LEMLEY & MAITRA – VIDEO GAME LAW

Chapter 9

Reverse Engineering, Interoperability, Antitrust, and Market Structure

In this chapter, we consider how legal rules (specifically, copyright and antitrust)
affect the structure of the video game industry.

A. Walled Gardens and Interoperability

This chapter addresses the little case law we do have on interoperability in gaming
so far. This case law touches on a related concept, reverse engineering. In the copyright
chapter, we discussed the fact that game creators generally own a copyright to the
underlying game code and the audio-visual images produced by that code. That means
you can’t copy either the code or its audio-visual manifestation. But what if someone
reverse engineered a game or console only to understand and emulate how the game or
console worked (remember, functionality is non-copyrightable) – and part of the process
necessarily involved copying copyrighted code? The two cases of this chapter address
this fact pattern.

SEGA ENTERPRISES LTD.

v.
ACCOLADE, INC.,
United States Court of Appeals for the Ninth Circuit
977 F.2d 1510 (9th Cir. 1992)

REINHARDT, Circuit Judge:

This case presents several difficult questions of first impression involving our
copyright and trademark laws. We are asked to determine, first, whether the Copyright
Act permits persons who are neither copyright holders nor licensees to disassemble a
copyrighted computer program in order to gain an understanding of the unprotected
functional elements of the program. In light of the public policies underlying the Act, we
conclude that, when the person seeking the understanding has a legitimate reason for
doing so and when no other means of access to the unprotected elements exists, such
disassembly is as a matter of law a fair use of the copyrighted work. Second, we must
decide the legal consequences under the Lanham Trademark Act of a computer
manufacturer’s use of a security system that affords access to its computers to software
cartridges that include an initialization code which triggers a screen display of the
computer manufacturer’s trademark. The computer manufacturer also manufactures
software cartridges; those cartridges all contain the initialization code. The question is
whether the computer manufacturer may enjoin competing cartridge manufacturers
from gaining access to its computers through the use of the code on the ground that such
use will result in the display of a “false” trademark. Again, our holding is based on the
public policies underlying the statute. We hold that when there is no other method of
access to the computer that is known or readily available to rival cartridge manufacturers,
the use of the initialization code by a rival does not violate the Act even though that use
triggers a misleading trademark display. Accordingly, we reverse the district court’s
grant of a preliminary injunction in favor of plaintiff-appellee Sega Enterprises, Ltd. on
its claims of copyright and trademark infringement. We decline, however, to order that
an injunction pendente lite issue precluding Sega from continuing to use its security
system, even though such use may result in a certain amount of false labeling. We prefer
to leave the decision on that question to the district court initially.

I. Background
Plaintiff-appellee Sega Enterprises, Ltd. (“Sega”), a Japanese corporation, and its
subsidiary, Sega of America, develop and market video entertainment systems, including
the “Genesis” console (distributed in Asia under the name “Mega–Drive”) and video
game cartridges. Defendant-appellant Accolade, Inc., is an independent developer,
manufacturer, and marketer of computer entertainment software, including game
cartridges that are compatible with the Genesis console, as well as game cartridges that
are compatible with other computer systems.
Sega licenses its copyrighted computer code and its “SEGA” trademark to a
number of independent developers of computer game software. Those licensees develop
and sell Genesis-compatible video games in competition with Sega. Accolade is not and
never has been a licensee of Sega. Prior to rendering its own games compatible with the
Genesis console, Accolade explored the possibility of entering into a licensing agreement
with Sega, but abandoned the effort because the agreement would have required that
Sega be the exclusive manufacturer of all games produced by Accolade.
Accolade used a two-step process to render its video games compatible with the
Genesis console. First, it “reverse engineered” Sega’s video game programs in order to
discover the requirements for compatibility with the Genesis console. As part of the
reverse engineering process, Accolade transformed the machine-readable object code
contained in commercially available copies of Sega’s game cartridges into human-
readable source code using a process called “disassembly” or “decompilation”. Accolade
purchased a Genesis console and three Sega game cartridges, wired a decompiler into the
console circuitry, and generated printouts of the resulting source code. Accolade
engineers studied and annotated the printouts in order to identify areas of commonality
among the three game programs. They then loaded the disassembled code back into a
computer, and experimented to discover the interface specifications for the Genesis
console by modifying the programs and studying the results. At the end of the reverse

