The European Commission believes that Apple is violating European competition laws and raising prices for consumers in how it operates its App Store. The Spotify case is a good example of why reality is more complicated than that. 

Last Friday, the European Commission announced its preliminary view that Apple is violating European competition laws in how the company operates its App Store. The particular focus was on the knock-on effects in the music streaming market, but the issues are obviously broader, and also related to the Epic v. Apple antitrust trial, which started this week in a federal district court in California. 

A key issue in both of those settings is the fees that Apple charges. The Commission focused on Apple’s rules for in-app purchases and a related provision—the anti-steering rule—which Apple uses to boost the odds that purchases occur inside the app. The Commission’s statement focuses on the music streaming market, but that is something of a red herring as the rules in question do not target that market and apply generally across the App Store. Nothing in what the Commission did last week offers a real vision of how fees are supposed to work on these two-sided platforms.

As I have discussed here before, Apple charges companies like Spotify nothing for the millions of downloads of their advertising-supported version, but when customers become a paying premium subscriber, Apple charges Spotify (and other developers) a 30 percent commission on in-app purchases. (The full-blown version of the rules is more complex, but we can ignore that here.) Spotify then faces a question of what to do about that charge and its approach to that has bounced around (as Spotify details here), but Spotify ultimately chose not to offer a direct upgrade path from within the app. Apple wasn’t somehow targeting Spotify specifically, but Spotify doesn’t want to pay those fees and filed a complaint with the Commission roughly a year ago.

Last week, the European Commission announced its initial view that Apple is abusing a dominant position and in doing so is distorting competition in the market for music streaming services. In the Commission’s view, all of that is harming competition and raising prices for consumers. The Commission focused on Apple’s requirement that developers like Spotify use its in-app purchase system to complete payments in the Spotify app and on Apple’s anti-steering clause, which bars firms like Spotify from telling customers that they could subscribe more cheaply outside of the Apple app.

Focus on what Spotify wants here: By not offering subscriptions within its app, Spotify is paying Apple almost nothing. But Spotify wants more: it wants to offer paid subscriptions in its app and wants open competition for payment service in the App Store. That would mean that Spotify subscribers could complete transactions through Visa, MasterCard, or another service and pay say a 2-3 percent fee for those services. In that framework, Apple would be just another competitor to complete the transaction.

And that is the problem. Visa and MasterCard bear their own costs associated with running a payments system but they aren’t bearing any of the costs associated with creating iOS, security, and the distribution of apps. Visa and MasterCard don’t need to recover those costs via their payment charges, and their prices reflect that. The 30 percent fee that Apple charges is just a convenient tool for charging for all of the fees associated with running the platform. Apple could charge Spotify each time one of its advertising-supported apps was downloaded and if that was the pricing mechanism, presumably that number would be much lower and quite, quite different from the 30 percent rate, even though that might produce exactly the same amount of revenue from Spotify to Apple.

“By not offering subscriptions within its app, Spotify is paying Apple almost nothing. But Spotify wants more: it wants to offer paid subscriptions in its app and wants open competition for payment service in the App Store.”

If the Commission opens up the app store to allow competing in-app payments, Spotify (and other developers) would pay the costs associated with a payment of the sort that Visa and MasterCard offer, but none of the costs associated with the additional services provided by the iOS platform and the App Store. All of that could push Apple to charge developers in different ways. There is a variety of API-based pricing (see, for example, Amazon web services) and we could imagine other metrics that track app usage on an iOS device and then bill developers in connection with that usage.

The Commission believes that Apple’s charges to Spotify boost the prices that Spotify charges to consumers, and I assume that is likely true. Spotify needs employees, real estate, music, app distribution services, and more, and the prices that Spotify pays for all of those services need to be recovered from payments paid by Spotify’s users (and, of course, by the advertisers who pay Spotify money, as Spotify is another two-sided market). The existence of charges for each of those inputs almost certainly raises Spotify’s prices, but that of course doesn’t say anything about the legitimacy of that causal chain. Presumably, no one would claim that Spotify should be allowed to pirate music so as to reduce its costs and then its prices to customers. And Spotify, like Apple, has alternatives in how it can charge customers and cover its costs. It could offer the same price for premium no matter how the customer bought it or it could, as it tried out for a period, offer a higher price within its app and lower prices outside of it.

It seems clear that Spotify saw the two-tier pricing policy as putting it at a competitive disadvantage with Apple’s own music streaming service. Of course, Apple doesn’t pay the 30 percent charge to itself, but it clearly bears the costs associated with running the platform. Those are the costs the Spotify is seeking to avoid and Spotify will gain a competitive advantage if it can succeed in doing that. 

The Commission situated its analysis in the music streaming market, but again, the App Store provisions in issue here apply broadly across the App Store. Epic has complained about these provisions in its lawsuit as well, and that helps to make clear that Apple isn’t specifically targeting markets where it has a competitive product. Apple has nothing like Fortnite. There is nothing in the Commission’s analysis that is specific to the music streaming market. And Apple charged the 30 percent rate when it launched the App Store even though there is no real contention that Apple had market power at that point.

So what is the actual harm here that a competition system should address? We should pay attention to how people change their behavior in response to fees. Here we are seeing the consequences. Spotify really wants to sell premium subscriptions through the app as this is almost certainly the best place to do that. But if Spotify can avoid the fees by not selling inside the app and instead selling outside the app, it will do so if the fees are high enough. All of that creates extra transaction costs that are bad for consumers and for Spotify.

The solution to that is to move to an unavoidable payment mechanism. Spotify won’t change its behavior to avoid fees if the change doesn’t avoid fees. Again, a payment structure that reflected Spotify’s activity on iOS devices might be preferable. And an approach like that would mean Apple could get rid of the anti-steering clause. That clause is just designed to protect Apple’s current mechanism for getting paid by Spotify and wouldn’t be needed if Apple had implemented a different approach for getting paid by Spotify. Of course, there is an air of armchair mechanism design to all of this, and that suggests that regulators need to recognize that second-best payment schemes of the sort used by the App Store may be the best that we can do.