Thread by @leah_nylen

We're now switching to Apple's experts. Apple lawyer Daniel Swanson calls MIT's Richard Schmalensee, their main economic witness

mitsloan.mit.edu/faculty/direct…

Schmalensee says he has testified in court before, most notably as Microsoft's expert in US v Microsoft. He has consulted for @FTC Bureau of Economics and @JusticeATR. He was member of CEA during George H.W. Bush admin from 1989 to 1991

Over the past 20 years, Schmalensee says he's frequently paired with David Evans, Epic's main economist, including on 3 books, half dozen articles, 8 book chapters and various amicus briefs including one cited by the Supreme Court in the American Express case.

Schmalensee says he disagrees with Evans testimony. "That’s not the way I think about the business. Apple’s iOS business is clearly a platform linking consumers and developers. The iOS is at the core of that platform. It links apps to those devices."

"The App store facilitates transactions between consumers and app developers," Schmalensee says.

Evans' analysis that the market is for smartphone operating systems is wrong. "There really isn’t a market there. The apple iOS has never been licensed separately from devices."

Apple’s “IAP is like a credit card terminal. It connects to a credit card processor,” Schmalensee said. The IAP helps Apple collect its commission. “It is an integral part of its store.”

Schmalensee said the fact that developers don't want to use IAP doesn't indicate there is separate demand and a separate market, only that they don't want to pay Apple's commission.

As Schmalensee talks about the American Express case, Judge Yvonne Gonzalez Rogers jumps in: "In Amex there wasn’t a duopoly."

“If you went to the register it would show there are other payment options,” YGR says. What’s wrong with giving consumers choice?

If consumers have choice, “you are undercutting the App Store's ability to collect its commission. You are undermining its revenue stream,” Schmalensee says. He says Amex is "analytically the same" as this case. "I don’t think it's factually the same," YGR replies.

Apple conducts research and development on its devices and operating system in way that impacts the whole business, Schmalensee says. “You can’t allocate those joint costs in a way that’s not arbitrary.”

(This is pushing back on Evans' testimony about the profit and loss specific to the app store)

As an example, a farm that raises steers might sell them both for meat and for leather. You couldn't allocate the cost of cattle feed to one line of the business since both would benefit from feeding the cattle, Schmalensee says.

(Can't say I ever expected Apple's smartphones to be compared to cows...)

"A number of online app stores require use of their own payment system to collect commissions. If that’s a tie, then both Apple and all these other stores have to try to figure out some other way, likely a more expensive way to collect commissions," Schmalensee says.

Swanson has finished his direct testimony. Epic's Gary Bornstein is up for cross.

This audio is so smudgy RN I'm having difficulty hearing Bornstein's questions

Bornstein is asking about Apple's anti-steering rules and whether they go further than American Express's. "They prohibit communications...including targeted emails to users," Bornstein says. Schmalensee agrees.

Schmalensee says that Apple's iOS business has three elements: the device itself; the operating system; and the App Store.

Bornstein compares that to Microsoft. You have a PC/laptop, which could be made by anyone, the Windows operating system, and then Steam or another software store.

Bornstein: "The only reason you consider the three elements as part of the platform are they are owned by Apple?" "Yes, and they have joint costs," Schmalensee says.

“And that is Apple’s choice about how to run its business than any inherent feature?” Bornstein asks. "It is certainly Apple’s choice as to how to run its business," Schmalensee says.

Bornstein returns to American Express and asked whether a business can compete with a two-sided platform on only one side of the market. Schmalensee agrees.

(Nerd note: That actually contradicts the decision in the Sabre case where the judge said two-sided platforms can only compete against other two-sided platforms. Most antitrust folks think that decision was wrong, though).

Taking our morning break. Back in 20 mins.

Back now. YGR didn't tell Schmalensee he couldn't talk to Apple's lawyers during the break, which upset Bornstein, but the judge says its her fault.

It's a general rule in court that when a witness is on the stand, s/he can't talk to anyone about it so as not to influence the testimony.

Bornstein is asking Schmalensee about an analysis done by another Apple expert, Loren Hitt, which looked at how the introduction of the Nintendo Switch impacted iOS users.