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engineering process, Accolade created a development manual that incorporated the
information it had discovered about the requirements for a Genesis-compatible game.
According to the Accolade employees who created the manual, the manual contained
only functional descriptions of the interface requirements and did not include any of
Sega’s code.
In the second stage, Accolade created its own games for the Genesis. According to
Accolade, at this stage it did not copy Sega’s programs, but relied only on the information
concerning interface specifications for the Genesis that was contained in its development
manual. Accolade maintains that with the exception of the interface specifications, none
of the code in its own games is derived in any way from its examination of Sega’s code.
In 1990, Accolade released “Ishido”, a game which it had originally developed and
released for use with the Macintosh and IBM personal computer systems, for use with
the Genesis console.
Even before Accolade began to reverse engineer Sega’s games, Sega had grown
concerned about the rise of software and hardware piracy in Taiwan and other Southeast
Asian countries to which it exported its products. Taiwan is not a signatory to the Berne
Convention and does not recognize foreign copyrights. Taiwan does allow prosecution
of trademark counterfeiters. However, the counterfeiters had discovered how to modify
Sega’s game programs to blank out the screen display of Sega’s trademark before
repackaging and reselling the games as their own. Accordingly, Sega began to explore
methods of protecting its trademark rights in the Genesis and Genesis-compatible games.
While the development of its own trademark security system (TMSS) was pending, Sega
licensed a patented TMSS for use with the Genesis home entertainment system.
The most recent version of the Genesis console, the “Genesis III”, incorporates the
licensed TMSS. When a game cartridge is inserted, the microprocessor contained in the
Genesis III searches the game program for four bytes of data consisting of the letters “S–
E–G–A” (the “TMSS initialization code”). If the Genesis III finds the TMSS initialization
code in the right location, the game is rendered compatible and will operate on the
console. In such case, the TMSS initialization code then prompts a visual display for
approximately three seconds which reads “PRODUCED BY OR UNDER LICENSE
FROM SEGA ENTERPRISES LTD” (the “Sega Message”). All of Sega’s game cartridges,
including those disassembled by Accolade, contain the TMSS initialization code.
Accolade learned of the impending release of the Genesis III in the United States
in January, 1991, when the Genesis III was displayed at a consumer electronics show.
When a demonstration at the consumer electronics show revealed that Accolade’s
“Ishido” game cartridges would not operate on the Genesis III, Accolade returned to the
drawing board. During the reverse engineering process, Accolade engineers had
discovered a small segment of code—the TMSS initialization code—that was included in
the “power-up” sequence of every Sega game, but that had no identifiable function. The
games would operate on the original Genesis console even if the code segment was
removed. Mike Lorenzen, the Accolade engineer with primary responsibility for reverse

