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Fortnite, Apple, and the Fate of the Metaverse – A Game Theory Perspective

jitha 1 Comment

I woke up Friday morning to see this video trending on Twitter.

I thought it was quite epic. Fortnite mocking Apple with a parody of its own iconic Super Bowl commercial from 1984. (See original below if you haven’t).

Now, I don’t play Fortnite, but I have been following the ongoing war (if only of words, until this week) between Epic Games (the maker of Fortnite) and Apple.

But when the two players took it up a few notches this week (Apple banned Fortnite on the App Store; Epic released the video above, and also started a lawsuit and a PR campaign against Apple), my first thought was: “Such an interesting move!”

Because that’s what this is – one move, in an ongoing battle of wits between the two players.

And like all games, it can be analyzed, to predict the outcome.

But first, an overview of the game board.

If you’re already familiar with Fortnite and the ongoing saga, feel free to skip this section.

But if, like me, you haven’t played Fortnite and are wondering what the fuss is about, read on.

Fortnite is an online video game developed by Epic Games. It’s quite new – launched only in 2017. But it has been a gargantuan success – in just 3 years, it has amassed 350 million users (as of April 2020).

Beyond being just a game, it also doubles up as a virtual world for people to interact. Think Second Life, only much better. Think Metaverse, if you’ve read Snow Crash. Or the Oasis from the movie Ready Player One.

Like most games, it has a mobile app for iPhone and Android. And like all mobile games, it has to pay Apple and Google a cut (30%) on all in-app purchases.

In Fortnite, players can buy skins, “costumes”, or virtual currency called V-bucks (1000 V-bucks for $9.99) for use in the game. This is a substantial source of revenue for Epic Games. Fortnite brought in USD 1.8 Billion in revenue in 2019. Of course it pinches to give Apple 30% on all purchases.

Epic has tried to push Apple to waive this fee for Fortnite in the past, but Apple has stayed firm.

So, this week, Epic snuck in an update in its mobile app, allowing users to purchase V-bucks directly from the company, side-stepping the App Store’s 30% commission. Something Apple prohibits developers from doing.

And so, to nobody’s surprise, Apple banned the app.

And Epic immediately released the video above, announced an anti-trust lawsuit, and started a social media and PR campaign.

And by the way, Epic planned this from the start [1].

I know what you’re thinking. Why would Epic voluntarily get its app banned from the App Store, losing millions of users?

It all makes sense, I promise.

But for that, you need to understand the two players.

Player 1: Epic Games

Epic Games has been going at Apple for a while, regarding the App Store monopoly.

See here, for instance, Tim Sweeney (CEO of Epic Games) comparing Apple to the DMV.

Tencent owns 40% of Epic Games. Having a Chinese company as a significant owner is not an amazing situation to be in, in the US today.

To learn more about Epic Games and its strategy, check out Matthew Ball’s epic (well) six-part primer.

Player 2: Apple

Apple has significant share of the mobile phone market in the US (~60% of mobile phones in the US are iPhones).

It’s embroiled in an anti-trust battle with the US government.

It has a history of arm-twisting and bullying smaller companies. For instance, if your company’s logo is a fruit, even if it’s not an apple, Apple can make your dreams go pear-shaped.

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Do these two logos look similar to you? To Apple, they do.

Epic is not the first company at loggerheads with Apple regarding the 30% commission. Netflix and Spotify, among others, have stopped selling subscriptions on the App Store altogether. You can use Spotify and Netflix on iPhones. But if you want to pay for them, you have to visit their websites.

OKAY. Enough talk, let’s get on with the game.

The game begins. Ready Player Two.

Apple has pre-committed to removing an app from the App Store if it tries to bypass its rules. No matter how important the app is.

Given this pre-commitment, Apple had no choice when Epic tried to bypass it with its “sneaky” update.

In a sense, Epic forced Apple’s hand by doing this. It forced Apple to appear aggressive by banning its app. Even though it was the only move Apple could plausibly make.

Epic was already engaged in a PR battle with Apple (accompanied no doubt by closed-door negotiations). Apple wasn’t budging.

Epic could have continued the battle of attrition. But instead, by forcing Apple to carry out its threat, it has constrained the gamespace.

It has made it much harder for Apple to now offer only a symbolic olive branch.

But again, why would Epic want to get its app banned, losing millions of users?

Fact is, as Peter Rojas says in this interview, this is not a exorbitantly expensive threat for Epic to make. Only 20% of Fortnite players are primarily on mobile.

And this number is likely to grow over time, making it harder for Epic to take this approach in the future.

Ergo, the best time to do this was yesterday. The second best time is NOW.

Like Denzel Washington says,

Training

Game Theory Sidebar 1:

Threats and commitments are important tools in strategic games and negotiations.

To quote Thomas Schelling in The Strategy of Conflict [2]:
“The sophisticated negotiator may find it difficult to seem as obstinate as a truly obstinate man. Deterrence won’t work for the truly obstinate.

