Why iPhone Owners Benefit From Apple's App Store 'Monopoly'

Why iPhone Owners Benefit From Apple's App Store 'Monopoly'
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Owners of Apple iPhones can buy apps only through the Apple App Store, which charges a 30 percent commission on all the apps purchased. The recent decision by the Supreme Court granting standing to iPhone owners is based upon an assumption that this “monopolization” of the iPhone app market harms iPhone owners.

That assumption is incorrect, for two reasons. First, the commission is equivalent analytically to a tax on app purchases; but consumers considering the purchase of an iPhone know that the availability of apps will be limited to the App Store, so that they will have to pay some part of the required commission. That knowledge must have the effect of reducing the amount that consumers are willing to pay for iPhones, so that the “monopolization” of the iPhone app market and the 30 percent commission actually have the effect of shifting revenues from iPhone sales to app sales.

To the extent that the commission “tax” is borne by app developers, either it has the effect of reducing the development of iPhone apps, or it does not. If it does, the smaller availability of apps reduces, again, the amount that consumers are willing to pay for iPhones. If it does not, then it is developers who are harmed, but there is no economic inefficiency---no consumer harm or resource misallocation---because there is no change in the availability of apps. The commission simply transfers wealth from app developers to the App Store, an outcome that is not a proper focus of public policy because it is no different from a negotiating outcome more favorable to one party than an alternative outcome might have been.

The second reason is the more important. Consumers of iPhones are heterogeneous; some value the iPhone more highly than others precisely because they plan to use apps more intensively. At the point at which iPhones are sold, Apple cannot distinguish between purchasers with higher vs. lower valuations; but subsequent app purchases lead consumers to reveal their relative valuations.

In other words, the “monopolization” of the app market allows Apple to exercise more than simple market power; it enables Apple to engage in differential (“discriminatory”) pricing, in which those who value iPhones (apps) more highly pay higher prices in the form of the iPhone price plus app prices, while those who value iPhones less highly pay less.

Perhaps counterintuitively, differential pricing improves economic efficiency---consumer wellbeing---in particular when there are large fixed costs and scale economies. For the iPhones themselves, development costs are significant, so that average costs (development plus production) fall as output rises. This effect is even more pronounced for apps: Once an app is developed, the marginal cost of selling it to an additional iPhone owner is effectively zero.

Without differential pricing, all consumers would pay the same price; consumers who value the iPhones relatively less will tend to drop out of the market, leaving the higher-valuation consumers to bear all of the fixed costs. With differential pricing, the fixed costs are spread across a broader base of purchasers, in proportion to the respective valuations. Consumers who value the iPhones less highly are better off simply by virtue of the fact that they remain in the market that they would have exited in the absence of differential pricing. Consumers who value the iPhones more highly are better off because they are relieved of part of the burden of covering the fixed costs of the iPhones (and perhaps some of the apps), which now are covered in part by the lower-valuation consumers.

The argument that the “monopolization” of the App Store by Apple harms consumers of iPhones is rather strange given that there is available a close substitute: phones operating on android systems. Why two different pricing systems for apps have passed a market test is an interesting question, but in any event one of the longstanding problems with much antitrust analysis is that it requires a definition of the relevant market, which can be manipulated so as to yield a broad range of answers with respect to the issue of consumer wellbeing. The recent Court decision seemingly defines the “market” to include only iPhones and iPhone apps, an orientation that has yielded a deeply problematic answer.

Benjamin Zycher is a resident scholar at the American Enterprise Institute. 

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