Apple Has Two Trillion Reasons to Fight for App Store

Apple Inc.’s AAPL 0.66% lawyers’ have an unenviable task: Defending a key underpinning of a $2 trillion enterprise comes with high stakes.

The outcome of the bench trial between Apple and Epic Games, which gets under way Monday, is far from certain. And even a ruling there may not settle the issue for some time, as the legal and financial muscle on both sides makes appeals a near certainty.

Apple has among the world’s deepest pockets, with nearly $83 billion in net cash and a business that generated more than $90 billion in free cash flow over the past four quarters, according to FactSet. Epic, meanwhile, raised $1 billion in its latest funding round earlier this month and has a list of backers that includes Sony, Walt Disney and Chinese videogame titan Tencent.

But Epic isn’t Apple’s only problem when it comes to defending its App Store business model: The iPhone maker was charged Friday by the European Union with antitrust violations for allegedly abusing its control over the distribution of music-streaming apps. Apple still has a chance to argue its case before the EU’s regulatory commission before it renders its decision.

Both the Epic Case and EU probe are targeting elements key to the App Store model, such as the company’s tight control of which apps can be installed on its devices, and its requirement that transactions on those apps run through its own system. Lawmakers and regulators on this side of the pond also have their eye on the issue.

The latest developments come as the App Store business has never been stronger. Last week, Apple reported record services revenue of $16.9 billion for its fiscal second quarter, up 27% year over year. The App Store was credited as the largest driver of that growth in the company’s quarterly filing, as it has been pretty consistently for the past five years. Apple said on a conference call following the quarterly results that App Store revenue hit a record in the quarter, and analysts project the business will generate about $21 billion in revenue for the company’s current fiscal year ending in September, according to consensus estimates by Visible Alpha.

That would amount to just about 6% of Apple’s total projected revenue for the year. But services such as the App Store have an outsize impact on Apple’s bottom line due to the higher margins they generate compared with device sales. Apple’s gross margin on services revenue hit 70% in the most recent quarter—up 12 percentage points from when the company began disclosing service margins at the beginning of its 2018 fiscal year.

Services are key to Apple’s efforts to diversify its business away from hardware sales. These efforts have struck a chord with investors, who have propelled the company’s market value up more than 170% over the past three years, now past $2 trillion. Apple has shown a willingness to deal; the company reduced its fee take on the App Store by half for small developers late last year.

But the key points at issue in the Epic case and the EU charges go well beyond the size of Apple’s cut. And those seem like areas in which the company is less likely to compromise. “The idea behind curating the App Store in order to get the privacy and security that our customers want, I think is very important,” Apple Chief Executive Tim Cook said on the company’s conference call last week.

The company now just has to convince a lot of people in power of that.

Apple’s stock-market value hit a new record this year, but its longstanding disputes with app developers are bubbling over into public view. WSJ explains why high-profile companies like Epic Games, Spotify and Tinder are at odds with App Store rules. Video/illustration: Jaden Urbi/WSJ

Write to Dan Gallagher at dan.gallagher@wsj.com

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