By Shannon Liao

This week, tech giant Apple and multibillion-dollar video game company Epic Games faced off in court in an antitrust case that could change the way we use our smartphones. In addition to giving us insight into Epic Games’s inner workings, the trial includes multiple pieces of evidence from third parties like Microsoft and Sony.

These documents shed light on Xbox’s finances and PlayStation’s negotiations with Epic, among other details. While some of these revelations have been long known to close followers of the gaming industry, the high-profile trial is exposing a broader audience to some eye-opening information. For a secretive industry like the video games market, the trove of documents that have been uploaded provide an important glimpse at what goes on behind closed doors.

– The Xbox has always been sold at a loss

In the course of the trial, Apple has mentioned Microsoft and Sony as industry peers whose practices justify iOS’s 30% rate; both companies charge Epic the same commission. To rebut this, Epic has claimed that console makers like Microsoft and Sony need their 30% cut on game sales in their digital stores, since the hardware is sold at a loss.

Microsoft’s vice president of business development Lori Wright confirmed in testimony that the company sells Xbox consoles at a loss and has never made a profit from selling the hardware. Wright said it was more important for users to “be able to have a console” and enjoy an “end-to-end user experience” that includes buying Xbox games and subscriptions.

Microsoft explained in a statement on Thursday: “The gaming business is a profitable and high-growth business for Microsoft. The console gaming business is traditionally a hardware subsidy model. Game companies sell consoles at a loss to attract new customers. Profits are generated in game sales and online service subscriptions.”

Historically, other consoles have followed a similar business model, according to Niko Partners senior analyst Daniel Ahmad, who named Sony’s PlayStation 3 as a console that was estimated to have lost $300 on each unit sold for some number of years, thanks to the research and development costs of adding Blu-ray and a specially designed “Cell” processor.

“It is typical for console hardware to sell at a loss (initially), and have the software sales make up profit – similar to a razor and razor blade model,” said Ahmad. “Software and services are high margin, especially when distributed digitally, while the profit margin on hardware is low, or even negative initially.”

Meanwhile, Apple’s sale of iPhones is extremely lucrative, Epic CEO Tim Sweeney noted last December.

“Apple’s hardware sales are, I think, the most profitable business line in the history of the world. It has massive markups on the hardware, which they deserve to earn, because they’re building great hardware,” Sweeney said. “But the console business model is different. Sony and Microsoft generally over the console generations lose money on the hardware.”

The issue for Epic is that Apple’s 30% commission sits atop the money it earns from people buying iPhones and iPads, said Sweeney. “It’s not subsidizing the hardware. You paid for it and you paid Apple a massive profit margin, when you bought the device.”

Apple said Wednesday it does not believe this argument will really move the needle when it comes to antitrust law.

– Sony took issue with letting ‘Fortnite’ gamers play with users of other platforms

Two documents entered into evidence by Apple about Sony have been removed after Sony requested confidentiality. However, both had already been published to an online repository of evidence. As Judge Yvonne Gonzalez Rogers said on Tuesday, “I’m not sure if at this point whether the genie is out of the bottle.”

In one email thread captured in the since-removed documents, Epic Games vice president of business development Joe Kreiner wrote that if Epic and Sony can announce cross play together, or the ability to play on PlayStation alongside users on other platforms simultaneously, “Epic (will go) out of its way to make Sony look like heroes.”

Gio Corsi, senior director at Sony replied, “Sorry that you feel things are moving too slowly for Epic with PlayStation and cross platform play. I was under the impression that there was no movement with Microsoft on cross-platform. Has that changed?” He added that “cross-platform play is not a slam dunk no matter the size of the title.”

The hiccup? It wasn’t clear to Sony how PlayStation benefited from the arrangement. Many companies were exploring the idea, Corsi said, but “not a single one can explain how cross-console play improves the PlayStation business.”

Kreiner responded that cross-play would increase player engagement and likely lead to increased revenue. “Microsoft is close to resolution, I’m out with them tonight,” he said.

Ultimately, Epic got what it wanted. In September 2018, PlayStation announced cross play in “Fortnite” would be available. Part of the deal included Epic agreeing to pay Sony royalties if revenue fell below a certain threshold from enabling cross play. Sweeney, Epic’s CEO, confirmed in Monday testimony that Epic had to pay revenue to Sony in certain cases, such as if someone made in-game purchases on iPhone but spent most of their time playing on PlayStation.

– Games coming in 2021

Xbox also showed a bit of its hand in upcoming Xbox Game Pass deals. “S.T.A.L.K.E.R. 2,” a horror first-person shooter game set in the Chernobyl Exclusion Zone, will be a three-month console exclusive coming out later this year, according to a game portfolio presentation entered into evidence.

“The Gunk,” a space-themed adventure game about two people trying to survive and reach a planet full of resources, is slated for an earlier release than “S.T.A.L.K.E.R. 2” and will be a permanent Xbox Game Pass exclusive, according to the presentation. Both games and certain details around their release had already been announced, but the length of the exclusivity arrangements and timings of each release were unknown.

In the same presentation, two members of the Xbox team, Mike Mace and Jon Katz, detailed how they had played through the PlayStation exclusive “The Last of Us Part II” in a case study saying the game is “exceedingly rare” and moves forward “the art of narrative storytelling in video games.” The art outweighs whether everyone likes the game or has fun playing it, the Xbox team wrote.

Microsoft also regularly estimates how much money its competition is making, keeping tabs on companies including Tencent, Nintendo, Sony, Electronic Arts, Epic Games and Activision Blizzard, according to an internal financial document dated May 2020.

The Epic vs. Apple trial continues for another two weeks, with Apple CEO Tim Cook expected to take the witness stand toward the end. As more documents are entered into evidence, we’ll pore over them for more insight into the gaming industry.

The Washington Post



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