Did Apple Just Have Its Moat Blocked? (Epic Games Lawsuit)

So here on the channel, I love talking long-term Warren Buffett-style value investing, and that strategy largely boils down to four key points. There's understanding the business, so you know what you're getting yourself into. Then you find a competitive advantage or a moat to ensure the future success of the business. Then we check if the management team is running the joint with skill and integrity. Lastly, we value the shares and ensure we're getting a margin of safety. Four key pillars that encompass every little thing we do when we analyze a business.

But in today's video, we're going to be focusing in on the moat, the company's competitive advantage. Because something that we're seeing more and more lately is companies that we would say have excellent, almost impenetrable moats are being financially penalized because of it, and the latest offender/victim is Apple. This is a really, really interesting case study. So, without further ado, let's roll the intro and discuss.

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This video is sponsored by Stake. Sign up today for free brokerage when trading U.S. listed stocks and use the referral link in the description for a free stock when you fund your account. So, as we always say, a competitive advantage to a business is like a moat to a castle; it stops attackers from getting in. In business, a competitive advantage is an intrinsic characteristic of a company that naturally protects it from its competitors. An example of a moat might be a patent, or a powerful brand; it could be a service or platform whose value is in the number of users, not necessarily the platform's features. Heck, a moat can be as simple as a boom gate in front of a car park on a busy street. You can understand that these intrinsic characteristics naturally protect the business and thus protect its profits. Even if another competitor were to try and do what our company is doing, chances are they wouldn't be able to. That's the moat working its magic.

So no doubt, moats are extremely desirable from an investing standpoint. They protect the business, protect its profits, and allow the company to grow uninterrupted, and that is quite simply good for our investment. But in the last few years, we've started to see some negative effects from having an impenetrable moat, and I think we're starting to see a limit on how powerful a moat can be. Because the trend we're seeing more and more today is that companies trying to use their moats are actually getting punished for it.

Now, let me make myself clear: a lot of big companies have been caught abusing their competitive advantages, and that's definitely not a good thing. For example, Alibaba, China's big e-commerce site, was recently handed a 2.8 billion anti-trust fine after they told their merchants they weren't allowed to open a store on a rival e-commerce site. If they did, Alibaba would just give them the flick. Now that is definitely unfairly abusing the power gained from a competitive advantage. I mean, Google has also been on the receiving end of anti-trust fines. Notably, in 2017, Google was fined 2.4 billion euros by the European Commission for showing their own products first in Google search before showing competitors’ products.

Facebook currently faces an anti-trust complaint saying that they used their monopolistic position, which was gained because of their moat, to either acquire competitors or just simply block them from accessing Facebook's API. So there are cases out there where companies are being accused of or have blatantly abused their competitive advantages to unfairly profit and squash competition. Obviously, it's not a good thing.

But something happened just the other day which is now taking this crackdown to a whole new level, and it has to do with one of the biggest companies in the world: Apple and a particular type of moat they possess — a toll moat. So, not that hard to understand, as you might guess, a toll moat is where you have to pay the toll in order to get somewhere. The most obvious example is a toll road. You know, you want to travel onto the island over there to see Grandma? Well, there's only one road; I own it. You want to use it? Pay the toll. Traditionally, toll moats were really just seen in transport. But now we're in the digital age; we're also seeing toll moats on the internet, and that's where we get to Apple.

So there are an estimated 1 billion iPhone users in the world, and we all know that if you want to download apps to an iPhone, you have to go through the App Store. The App Store is owned by, you guessed it, Apple. And yes, they operate the App Store like a toll bridge for app developers. For any transactions that take place through the App Store, Apple gets a cut of 15 to 30 percent. So from Apple's perspective, you know, hey, we built this company; we made the iPhone; we made it so good that one billion people use it. The App Store that's on every single iPhone? We built that ourselves for our customers. So if you want to access our customers through our App Store, we want compensation for that. It's the perfect toll moat. In this example, Apple built the island; then they built the one road that goes to it, and now they're simply asking app developers to pay the toll to cross the bridge.

