Spotify v. Apple and a mess of claims

A couple of days ago, Spotify announced it was pushing the European Commission to investigate Apple’s app store practices. They claimed that Apple was discriminating against them (and presumably other streaming services) on account of their own competing Apple Music service. Spotify claimed they had to pay Apple 30 per cent of their revenue which was a ‘cost’ that Apple Music didn’t have to bear. They also claimed to be denied Siri integration and an Apple Watch app.

Let me first say that the Spotify site is very odd with some pretty misleading claims even if they are “technically” true. For instance, under a big banner saying “Siri Says no!” Spotify argues that when Siri launched in October 2011:

Siri launches on the iPhone, but won’t play Spotify

“Siri, can you play that awesome Spotify playlist?” Siri says no. And Siri still won’t talk to us today

That’s true, it didn’t. It didn’t open any app! It was a beta version. And, yes, Siri doesn’t do that today but that is because Spotify hasn’t done the work for deep integration that it can do. You can, of course, ask Siri to open the Spotify app and have been able to do that for a number of years. They made the same claim when the Apple watch launched in 2015 but, once again, there were no third party apps then. Instead, when apps were launched, Spotify did do one and it is there today.

But let’s get to the real issue: the money. Like all other apps with digital content, Spotify has to pay 30 per cent of its app store revenues to Apple when a consumer opt to purchase a subscription as an in-app purchase. What everybody knows, of course, is that drops to 15 per cent for the annual renewal after the first year. In other words, Apple charges more when it helps subscription services acquire a customer than when it helps retain them. That makes sense to me.

Interestingly, Spotify does not mention that for their free, ad-supported, customers and for customers who subscribe to Spotify outside of an in-app purchase (or are gifted it as some deal etc), Apple charges them nothing. That is what Apple does for all free apps and apps that do not sell digital content. To be sure, distributing those apps and developing iOS so that apps are easier to program and have more features costs Apple money. But it is recovering that money from those directly earning money on the App Store and what it earns from its devices in the iOS eco-system. It didn’t have to do that but it is clearly profitable for Apple to operate that way: something that it has done right from the start. In other words, it didn’t just offer a good deal with the App Store was small to get developers on but it continued that deal even after selling billions of devices.

All that aside, let’s look at the subscription side. Spotify has a point (and likely Netflix and others will have one too when Apple launches its TV service): Apple is a direct competitor to Spotify in music streaming. Given the way that works, every customer Apple gets in that regard is one that Spotify does not have. So if Apple is vertically integrated (which it is) then it is worth taking a look at incentives to see if something is askew.

Let’s start with pricing to consumers. At the moment, Spotify and Apple both charge $9.99 for a single user per month. Not surprising, that is the same for every streaming service without ads. At the moment, Spotify does not offer the ability to purchase a subscription through Apple so they aren’t, in fact, paying the claimed ‘tax’ Apple is supposed to be imposing (aka that’s not how taxes usually work). But other services do. Tidal, Pandora, SoundCloud and iHeart Radio charge $9.99 (themselves and on Google) and then $12.99 through the App Store. If we are being pedantic, this is 89.7 cents less than a cost-pass through but I would be remiss not to note that they could have charged more if they found it profitable too. Clearly, at the moment, Spotify has opted not to offer that option.

Now let’s look at Apple’s incentives here (ignoring the fact that the 30% fee was imposed way before music streaming services was a thing). Here is what Apple gets if it competes a customer away from Spotify if Spotify does offer purchases through Apple:

APPLE PRICE LESS FEE FROM SPOTIFY = APPLE PRICE LESS 0.3 * SPOTIFY’S PRICE

If we use Pandora as a proxy for this exercise, then Apple earns $9.99 – 0.3($12.99) = $6.093 by successfully attracting a customer. If Apple competes a customer away from Spotify when Spotify doesn’t offer purchases through Apple then Apple earns $9.99. In other words, Apple has a stronger incentive to compete when Spotify does not offer in-app purchases than when it does. It is also true that the lower the revenue share going to Apple, the stronger the incentive it has to compete with all streaming services. But what this means is that both Apple and Spotify would benefit to some degree if Spotify used in-app purchases and paid a fee to Apple. In other words, Apple has an incentive to get Spotify on-board if only to reduce competition between them. And yet, it clearly isn’t taking actions to do that.

Of course, this comparison does not take into account the competitive situation when a consumer is on an iPhone. In-app purchases reduce frictions and so for a consumer — with otherwise identical services — they see a situation where it costs $9.99 for Apple and $12.99 for Tidal which is quite a price difference. This is the situation Spotify want to neutralise which is why they would prefer to pay Apple nothing (or, at the very least, a much lower amount).

It is interesting to compare this situation with the situation where Apple did not own the App Store. In this case, it would charge the same fee for Apple Music as it does to Spotify. Now there would be no asymmetry that was transparent between Apple Music and Spotify. But what price would arise? And could it end up being better for consumers?

A good starting case is that the 30 per cent fee would still remain — after all, if Apple (as a so-called evil App Store monopolist) would charge that why not an independent evil App Store monopolist? In this case, the price of Apple Music would rise to $12.99, Spotify wouldn’t face its ‘argued for’ disadvantage and some Apple Music consumers would be worse off. In other words, this would be a pure shift from Apple and its consumers to Spotify. It is hard to see that is a good social outcome.

But there is a larger point: if you believe this counterfactual (and it seems plausible to me), then you cannot simultaneously believe that it is the vertical integration by Apple that is causing some competition problem. After all, competition is likely reduced by vertical separation.

Instead, what Spotify essentially need to argue is that what the market outcome should be is that prices for all streaming services should be $9.99 on the App Store and that Spotify and others should pay no more than Apple’s imputed costs for this. Let’s suppose we could work out that number and that it was $c per app download/update (normalised to be a monthly cost). This is a cost Apple pays as well as Spotify. In this situation, the price to consumers would reflect this cost (rather than Apple’s fee). Moreover, Apple would be indifferent (cost wise) as to whether a customer was no its service or another service. (At the moment, it may not be indifferent because of App Store revenue share). By our above analysis, it is highly unlikely that $9.99 will be the equilibrium price. If, as Spotify argue, $2.997 is higher than $c, then both it and Apple and everyone else will have an incentive to lower price — perhaps by as much as ($2.997 – $c). To be sure, that would likely be a better outcome for consumers. But the idea here is just to regulate prices. It would also reduce music streaming prices on the App Store and through other mechanisms. I have to wonder, therefore, why Spotify would argue for this.

It gets worse. If you regulate the App Store based on $c costs per download, surely Apple could argue that should apply to free apps as well. You see where this is going. And what is worse, this could make things pretty expensive for Spotify as they would have to pay that for every user. This is so potentially lucrative for Apple it is almost surprising they don’t do that.

Given that, perhaps there is a middle ground. What if Apple offered in-app purchases a deal? Pay 30 per cent for revenues on in-app purchases or pay a lower amount for all of your downloads. That is, offer Spotify a menu. The asymmetric cost option that is the 30 per cent revenue share or a full-cost option based on the pure services that Apple is providing for all Spotify’s customers. I like menus. They separate the puffery from the reality and allow for tailoring of business models in perhaps a more transparent manner. I don’t see any reason why Apple just doesn’t make that offer.

[A quick declaration: I was an expert against Spotify and Apple in the songwriter’s copyright case a couple of years ago where I was arguing for higher royalties (amongst other things) for songwriters. You can see a summary of my views here.]