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Google’s court loss, increased regulatory scrutiny could derail software profit machines for the tech giants

Monday’s court ruling that Google has operated an illegal app-store monopoly is the latest in a mounting series of threats to the $500 billion-a-year app-store economy, which has evolved into a profit machine for Apple and Google that helped define the smartphone era.

A jury unanimously sided with Epic Games, saying that Google had harmed the videogame maker by maintaining an illegal monopoly. Google said it plans to appeal the verdict and stands by its business model. In a separate case that concluded in 2021, a federal judge largely ruled against Epic even as she ruled that Apple must allow third-party software makers to steer customers to payment options within their own apps. The outcome might ultimately be decided by the Supreme Court.

Since that ruling, Google and Apple, which tightly control third-party software on most of the world’s billions of smartphones, have seen their control gradually erode as regulators in Europe, Asia and the U.S. have passed laws challenging company policies.

Beginning in March, Apple is expected to allow software downloads outside the confines of its App Store for the first time due to a new European Union law. In South Korea, the two companies were forced in 2021 to open their stores to alternative payment systems. The Justice Department and state attorneys general in the U.S. have trained their sights on a deal in which Google has paid Apple around $20 billion a year to be the default search engine on Safari on its more than one billion devices.

Despite these challenges, analysts are divided on the potential financial threat to Apple and Google’s businesses. The changes are still expected to take years to play out, and Apple and Google may yet comply with legal mandates in a way that doesn’t reduce revenue as much as expected. Last year, app store spending reached $167 billion, and mobile ad spending was $336 billion, according to data.ai, a mobile data and analytics firm.

For Apple, the regulatory and court challenges represent an unprecedented challenge to its much-vaunted services business, which had $85 billion in sales in its fiscal 2023, accounting for 22% of total revenue. The business, which encompasses the Google search payments and everything from its music and TV streaming services to its app store, has seen its growth rate decline by about half in the last year.

The majority of Apple’s services business is essentially selling access to its user base of more than a billion—either through taking a cut of App Store sales or by making Google the default search engine. Those two businesses are estimated to make up more than half of the services revenue, and more than two-thirds of the segment’s gross profit, according to Bernstein Research.

“Apple will hit a wall—either a wall of large numbers or a regulatory wall—and that will curb the growth of services,” said Peter Tuz, president at Chase Investment Counsel, an Apple shareholder. Tuz said he anticipates services could face annual declines in a few years.

For Google, its Android app store was one of its most enduring profit centers outside of search. That is now under threat. Epic didn’t ask to be awarded monetary damages or special treatment from Google, whose parent company is Alphabet. Instead, the maker of the popular videogame Fortnite wants Google to be forced to make its Android ecosystem more open and competitive.

It is unclear what that will look like. The federal judge in the case, U.S. District Judge James Donato, will determine remedies next year. The parties are scheduled to reconvene in January.

Meanwhile, the Supreme Court may be the ultimate arbiter of the app-store economy. A federal appeals court sided with Apple in April, declaring that it doesn’t have monopolistic control over mobile game transactions. Both Apple and Epic have asked for the Supreme Court to hear the case.

In the Netherlands and South Korea, Apple faced legal challenges to permit alternative methods for app payments. In response, Apple still charged apps a fee as high as 27% instead of its typical 30%, effectively making it more expensive to use an alternative payment system to Apple’s because the payments still need to be processed, said Rick VanMeter, Executive Director of the Coalition for App Fairness, an advocacy group founded by app developers such as Epic.

With the Justice Department’s challenge to Google’s multibillion-dollar annual search payments to Apple, a decision isn’t expected until next year, and even then it would face years of appeals. Toni Sacconaghi, senior analyst at Bernstein Research, also thinks Apple could make up any loss in default search revenue by taking payments from other search providers or even by making its own search engine.

“Apple still has the opportunity to provide a lucrative search revenue stream to someone else, perhaps even to themselves,” Sacconaghi said.

And even if Apple permits third-party app stores, competing digital storefronts might not take off. Many Apple consumers are now accustomed and more comfortable with the software environment Apple and Google provide on their app stores.

One area in which the two companies could lose significant revenue is in mobile videogames. In its fiscal year 2019, Apple’s operating profits from games totaled $8.5 billion, according to a Wall Street Journal analysis of figures released in its antitrust trial with Epic. That was higher than the videogame profits from Xbox maker Microsoft, Nintendo, Activision Blizzard and PlayStation maker Sony combined, the analysis showed.

If gaming app stores take off within the Apple or Google ecosystems, that could represent a major hit. Microsoft has previously attempted to bring its Xbox Game Pass service, which offers a portfolio of games to play through a subscription fee, to Apple’s app store. But the service had been blocked by Apple’s rules on the grounds that Apple can’t review each individual game on the gaming platform.

Apple is currently working to comply with a new European Union law, the Digital Markets Act, which will force the company to permit third-party app stores and alternative in-app payment services, the Journal previously reported. The company is aiming to allow third-party app stores in a software update slated for early next year, said people familiar with Apple’s plans. Apple faces an early March deadline for its store to comply with the European law.

The EU is also pursuing its own antitrust case against Apple, accusing it of violations for imposing rules that restrict app developers from informing users of other ways to pay for services that avoid Apple’s in-app payments commission. If the EU finds Apple broke antitrust laws, it could order Apple to lift those restrictions.

In China, the central government is further cracking down on which apps are permitted on the China version of Apple’s App Store, requiring all apps to be registered with the government. The move could chip away at Apple’s services business in China, which is the company’s third largest geographic market.