.

As Google and Apple "continue to add more services and directly compete with app developers," Schachter said, "we suspect some of these voices from the music, video, game businesses and others may become louder."

Apple and Google also face increased regulatory and legal pressure

But the app-store commissions are likely to come under pressure from others besides developers, most notably from the legal and regulatory arena, Schachter said.

In the next year, the US Supreme Court is scheduled to hear an appeal of an antitrust lawsuit filed against Apple by consumers that targets its commission fees. They charge that Apple's monopoly over the distribution of apps on the iPhone means developers have no choice but to pay its commissions, which the developers then pass on to their customers in the form of inflated prices. Should the court allow the case to continue, it could eventually upset the whole business model of the App Store.

Margrethe Vestager Meanwhile, Google's business practices have for years been under scrutiny by European competition regulators. Last month, they hit the company with a $5 billion fine for forcing smartphone makers to install its apps.

Such regulatory scrutiny may only increase, Schachter said. Developers such as Spotify are complaining directly to regulators, he noted.

With the big market growing rapidly (global app sales hit $86 billion last year) and with Apple and Google offering more services that compete with those of leading app makers, the companies' commissions and app stores are increasingly likely to draw regulators' attention, he said.

"We are concerned that given AAPL and GOOG's dominance of mobile [operating systems] combined with their growing efforts to add value and services to customers using those OSs, it will draw regulatory and legal attention," Schachter said, referring to the companies by their ticker symbols.

He continued: "We are particularly concerned that as AAPL and GOOG add more features and offerings such as voice assistants, Apple Music, YouTube Red, a potential video service from AAPL, and more, that competing developers will claim that AAPL and GOOG's position as owners of the platforms may give them 'unfair competitive advantages.'"

Apple and Google could take a big hit to sales and profits

Should all this pressure on the app-store commissions lead to decreased prices, the two giants could take a big hit, Schachter said. Over the past year, 14% of Apple's total revenue came from its services business, much of which is derived from commissions on App Store sales.

If nothing changes with commission rates, Apple should see an average commission rate of about 27% on such sales in its fiscal 2020, he estimated, taking into account the 15% rate it charges on ongoing subscriptions. The company's App Store revenue would be about $20.1 billion that year, while its total company earnings before interest and taxes (EBIT) would be about $78.6 billion, he said.

Sundar Pichai But if Apple were forced to slash its average commission rate to 15%, its App Store sales would fall to $11.2 billion in fiscal 2020, and its total company EBIT for the year would drop to $69.7 billion. If it had to cut commissions to 5% on average, its App Store revenue would be just $3.7 billion, and its companywide EBIT — essentially its operating profit — would be $62.2 billion.

Those estimates "highlight just how levered operating profit is to the high-margin dollars of the App Store," Schachter said.

Google could see a similar hit if it were forced to slash Google Play commissions, he said.

Assuming everything stays the same and the company continues to get an estimated average commission of 27% on app-store sales, Google will pull in $10 billion in such revenue in 2020, and its companywide EBIT will be about $40.2 billion.

But if rates were cut to 15%, Google's app-store revenue would be just $5.6 billion that year, and its EBIT for the year would be $35.8 billion, he said. If rates plunged to just 5%, its app-store revenue would be about $1.9 billion, and its total EBIT would be $32 billion.

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