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engineering the interface procedures for the Genesis console, sent a memo regarding the
code segment to Alan Miller, his supervisor and the current president of Accolade, in
which he noted that “it is possible that some future Sega peripheral device might require
it for proper initialization.”
In the second round of reverse engineering, Accolade engineers focused on the
code segment identified by Lorenzen. After further study, Accolade added the code to its
development manual in the form of a standard header file to be used in all games. The
file contains approximately twenty to twenty-five bytes of data. Each of Accolade’s games
contains a total of 500,000 to 1,500,000 bytes. According to Accolade employees, the
header file is the only portion of Sega’s code that Accolade copied into its own game
programs.
In 1991, Accolade released five more games for use with the Genesis III, “Star
Control”, “Hardball!”, “Onslaught”, “Turrican”, and “Mike Ditka Power Football.” With
the exception of “Mike Ditka Power Football”, all of those games, like “Ishido”, had
originally been developed and marketed for use with other hardware systems. All
contained the standard header file that included the TMSS initialization code. According
to Accolade, it did not learn until after the Genesis III was released on the market in
September, 1991, that in addition to enabling its software to operate on the Genesis III,
the header file caused the display of the Sega Message. All of the games except
“Onslaught” operate on the Genesis III console; apparently, the programmer who
translated “Onslaught” for use with the Genesis system did not place the TMSS
initialization code at the correct location in the program.
All of Accolade’s Genesis-compatible games are packaged in a similar fashion.
The front of the box displays Accolade’s “Ballistic” trademark and states “for use with
Sega Genesis and Mega Drive Systems.” The back of the box contains the following
statement: “Sega and Genesis are registered trademarks of Sega Enterprises, Ltd. Game
1991 Accolade, Inc. All rights reserved. Ballistic is a trademark of Accolade, Inc. Accolade,
Inc. is not associated with Sega Enterprises, Ltd. All product and corporate names are
trademarks and registered trademarks of their respective owners.”
[. . .]
Based on its conclusion that Sega is likely to succeed on the merits of its claims for
copyright and trademark infringement, on April 3, 1992, the district court enjoined
Accolade from: (1) disassembling Sega’s copyrighted code; (2) using or modifying Sega’s
copyrighted code; (3) developing, manufacturing, distributing, or selling Genesis-
compatible games that were created in whole or in part by means that included
disassembly; and (4) manufacturing, distributing, or selling any Genesis-compatible
game that prompts the Sega Message. On April 9, 1992, in response to a request from
Sega, the district court modified the preliminary injunction order to require the recall of
Accolade’s infringing games within ten business days.
[. . .]

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 III. Copyright Issues
Accolade raises four arguments in support of its position that disassembly of the
object code in a copyrighted computer program does not constitute copyright
infringement. First, it maintains that intermediate copying does not infringe the exclusive
rights granted to copyright owners in section 106 of the Copyright Act unless the end
product of the copying is substantially similar to the copyrighted work. Second, it argues
that disassembly of object code in order to gain an understanding of the ideas and
functional concepts embodied in the code is lawful under section 102(b) of the Act, which
exempts ideas and functional concepts from copyright protection. Third, it suggests that
disassembly is authorized by section 117 of the Act, which entitles the lawful owner of a
copy of a computer program to load the program into a computer. Finally, Accolade
contends that disassembly of object code in order to gain an understanding of the ideas
and functional concepts embodied in the code is a fair use that is privileged by section
107 of the Act.
Neither the language of the Act nor the law of this circuit supports Accolade’s first
three arguments. Accolade’s fourth argument, however, has merit. Although the
question is fairly debatable, we conclude based on the policies underlying the Copyright
Act that disassembly of copyrighted object code is, as a matter of law, a fair use of the
copyrighted work if such disassembly provides the only means of access to those
elements of the code that are not protected by copyright and the copier has a legitimate
reason for seeking such access. Accordingly, we hold that Sega has failed to demonstrate
a likelihood of success on the merits of its copyright claim. Because on the record before
us the hardships do not tip sharply (or at all) in Sega’s favor, the preliminary injunction
issued in its favor must be dissolved, at least with respect to that claim.

A. Intermediate Copying
We have previously held that the Copyright Act does not distinguish between
unauthorized copies of a copyrighted work on the basis of what stage of the alleged
infringer’s work the unauthorized copies represent. Walker v. University Books, 602 F.2d
859, 864 (9th Cir. 1979) (“[T]he fact that an allegedly infringing copy of a protected work
may itself be only an inchoate representation of some final product to be marketed
commercially does not in itself negate the possibility of infringement.”). [. . .]On its face,
that language unambiguously encompasses and proscribes “intermediate copying”.
Walker, 602 F.2d at 863–64; see also Walt Disney Productions v. Filmation Associates, 628
[Link]. 871, 875–76 ([Link].1986).
[. . .] The intermediate copying done by Accolade therefore falls squarely within
the category of acts that are prohibited by the statute.
[. . .] [T]he question whether intermediate copying of computer object code
infringes the exclusive rights granted to the copyright owner in section 106 of the
Copyright Act is a question of first impression. In light of the unambiguous language of

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the Act, we decline to depart from the rule set forth in Walker for copyrighted works
generally. Accordingly, we hold that intermediate copying of computer object code may
infringe the exclusive rights granted to the copyright owner in section 106 of the
Copyright Act regardless of whether the end product of the copying also infringes those
rights. If intermediate copying is permissible under the Act, authority for such copying
must be found in one of the statutory provisions to which the rights granted in section
106 are subject.

