Apple faces massive risk, and it’s not about iPhone demand or tariffs

As Apple (AAPL) shares slide on news of hardware woes like supplier cutbacks and threats of added U.S. tariffs on Chinese-manufactured goods, the viability of the company’s multibillion-dollar services division could pose a more existential threat depending on the outcome of a forthcoming decision from the Supreme Court.

Apple’s lucrative App Store, part of its services arm that generated $37.2 billion in fiscal year 2018, is the subject of a would-be antitrust class action that, if permitted to go forward, threatens profits for the division that’s increasingly relied upon to counter sluggish demand for mobile phones.

At issue is a group of iPhone consumers who say App Store revenues are, at least in part, the ill-gotten gains of an illegal monopoly. The consumers allege the App Store is controlling retail prices by charging developers a 30% commission passed on to app purchasers who have no alternative market in which to purchase iPhone apps.

A loss that could cost Apple billions

If the Supreme Court allows the case to move forward, and Apple loses at trial, it could be a punishing blow. App Store sales are estimated to account for about 37% of the company’s projected total annual services revenue of $46 billion in fiscal year 2019, according to a November 26 analyst’s report from Bank of America Merrill Lynch. Under a scenario where App Store commissions drop just 5% from the current rate of 30%, the analysts predict a 17% drop in App Store revenue, or a loss of $2.8 billion.

Regardless of whether the app store is or is not an illegal monopoly, the justices are faced with a more preliminary question: Whether iPhone users have a right, or “standing,” to bring the antitrust claim against Apple, in the first place.

In 1977, the Supreme Court ruled in Illinois Brick v. Illinois that only direct purchasers, or those who suffer immediate harm from allegedly monopolistic conduct, can bring a claim for damages under anti-competitive laws.

Apple and app developers argue App Store buyers are indirect purchasers with no right to sue, but if the Supreme Court allows the claim to go forward, Apple will have to defend its services empire within a new antitrust landscape.

The key question the Supreme Court must decide

The Supreme Court’s key question is whether Apple is setting or controlling the retail price, according to George Hay, professor of law at Cornell Law School, and a leading authority on antitrust law.

“Antitrust places no restrictions on the ability of a single firm to charge whatever it wants,” Hay said. “Of course a commission drives the price up.”

For their part, iPhone consumers suing Apple argue that its price categories requiring prices to end for example in 99-cent increments equate to control of the retail price. “A lot of it smells like it’s Apple not just charging the developer a commission, which they’re allowed to do, but somehow controlling the retail process and retail price,” Hay said.

Interestingly, the app industry — which gets charged the 30% commission — seems to be coming out on the side of Apple. The App Association, which represents more than 5,000 Apple and Android apps, filed an amicus brief in support of Apple, and its president, Morgan Reed, contended that Apple does not in fact control the price for apps. He noted, as evidence of this lack of control, that Apple permits developers to offer free apps in the store.

Moreover, nearly all of the app developers the App Association represents sell on both platforms, Reed said. Despite the fact that, according to a study by SensorTower, the App Store has been pulling in nearly double the revenue of its closest competitor, Google Play, Reed contends, “There’s not a dominant monopolist in the handset or tablet space.”

“It’s very easy to talk about a high-profile company like Apple, to see it as a big company and therefore it dictates terms,” Reed said, emphasizing that developers are a powerful community numbering hundreds of thousands strong that can take action against Apple if it decides the commission “rent is just too damn high.” Apple customers, he says, are more likely to pay upfront for apps than Android users.

Reed says developers do receive benefits in exchange for commissions charged by Apple and Google Play, such as reduced overhead costs, lawsuit avoidance, copyright and intellectual property dispute protection, a platform that users trust to secure data, and credit card processing. They play a role of “convener,” Reed said, which promotes efficiency and cost savings for developers and consumers.

Reed said the advent of app-based software drove down the average price upfront paid for software from around $50 for boxed software to around $3. He reasons that developer costs would skyrocket if they were required to build solutions and marketing plans for dozens of app stores.

“If the outcome was a dissolution of the App Store that’s catastrophic for developers,” Reed said. “Now you’d be out there as a developer as an island on the internet.”

Now that the case has been argued in the Supreme Court, the justices could issue a decision any time between now and the end of its term, this summer. If the high court allows the case to proceed as a class action, it could be years before a final ruling comes down. Still, Apple may be on the hook for triple damages to consumers if it loses the potential case.

Alexis Keenan is a New York-based reporter for Yahoo Finance. She previously produced live news for CNN and is a former litigation attorney. Follow her on Twitter at @alexiskweed

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