Hitt apparently looked at percentage of time played. Bornstein askes Schmalensee to confirm that when you use percentages, the time on iOS would go down in the case of new players or increased time spent because of math.

“When Fortnite launched on the Switch, it wasn’t substitution but a total absolute increase in play and spending,” Bornstein says. Schmalensee agrees that Epic's expert Michael Cragg found that. "That’s what the exhibit showed. Hitt’s analysis takes a different cut at it."

Bornstein has moved on to ask Schmalensee about why Apple's side is defining the market as game app transactions.

"If there were a different plaintiff here who doesn’t make game apps, you might have a different market definition?" Bornstein says.

"Yes," Schmalensee says. You would start by looking at the plaintiff to help define the market. If it were a crotcheting app, he'd start there.

Schmalensee notes that in American Express, the DOJ tried to define the market for travel and entertainment transactions, but the judge rejected that and found the market was credit card payment transactions.

You look at the predominant product of the plaintiff, Schmalensee says. Bornstein asks if Epic could be considered as a distributor because of its Epic Games Store business.

If Epic was suing in that capacity, the market would be the market for being an app store, Bornstein asks. Schmalensee agrees he said that at his deposition but his view is more complicated and he'll expound on redirect.

Schmalensee admits that he likes to play Tetris but has never played Fortnite.

Back to Amex. Bornstein says the App Store is like the Amex network in that it neither buys nor sells but facilitates transactions. Schmalensee agrees.

“The transaction service has nothing whatsoever to do with the content the developer provides to the user,” Bornstein says.

"Yes, except for the nature of the content might affect whether a commission is owned," Schmalensee says.

"The transaction services are the same services whether a developer sells games or music or coffee or crocheting materials?" Bornstein asks.

Correct, Schmalensee says.

* owed not owned.

When Epic Games Store entered the market for PC/Mac Games, Steam changed its commissions, Bornstein says. Schmalensee agrees. Consoles, Apple's App Store and Android's Play Store did not, he acknowledges.

Bornstein returns to Schmalensee's criticism of Evans' market and his belief there is no market for operating systems. There is a bundled market of devices and operating systems, Schmalensee says.

Now they are arguing about whether Android is zero price. Bornstein says Android OEMs don't pay money but they have obligations to give certain preferential treatment to Google's apps. "They don’t have out of pocket costs. There are burdens," Schmalensee says.

"There is a non-monetary price to get access to the Android system," Bornstein says. "In that sense, Android is not free."

“They are hardly substantial," Schmalensee says, calling Bornstein's description a "novel" understanding of Android and that he's not sure how Android is actually monetized.

(Well, Mr. Schmalensee, perhaps you should go read the complaint in US v Google. The Justice Department has a theory about that.)

During Tim Sweeney's testimony, Apple walked him through a chart where he filled out what the commission was on various game consoles and whether those allowed alternate stores.

Bornstein is now having Schmalensee fill in a chart of different places to play games, their restrictions and operating systems.

Schmalensee agrees that PC/Mac/iOS/Android are general purpose operating systems while game consoles have niche operating systems that's generally for a specific purpose, gaming.

Schmalensee agrees that he has said that game consoles operate a “radically different business model” from computers and mobile.

Bornstein asks Schmalensee whether Apple imposed a price increase when it started requiring developers to use IAP. He says that if they had being charging before and then had to use IAP, that would be a price increase.

When Apple started requiring subscriptions to use IAP in 2011, was that a price increase, Bornstein asks. Schmalensee says he wasn't sure if apps could offer subscriptions before then.

Bornstein is now asking whether government regulation would impact a company's actions. “It was widely recognized that the government’s focus on Microsoft’s conduct led Microsoft to rein in its behavior,” Bornstein said. “It was certainly discussed,” Schmalensee says

Schmalensee acknowledges that Apple has been under antitrust scrutiny in the US and elsewhere for a number of years.

They are now discussing the profit and loss statements that were produced by Apple from Tim Cook's files. Schmalensee acknowledges that these statements exist and do allocate some of the joint costs to the App Store.

“Accountants love to do that sort of thing,” he says. “It’s not clear how useful it is.”

