Apple’s Walled Garden Under Siege

Apple's Business Threatened

The US Department of Justice sued Apple for illegal monopoly over the smartphone market in a landmark antitrust case, under the 1890 Sherman Act. Attorney General Garland accused the tech giant for "exclusionary, anticompetitive conduct that hurts both consumers and developers" ^[1]. Some of those anticompetitive practices include limited functionality of non-Apple smartwatches, undermining cross-platform messages and limiting third-party digital wallet. ^[2]

The stakes are definitely high since this is the same legislation used by the US government against Microsoft at the turn of the century, for monopolizing the web browser market for Windows. Although it failed to break up Microsoft's business, the legal battle resulted in a settlement between the two parties that forced it to change its practices. ^[3]

Thursday's complaint threatens Apple's entire business model that is often described as a walled garden. Apple's main strength is its sticky and enclosed ecosystem, where its products and services work very well between them, offering an unmatched seamless experience. However, this creates a moat that users can't easily escape and switch to other ecosystems. Its smartwatches for example, don't work with non-iPhone smartphones, at least not without losing some functionality.

The DoJ's complaint is the latest in a series of legal actions that aim to crack the tech giant's walled garden. The European Union recently unveiled landmark legislation that aims to regulate online services, from social media platforms to internet browsers and more, identifying six gatekeepers that include Apple. To comply with the Digital Markets Act (DMA) Apple opened up its app store in the EU, changing the way distribution works and lowering its lucrative fees. Developers can now bypass the App Store and Apple's cut drops to as low as 10% (from 30%) ^[4]. Moreover, the EU Commission fined Apple nearly €2 billion for "abusing its dominant position", by imposing restrictions on music streaming in its App store. ^[5]

These actions by regulators can undermine the tech giant's top and bottom lines, at a period when it lacks growth. Its revenues rose 2% y/y in the last three months of 2023 (Q1 FY24) ^[6], but that comes after four straight quarters of contraction, which was its worst streak in twenty-two years. These problems are largely due to a lack of innovation that prevents it from finding a new growth market. The US Attorney General said on Thursday that Apple has achieved the monopolistic power that stifles innovation "not by making its own products better — but by making other products worse". ^[1]

The iPhone maker appears to fall behind in the AI arm race, as rival Samsung has already launched flagship smartphones with artificial intelligence capabilities ^[7]. Bloomberg reported that Apple is looking to license Alphabet's Gemini AI for its iPhones ^[8], which could provide a short-term fix, until it can develop its own work. However, resorting to the maker of the competing Android smartphone operating system is concerning.

Apple also missed a chance to innovate and establish a new market, as it has reportedly scrapped its work on electric vehicles unit ^[9], at a time when Chinese rival Xiaomi begins delivering its SU7 EV ^[10].

The firm is making progress on a still nascent market, that of Augmented Reality headsets (AR). It aims to establish an early foothold at a market that could grow by around 37% (CAGR) by 2027 according to the International Data Corporation (IDC) ^[11], with the Vision Pro. Its lofty price is prohibitive of mass adoption though and it is unlike to become a growth driver in the near future.

Apple's headwinds reflect on its stock, which falls this year. This is in stark contrast to most of its Magnificent Seven peers that go from strength to strength, largely due to their leading work on artificial intelligence. The legal actions can undermine its business model, but other Big Tech companies face similar scrutiny. Things look pretty grim for Apple at this stage, but there is scope for better days ahead. It is one of the most valuable companies in the world, with a large and committed user base. Getting AI right will be crucial, as it will allow it to benefit from a potential smartphone super cycle.