It’s very easy to keep demanding during a negotiation, because you (a) will always accept less, than not having a deal, and (b) you can always retreat if they don’t accept. But the other side knows this too, so it’s an impasse.

If a man comes to your porch and says he’ll stab himself if you don’t give him $10, you’re more likely to listen if his eyes are bloodshot.“

“Bargaining power = the power to bind oneself”.

“It’s a voluntary but irreversible sacrifice of freedom of choice, to signal that you can’t retreat from a certain ask.”

“If you commit to a path of action, the opposite party has lost all leverage”

Epic just stole Apple’s lunch. And leverage.

The Middle Game

Epic is trying to rally developers to its side. It’s trying to paint the battle as a David vs. Goliath struggle. The meek, tiny developer taking on the formidable bully.

But it’s unlikely to work, for two reasons:

  • Epic is a huge company itself (valued at USD 17 billion), backed by Tencent, a USD 600 billion behemoth. This is like Godzilla fighting King Kong. We don’t care, except the fast-paced action is fun to watch.
  • Small developers might actually prefer the App Store [3], because it gives them a semblance of a level playing field. Consumers trust all apps on the App Store, because they know Apple has vetted and approved them. So, even if you’re a small developer, customers don’t worry about giving you their credit card details. Trust is important!

Epic will no doubt also play up the anti-trust / monopoly angle.

It will ask, “Should one company have so much control on mobile users’ choices?” This line of attack has more promise, as we’ll see in the end game.

Apple, for its part, is trying to tell consumers it’s no big deal (it is).

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Before we go to the endgame, a quick interlude.

Game Theory Sidebar 2:

Quoting again from The Strategy of Conflict:

In a negotiation, if you ask for 60% and then go down to 50%, you will be expected to dig your heels in. And so the counter-party will push less. If you say 47%, they’ll assume that you can give up more and will push until you find another persuasive new boundary.

In war, similarly, one cannot satisfy an aggressor by letting him have a few square miles on this side of a boundary. He knows that we both know that we both expect our side to retreat until we find some persuasive new boundary that can be rationalized.

That’s also why “just one more drink” is a very unstable compromise.

Some outcomes have intrinsic magnetism. Outcomes that are prominent, unique, simple, or have a precedent / logic, drive agreement towards them. Often, this eventual compromise point can be predicted in advance.

For example, in a price negotiation: rounding down, splitting the difference, etc. are explicit expectations of counter-offer. And you often have no choice but to follow this drill. Even if you had strong prior reasons to quote 51.5% as your first offer.

These focal points / likely outcomes are called “schelling points”.

Framing the situation in a way that coordinates expectations of the opposite party towards your favored outcome – this schelling point – can multiply the probability of success.


So what’s the “schelling point” of this battle between Apple and Epic Games? Let’s see in the end game.

The End Game

I see three possible outcomes from this impasse.

Outcome 1: Apple gives in and waives the commission for certain in-app purchases.

There is a sort of precedent for this.

McDonald’s doesn’t pay a commission on every in-app purchase of food. Neither does Uber, on every ride booked through the app.

But there’s an important distinction. Food purchases and cab rides have a very real marginal cost of fulfillment.

What about virtual currencies? Not so much. 1000 V-bucks on Fortnite cost Epic exactly zero real bucks to make.

And this is an outcome Apple really does not want.

If they allow this once, the floodgates will open. Every app will move to an in-app purchase model, and frame it in exactly the same way as Epic Games has.

And even Apple accepts this as a special deal with Epic Games, it sets a dangerous precedent. Because Microsoft xCloud and Google Stadia (cloud gaming services) will come next.

No, this is not a hill that Apple wants to die on.

Luckily for Apple, this is also not a position Epic games can defend.

As Ben Evans says,

Moreover, the App store is not all eye-gouging profiteering. It does provide a service, and that does costs money.

  • Users like it – it allows them to trust new apps from unknown developers.
  • Developers like it too, for the same reason. It gives them a level playing field.

Putting it all together:

Probability of Outcome 1: 10%.

Outcome 2: Apple reduces its commission and everyone wins.

Again, this makes sense at a high level.

Apple’s 30% has no basis in logic. Steve Jobs chose 30% because it was the same as iTunes.

What! Let’s get this straight. In 2003, iTunes decided to charge artists 30% of individual song sales. That’s the only reason why the totally unrelated App Store charges 30% for apps!

There is clearly room to go down. And push comes to shove, Apple would be ready to reduce the commission. After all, it already has different slabs of commission for different kinds of products.

Maybe it can reduce it to a new schelling point. 25%? 20%?

However, this is not what Epic wants. They want to pay zero percent commission to Apple.

To Epic, the stand is philosophical. And while this may be a coincidence – it’s also more lucrative ?.