Schmalensee acknowledges that Apple requires developers who sell digital goods to use IAP and explicitly requires developers who sell physical goods to use a different payment mechanism. "Apple could make a different choice," he says.

Bornstein ends. Apple's Daniel Swanson is now back for redirect.

Swanson returns to anti-steering provisions. “It’s exactly the same thing as Amex,” Schmalensee says. "“You can’t say you’ll take the card, put the decal in the window and then try hard not to take the card.”

And YGR jumps in with a bombshell! "I have the ABA’s Antitrust Law book up here and I’ve heard quite a bit of evidence throughout the trial regarding how big Apple is and how anticompetitive it is."

YGR: I put in my PI order with respect to essential facilities. Neither of the parties have any interest in briefing or providing evidence on that topic.

It says that (and I think she is reading from the ABA book here), essential facilities claims arise in a vertical context when a plaintiff alleges a duty to deal because a facility is so superior competitors cannot succeed without accessing it.

"It sounds to me like what Epic is saying is we want Apple to allow us to deal on their platform. And there are only two of these platforms, and because there are only two platforms, all these competitors can’t succeed without access to these platforms."

YGR says she hasn't practiced antitrust in 40 years, but why isn’t anyone trying to use that doctrine.

Schmalensee says he is not a lawyer but the doctrine originated out of railroads, where the only way to access things was to use the tracks.

YGR: This case seems to be arguing that "everybody has a communications device. And the only way to access those billions of customers is through Android or the iPhone."

Schmalensee says the essential facilities argument doesn't work here, in his view. Epic is arguing it can't be a store without access to iOS, but it has access through Apple's App Store. It just doesn't like the terms its been given.

YGR invites Epic's lawyers to offer some more briefing on duty to deal and essential facilities issues. Bornstein says its already in their findings of facts.

And with that Schmalensee is excused. Next up is Francine LaFontaine, a former FTC top economist. She is being examined by Karen Dunn.

LaFontaine is explaining what substitutes are. High heels and flats are two types of shoes you might substitute for one another.

Now cluster markets, which are when sellers offer a similar mix of multiple products. She's using Staples and Office Depot as an example. They sell a lot of office products that business customers might need.

In this case, for game apps, there are consoles in addition to app stores, LaFontaine says. For other apps, other options might be available for distribution but not to the same extent as game apps.

She gives an example of a supermarket that imposes a restriction on some of its distributors. A wine distributor challenges the restriction. That requires thinking about where wine gets sold, LaFontaine says.

It wouldn’t be limited to supermarkets. There would be liquor stores. “The market would be defined to include all those options since they are all ways in which consumers can get access to the product,” she says.

Even though the liquor store might sell crackers, that's not the primary reason why anyone goes there, she says. “I would go to those stores for wine and liquor, but not the crackers typically," she says.

And with that analogy we are now breaking for lunch. Back at 1:15/4:15.

Back post-lunch. LaFontaine is back on the stand with questioning by Apple's Karen Dunn.

Dunn asks whether the fact that Epic's Game Store has apps like Spotify changes her analysis. No, LaFontaine says, the Epic Games Stores is like the liquor store, a place consumers primarily go to for games (not crackers).

Epic's market definition, which focuses just on Apple's App Store, "is too narrow because it focuses on the one platform and consumers can transact on other platforms," she says.

Consumers don’t buy smartphone operating systems, they buy phones, LaFontaine says.

Dunn finishes and Epic’s Gary Bornstein is now up

Bornstein asks LaFontaine whether her description of cluster markets that involved the DOJ’s Aetna-Humana challenge was in her expert report. She says it was not. YGR strikes it from the record

Under questioning, LaFontaine acknowledges she has never served as a testifying expert in an antitrust case before and hasn’t written much about antitrust or two-sided markets

In this case what is the product? Bornstein asks. Transactions, LaFontaine says. What are the ways that similarly situated consumers and developers would be able to transact, she says

The product would depend on the transactions that are relevant to this case, she said. So it matters who the plaintiff is in the case? Bornstein asks.

No, she says. If the plaintiff here was Match Group, would that change the analysis? Bornstein asks

It might change how the analysis starts, she says

"It matters that there would be other options available to consumers in defining the market," LaFontaine says.