B. The Idea/Expression Distinction

Accolade next contends that disassembly of computer object code does not violate
the Copyright Act because it is necessary in order to gain access to the ideas and
functional concepts embodied in the code, which are not protected by copyright. 17
U.S.C. § 102(b). Because humans cannot comprehend object code, it reasons, disassembly
of a commercially available computer program into human-readable form should not be
considered an infringement of the owner’s copyright. Insofar as Accolade suggests that
disassembly of object code is lawful per se, it seeks to overturn settled law.
Accolade’s argument regarding access to ideas is, in essence, an argument that
object code is not eligible for the full range of copyright protection. Although some
scholarly authority supports that view, we have previously rejected it based on the
language and legislative history of the Copyright Act. Johnson Controls, Inc. v. Phoenix
Control Sys., Inc., 886 F.2d 1173, 1175 (9th Cir. 1989); Apple Computer, Inc. v. Formula
Int’l Inc., 725 F.2d 521, 524–25 (9th Cir. 1984); see also Apple Computer, Inc. v. Franklin
Computer Corp., 714 F.2d 1240, 1246–48 (3d Cir. 1983), cert. dismissed, 464 U.S. 1033, 104
[Link]. 690, 79 [Link].2d 158 (1984).
[. . .]
Nor does a refusal to recognize a per se right to disassemble object code lead to an
absurd result. The ideas and functional concepts underlying many types of computer
programs, including word processing programs, spreadsheets, and video game displays,
are readily discernible without the need for disassembly, because the operation of such
programs is visible on the computer screen. The need to disassemble object code arises,
if at all, only in connection with operations systems, system interface procedures, and
other programs that are not visible to the user when operating—and then only when no
alternative means of gaining an understanding of those ideas and functional concepts
exists. In our view, consideration of the unique nature of computer object code thus is
more appropriate as part of the case-by-case, equitable “fair use” analysis authorized by
section 107 of the Act. See infra Part III(D). Accordingly, we reject Accolade’s second
argument.
[. . .]
D. Fair Use

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 Accolade contends, finally, that its disassembly of copyrighted object code as a
necessary step in its examination of the unprotected ideas and functional concepts
embodied in the code is a fair use that is privileged by section 107 of the Act. Because, in
the case before us, disassembly is the only means of gaining access to those unprotected
aspects of the program, and because Accolade has a legitimate interest in gaining such
access (in order to determine how to make its cartridges compatible with the Genesis
console), we agree with Accolade. Where there is good reason for studying or examining
the unprotected aspects of a copyrighted computer program, disassembly for purposes
of such study or examination constitutes a fair use.

1.
As a preliminary matter, we reject Sega’s contention that the assertion of a fair use
defense in connection with the disassembly of object code is precluded by statute. First,
Sega argues that not only does section 117 of the Act not authorize disassembly of object
code, but it also constitutes a legislative determination that any copying of a computer
program other than that authorized by section 117 cannot be considered a fair use of that
program under section 107. That argument verges on the frivolous. Each of the exclusive
rights created by section 106 of the Copyright Act is expressly made subject to all of the
limitations contained in sections 107 through 120. 17 U.S.C. § 106. Nothing in the
language or the legislative history of section 117, or in the CONTU Report, suggests that
section 117 was intended to preclude the assertion of a fair use defense with respect to
uses of computer programs that are not covered by section 117, nor has section 107 been
amended to exclude computer programs from its ambit.
Moreover, sections 107 and 117 serve entirely different functions. Section 117
defines a narrow category of copying that is lawful per se. 17 U.S.C. § 117. Section 107, by
contrast, establishes a defense to an otherwise valid claim of copyright infringement. It
provides that particular instances of copying that otherwise would be actionable are
lawful, and sets forth the factors to be considered in determining whether the defense
applies. Id. § 107. The fact that Congress has not chosen to provide a per se exemption to
section 106 for disassembly does not mean that particular instances of disassembly may
not constitute fair use.
[. . .]