But here's what happened: Epic Games, creators of Fortnite, got fed up with this huge 30% toll they were paying through the App Store. It was costing them a huge chunk of money. In fact, between January 2017 and October 2020, Epic Games paid 237 million dollars worth of commissions to Apple just for Fortnite. So in August 2020, they implemented a plan called Project Liberty. Now, what did they do? Quote: “Epic Games updated Fortnite on its servers to reduce the price of in-game currency by 20% if players bought directly from the company”, bypassing Apple’s take and violating Apple’s rules on steering users away from its in-app payments. Apple removed Fortnite from the App Store, meaning that new users could not download it, and that it would eventually stop working on iPhones because the app could not be updated. So then Epic sued Apple. A bit of a legal battle ensued, and now just the other day, I see this quote: Judge Von Gonzalez Rogers issued an injunction that said Apple will no longer be allowed to prohibit developers from providing links or other communications that direct users away from Apple in-app purchasing.

So what this means is that developers are now allowed to take the island's residents to their stores on the mainland by boat, bypassing the Apple toll bridge, even though Apple owns the whole island. This judge has forcibly removed Apple’s toll moat. Apple is now forced to allow apps available in their App Store to redirect their customers’ purchases so that Apple gets cut out. It's kind of like saying, you know, “Hey man, I know you've got the contacts; I'll pay for an introduction,” then later cutting your own deal with the contact and then not paying the finders fee.

Now, from the consumer and developer perspective, this is obviously fantastic. You know, developers are cheering; they no longer have to suffer the 30% Apple stranglehold just to do business with iPhone users. And iPhone users may benefit with lower prices on in-app purchases because of it. But this is really interesting because from an investing perspective, this sucks. I mean, one of the main reasons you'd buy into Apple is because they've got multiple moats, one of which being a toll moat on their App Store.

I mean, it's genius — they make the iPhone super successful, then they say, “Hey, if you want to sell stuff through our App Store on our phones, we get 15 to 30 percent!” Genius. What a great competitive advantage that is. But then it gets forcibly removed. But the crazy thing is this isn't an illegal practice. They're not saying, you know, “If you sell your app on Google’s Play Store, then we’re going to delete it from the App Store.” This isn't saying, you know, “We like your app, but we're going to make a similar app and show it before yours on the App Store.”

This toll-style business model is perfectly normal — a perfectly legal business model. There's nothing stopping Epic Games from building their own smartphones and making their own App Store where they can collect a hundred percent of the revenue. Now that's obviously extremely unlikely and unrealistic, but that's what Apple has done over the years. Don't they deserve to benefit from their hard work and their successes? You know, clearly, this is a very interesting case because we've never seen this happen before. And as crazy as it sounds, does this mean you could potentially take toll road companies to court? It's the same business model.

So overall, that's the situation with Apple, and from an investing standpoint, it begs the question: can a moat become too strong? Personally, I love reading into these stories because there is just so much gray area. But overall, I think that would just about do us for this video. But I would love to hear, finally, your perspective. Do you believe successful businesses deserve to use the advantages they gain from providing great products and services, or do you think, regardless of how popular, useful, or fun a company's products or services are, they shouldn't be allowed to use those advantages of success?

So let me know your take. I'm very interested to hear. I welcome all opinions; I'm very interested to hear what you guys have to say. So let me know your immediate reaction to this story — you know, fair or unfair? You know, I'd love — I'd really love to hear from you guys down in the comments section. So drop a comment, leave a like on the video if you did find it useful or if you enjoyed it.

We'll have to see what comes of this because I have a feeling this is not the final chapter in this story. But we'll keep following it and see where it ends up, I guess. But for now, it definitely looks as though Apple has had one of their competitive advantages forcibly taken away from them, which is really interesting, and we really haven't seen this happen like this before. So I’m really interested to hear your opinion; leave that down in the comment section below.

But thanks very much for watching the video, guys. If you're interested in how I go about my investing, passive investing, active investing, a whole lot, check out Profitful. Links in the description below. Subscribe to the channel if you've not done so already. Check out New Money Clips as well — we’re getting that one up off the ground. Thank you so much! We've got 3,000 subscribers on New Money Clips, which is just awesome! So if you haven't checked out that channel, please head over, subscribe, watch some of those videos, and give me some input. You know, let me know what you like, what you don't like over there.

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