In the Staples matter, there were separate products being sold like tape and staplers, Bornstein says. LaFontaine agrees. But in this case, there is just one product being sold, transactions, Bornstein asks. "It is transactions," LaFontaine says.

"There are differences for the set of options that these customers have," LaFontaine says.

“You started with game transactions because Epic is the plaintiff," Bornstein says. That’s the product that Epic and Apple interact on, LaFontaine says.

LaFontaine said she didn't know until her deposition that Epic owns a social networking site called Houseparty.

She also didn't know that Epic has other apps that relate to the Unreal Engine on the app store.

LaFontaine said she didn't do a hypothetical monopolist test, which is an economic test to determine if a company has monopoly power. law.cornell.edu/wex/hypothetic…

YGR asks a question: "Whose definition came first, yours or Hitt's?" LaFontaine: "We had some discussions and I think we arrived, Hitt and Schmalensee and I arrived at it working together on that definition."

LaFontaine said she came up with the digital game transaction market in part because of "what i understood what the law would require” since Apple operates a two-sided transaction platform (and is therefore subject to Amex)

LaFontaine says the games transaction market includes three types of transactions: in-app transactions, downloads and updates.

"They contribute to satisfying the consumer need" to play games, she says.

Back to substitutes. LaFontaine agrees a substitute for doing a transaction on the phone is to do one on a friend's computer or console.

"You could also do it on the website of the company directly on your phone," she said. But yes, there's going to be a certain number of people who do that, though this particular example is less likely, she says.

"I don't consider those to be great" substitutes, LaFontaine says of using a friend's console for transactions.

LaFontaine acknowledges that the App Store "has been a profitable business" and that many developers pass on the costs for using Apple's in-app payments to consumers.

LaFontaine defined the geographic market as U.S. consumers but global developers. She acknowledges that US consumers are limited to using Apple's US App Store.

Also LaFontaine says she's never tried to download software on her computer (REALLY?!)

And with that, she's done.

YGR says she hasn't seen any definitive authority as to the precise mechanism by which the court defines the market. "It reminds me of qualified immunity. One side says its black. The other side it's white. Typically it's somewhere in the grey."

"If it was clear cut, you would agree," she says.

Next up Loren Hitt. Not entirely certain which Apple lawyer is talking.

Hitt is a professor at University of Pennsylvania Wharton Business School. oid.wharton.upenn.edu/profile/lhitt/

Hitt said he examined output, pricing and quality and found “no evidence based on those metrics that Apple engaged in anti-competitive conduct."

Epic's Evans didn't look at output or quality, Hitt says.

Hitt examined 60 billion transactions in the App Store between 2010 and 2018. Developers self-identify themselves, so he looked at game transactions. Over those 8 years, the number of transactions increased 1200% and the revenue grew 2600% "This is very, very rapid growth."

“The App Store itself has been growing six times as fast as the market for game transactions," Hitt says.

Since I'm not in court not entirely certain but I think this is the graph (page 63 of his written)

Apple has reduced the rate of the commission over time, Hitt says. The general commission is 30 percent. But subscriptions, video subscriptions, and small businesses that earn less than $1 million pay 15 percent

“Did you see any documents that the 2021 change was contemplated prior to the beginning of this lawsuit?” Judge asks. "I don’t recall," Hitt says.

For the most part Epic pays 30 percent on all platforms, Hitt says. He also lists a number of other platforms that charge 30 percent

Hitt says the fact that Microsoft or other consoles sell their devices below cost doesn't impact his analysis that 30 percent is the market price since everyone seems to charge that, whether they sell hardware or not.

Developers can monetize without paying a commission to Apple by using advertising, selling digital content outside the app or promotional partnerships, Hitt says

In 2019, 91 percent of games were free to download in the App Store, Hitt says. About 76 percent of games are totally free, so free to download and no in-app purchases.

He's now describing this graph which shows games that charge for downloads have decreased over time (red line) while the ones with in-app purchases (green) has increased

And now done for the day. Loren Hitt will resume his testimony in the morning.

Also Epic's Katherine Forrest says Epic may rest its case by Friday, letting Apple start its case. After Hitt finishes, we will go through more experts.