2.
Section 107 lists the factors to be considered in determining whether a particular
use is a fair one. Those factors include:
(1) the purpose and character of the use, including whether such use is of a
commercial nature or is for nonprofit educational purposes;
(2) the nature of the copyrighted work;

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 (3) the amount and substantiality of the portion used in relation to the
copyrighted work as a whole; and
(4) the effect of the use upon the potential market for or value of the
copyrighted work.
17 U.S.C. § 107. The statutory factors are not exclusive. Rather, the doctrine of fair use is
in essence “an equitable rule of reason.” Harper & Row, Publishers, Inc. v. Nation
Enterprises, 471 U.S. 539, 560, 105 [Link]. 2218, 2230, 85 [Link].2d 588 (1985) (quoting
[Link]. No. 1476, 94th Cong., 2d Sess. 65, reprinted in 1976 U.S.C.C.A.N. 5659, 5679).
Fair use is a mixed question of law and fact. Id. “Where the district court has found facts
sufficient to evaluate each of the statutory factors,” an appellate court may resolve the
fair use question as a matter of law. Id.
In determining that Accolade’s disassembly of Sega’s object code did not
constitute a fair use, the district court treated the first and fourth statutory factors as
dispositive, and ignored the second factor entirely. Given the nature and characteristics
of Accolade’s direct use of the copied works, the ultimate use to which Accolade put the
functional information it obtained, and the nature of the market for home video
entertainment systems, we conclude that neither the first nor the fourth factor weighs in
Sega’s favor. In fact, we conclude that both factors support Accolade’s fair use defense,
as does the second factor, a factor which is important to the resolution of cases such as
the one before us.

(a)
With respect to the first statutory factor, we observe initially that the fact that
copying is for a commercial purpose weighs against a finding of fair use. Harper & Row,
471 U.S. at 562, 105 [Link]. at 2231.1 However, the presumption of unfairness that arises in
such cases can be rebutted by the characteristics of a particular commercial use. Hustler
Magazine, Inc. v. Moral Majority, Inc., 796 F.2d 1148, 1152 (9th Cir. 1986); see also
Maxtone–Graham v. Burtchaell, 803 F.2d 1253, 1262 (2d Cir. 1986), cert. denied, 481 U.S.
1059, 107 [Link]. 2201, 95 [Link].2d 856 (1987). Further “[t]he commercial nature of a use is a
matter of degree, not an absolute....” Maxtone–Graham, 803 F.2d at 1262.
Sega argues that because Accolade copied its object code in order to produce a
competing product, the Harper & Row presumption applies and precludes a finding of
fair use. That analysis is far too simple and ignores a number of important considerations.
We must consider other aspects of “the purpose and character of the use” as well. As we
have noted, the use at issue was an intermediate one only and thus any commercial
“exploitation” was indirect or derivative.

1 [The Supreme Court later overruled its presumption that commercial uses were unfair. –
Eds.]

