How Apple Gamed App Pricing

(Bloomberg Opinion) -- The appeal of Apple's iPhone isn't just the aesthetically pleasing marriage of form and function — it's also all the apps specially designed for the iPhone's software.

Apple has a lot of control over those apps. The company requires that they all be sold through the official App Store, and it charges app developers a 30 percent commission on sales. These restrictions and fees are pretty high, and have led to multiple class-action lawsuits. But it wasn't developers who sued Apple — it was iPhone owners.

Why? In the App Store's earliest days, developers paid the 30 percent commissions themselves. But soon, developers began passing most of those costs through to consumers, who then saw substantial increases in app prices.

These issues are at the heart of an antitrust dispute, which is now before the Supreme Court. In that case, Apple argues that it can't possibly be responsible for the app price increases, given that technically it levies fees on developers, rather than on consumers.

But the real issue for antitrust regulators is about competition: whether consumers had the opportunity or ability to take account of the developer commissions being fobbed off on them when they bought their phones.

It doesn't matter which side of the market — developers or consumers — is nominally being charged the fee. Rather, it matters who pays in the end. And Apple's developer fees have effectively turned into consumer subscription fees for using the App Store, albeit ones that rise with the number and types of apps you download.

But thinking about the problem this way raises a deeper economic question: Suppose Apple did just charge consumers a 30 percent subscription fee. Would that be monopolistic?

Of course, Apple is providing a lot of add-on value, such as vetting apps for security flaws. But let's suppose for the sake of argument that 30 percent is above the cost of ensuring a high-quality app ecosystem.

It's true that anyone who uses an iPhone is locked into the system's App Store. And people are not going to switch phones just to get a small discount on “Donut County” or any of the thousands of other apps Apple offers. So Apple just might look a lot like a monopolist from the iPhone owner's perspective — Apple can raise prices, at least a bit, and its customers will just have to pay.

But those people weren't always locked in.

For sure, the smartphone market isn't the most competitive on the block. Nevertheless, there are options. Theoretically, at least, shoppers should price in app fees when they choose which phone to buy, just like they do when locking in multiyear contracts with wireless providers. Apple has to keep its fees at a price the market will bear, or else consumers won't buy its phones.

If Apple instituted the 30 percent fees once people had already acquired their phones, then we would be worried. By analogy, we should be concerned, too, if consumers bought their phones without understanding the possibility that developer fees could be passed through to them in the future.

More broadly, when joining a platform requires making a large upfront investment like buying a smartphone, it's not only anticompetitive to raise prices on current users without clear warning in advance; it's also a problem to hide information about fees — and that me­ans all fees, not just the ones consumers can see out in the open.

Installing apps from anywhere else voids the phone's warranty.

Besides, as the class action lawsuits have argued, the apps themselves are just bits; Apple is providing those bits to consumers and collecting payment, so we might even think that Apple is the downstream seller of developers' apps, rather than an intermediary connecting developers to consumers.

At minimum, it's hard to imagine those costs scale linearly in proportion to apps' numbers of users — especially for apps that get millions of downloads.

I suppose some might argue that iPhones are really the only option. (After all, how could you live without those rounded corners?) But from an antitrust perspective, this seems like a hard case to make.

To contact the editor responsible for this story: James Greiff at jgreiff@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Scott Duke Kominers is the MBA Class of 1960 Associate Professor of Business Administration at Harvard Business School, and a faculty affiliate of the Harvard Department of Economics. Previously, he was a junior fellow at the Harvard Society of Fellows and the inaugural research scholar at the Becker Friedman Institute for Research in Economics at the University of Chicago.

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