  • Today, mobile accounts for only 20% of Fortnite users. Epic can afford to reject any sweeteners and fight for the grand prize. Better to fight now, rather than later when the downside of a ban is higher.
  • And there’s an even grander prize waiting. Epic has its own app store (not allowed on iOS yet), where it charges other games a commission of 12%. Seeing how successful Apple’s App Store is, that’s a lucrative business to be in.

So yes, a commission reduction will happen. Apple will make a peace offering. It may even lead to a tenuous peace.

But it won’t end the negotiations. Epic will hold out for Outcome 3.

Probability of Outcome 2: 30%.

Outcome 3: Apple allows other app stores.

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This is what the App Store is, to iPhone users. The only bridge crossing into town.

A user cannot download an app to the iPhone from outside the App Store. Android has alternate app stores and also allows you to directly install apps. iPhone does not.

The analogy of the toll bridge is one that trust-busters and anti-monopolists like to use. It came up in antitrust investigations when Buffett acquired the Buffalo Evening News in 1977. And it will come up for Apple.

This is where Apple’s position is weakest, and this is where Epic is hitting it.

As M. G. Siegler says in “The App Store Commandments“, maintaining an “only bridge to the iPhone” approach made sense in 2010. But it’s not acceptable anymore.

This is what Epic is gunning for. Breaking the Apple App Store’s monopoly on the iPhone, and introducing its own Epic app store.

Epic could have held out for a reduction in fees (Outcome 2). It could have negotiated a win-win closed door deal (Outcome 1). But no.

By forcing Apple to ban its app, Epic has bent reality through a new focal point – the inability to reach users if Apple aggressively bans an app.

This then, is the long-term schelling point – alternate app stores for iPhone.

It may take one year. It may take two. It will be fought hotly by Apple, before it capitulates.

All it’ll take is one bad Congressional anti-trust hearing. And then, Apple will look at Android. It’ll see that even though Google allows other app stores, its Play Store still accounts for a huge majority of Android app downloads[4].

It will reason that developers will still prefer the Apple App Store, if only because there will be much fewer users on other app stores.

Probability of Outcome 3: 60%.

And that’s how Apple will finally get a second app store. And a third. And a fourth.

All it takes is one big bite.

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Footnotes:

[1] Read more details in this article from the Verge: “The company behind Fortnite dared Apple to shutter its game on iPhones. Now Apple has gone ahead and sort of done that.

[2] The Strategy of Conflict is a great book on applying Game Theory to the real world. It’s unfortunately not available on Kindle. Don’t worry if you can’t access a physical copy – there are PDFs of the book that you can find on Google.

[3] I said the App Store is more pro-developer than less. But of course, we haven’t heard Tim Cook chant chant “Developers… Developers…” like this guy.

[4] Except in China, where Google Play is banned.

Four things Apple’s slow slide teaches us about business strategy

jitha

From a quick dipstick I did last week, I’d guess a good chunk of my readers use a Macbook, and even more use an iPhone. I think it’s fair to say: Most of us are Apple fans.

So, it’s concerning to see the company meandering over the last few years. Lackluster product launches, even more lackluster products. Even Siri seems dumb now.

 

Is Apple losing the plot?

Smart folks are really worried about Apple.

apple-slow-slide

Apple’s slow slide illustrates four key principles of business strategy:

1. The S-Curve of Company Growth: Any successful company inevitably goes through a life-cycle of stuttering beginnings, rapid growth, and then gentle maturation – an S-curve. This has been true both in the Internet era and before, as Ben Evans illustrates in The best is the last. Apple is no different. Apple may be the next Microsoft.

 

2. Limited Window of Optionality: There is a way to prolong your growth arc, though. Keep transforming your business, when your previous product is succeeding, and the wind is at your back. Jobs leveraged this limited window of optionality successfully, with the iPod, then the iPhone, and then the iPad. Larry Ellison did it at Oracle too.

But Tim Cook hasn’t been able to lead such pivots at all.

Why?

 

3. The Visionary Leader – Executor Follower Conundrum: Steve Jobs was a visionary (duh). And he built a strong team of executors around him, to implement his vision. So, guess who succeeded him? A superb executor, but short on vision. Tim Cook is great at delivering on an existing strategy, but he just hasn’t kept pace with a fast-changing world.

[The similarity with Microsoft shows here too. It’s the same reason Bill Gates chose Steve Ballmer as his successor. With similar effects.]

 

4. The Jobs-to-be-done Framework: There’s another interpretation of Tim Cook’s non-success. And it comes from Clayton Christensen’s second big theory – jobs-to-be-done. As he says, consumers buy products that complete specific jobs for them.

“People don’t buy quarter-inch drills, they buy quarter-inch holes.”

The job-to-be-done is quite clear with the iPod, the iPhone, and the iPad. But Apple is struggling to find jobs for the Apple Watch and Apple Pay.

 

So, plenty of problems for Tim Cook. But maybe, just maybe, we’re all wrong about this and a major pivot is coming.