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 The declarations of Accolade’s employees indicate, and the district court found,
that Accolade copied Sega’s software solely in order to discover the functional
requirements for compatibility with the Genesis console—aspects of Sega’s programs that
are not protected by copyright. 17 U.S.C. § 102(b). With respect to the video game
programs contained in Accolade’s game cartridges, there is no evidence in the record that
Accolade sought to avoid performing its own creative work. Indeed, most of the games
that Accolade released for use with the Genesis console were originally developed for
other hardware systems. Moreover, with respect to the interface procedures for the
Genesis console, Accolade did not seek to avoid paying a customarily charged fee for use
of those procedures, nor did it simply copy Sega’s code; rather, it wrote its own
procedures based on what it had learned through disassembly. Taken together, these
facts indicate that although Accolade’s ultimate purpose was the release of Genesis-
compatible games for sale, its direct purpose in copying Sega’s code, and thus its direct
use of the copyrighted material, was simply to study the functional requirements for
Genesis compatibility so that it could modify existing games and make them usable with
the Genesis console. Moreover, as we discuss below, no other method of studying those
requirements was available to Accolade. On these facts, we conclude that Accolade
copied Sega’s code for a legitimate, essentially non-exploitative purpose, and that the
commercial aspect of its use can best be described as of minimal significance.
We further note that we are free to consider the public benefit resulting from a
particular use notwithstanding the fact that the alleged infringer may gain commercially.
See Hustler, 796 F.2d at 1153 (quoting MCA, Inc. v. Wilson, 677 F.2d 180, 182 (2d Cir.
1981)). Public benefit need not be direct or tangible, but may arise because the challenged
use serves a public interest. Id. In the case before us, Accolade’s identification of the
functional requirements for Genesis compatibility has led to an increase in the number of
independently designed video game programs offered for use with the Genesis console.
It is precisely this growth in creative expression, based on the dissemination of other
creative works and the unprotected ideas contained in those works, that the Copyright
Act was intended to promote. See Feist Publications, Inc. v. Rural Tel. Serv. Co., 499 U.S.
340, ––––, 111 [Link]. 1282, 1290, 113 [Link].2d 358 (1991) (citing Harper & Row, 471 U.S. at
556–57, 105 [Link]. at 2228–29). The fact that Genesis-compatible video games are not
scholarly works, but works offered for sale on the market, does not alter our judgment in
this regard. We conclude that given the purpose and character of Accolade’s use of Sega’s
video game programs, the presumption of unfairness has been overcome and the first
statutory factor weighs in favor of Accolade.

(b)
As applied, the fourth statutory factor, effect on the potential market for the
copyrighted work, bears a close relationship to the “purpose and character” inquiry in
that it, too, accommodates the distinction between the copying of works in order to make
independent creative expression possible and the simple exploitation of another’s

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creative efforts. We must, of course, inquire whether, “if [the challenged use] should
become widespread, it would adversely affect the potential market for the copyrighted
work,” Sony Corp. v. Universal City Studios, 464 U.S. 417, 451, 104 [Link]. 774, 793, 78
[Link].2d 574 (1984), by diminishing potential sales, interfering with marketability, or
usurping the market, Hustler, 796 F.2d at 1155–56. If the copying resulted in the latter
effect, all other considerations might be irrelevant. The Harper & Row Court found a use
that effectively usurped the market for the copyrighted work by supplanting that work
to be dispositive. 471 U.S. at 567–69, 105 [Link]. at 2234–35. However, the same
consequences do not and could not attach to a use which simply enables the copier to
enter the market for works of the same type as the copied work.
Unlike the defendant in Harper & Row, which printed excerpts from President
Ford’s memoirs verbatim with the stated purpose of “scooping” a Time magazine review
of the book, 471 U.S. at 562, 105 [Link]. at 2231, Accolade did not attempt to “scoop” Sega’s
release of any particular game or games, but sought only to become a legitimate
competitor in the field of Genesis-compatible video games. Within that market, it is the
characteristics of the game program as experienced by the user that determine the
program’s commercial success. As we have noted, there is nothing in the record that
suggests that Accolade copied any of those elements.
By facilitating the entry of a new competitor, the first lawful one that is not a Sega
licensee, Accolade’s disassembly of Sega’s software undoubtedly “affected” the market
for Genesis-compatible games in an indirect fashion. We note, however, that while no
consumer except the most avid devotee of President Ford’s regime might be expected to
buy more than one version of the President’s memoirs, video game users typically
purchase more than one game. There is no basis for assuming that Accolade’s “Ishido”
has significantly affected the market for Sega’s “Altered Beast”, since a consumer might
easily purchase both; nor does it seem unlikely that a consumer particularly interested in
sports might purchase both Accolade’s “Mike Ditka Power Football” and Sega’s “Joe
Montana Football”, particularly if the games are, as Accolade contends, not substantially
similar. In any event, an attempt to monopolize the market by making it impossible for
others to compete runs counter to the statutory purpose of promoting creative expression
and cannot constitute a strong equitable basis for resisting the invocation of the fair use
doctrine. Thus, we conclude that the fourth statutory factor weighs in Accolade’s, not
Sega’s, favor, notwithstanding the minor economic loss Sega may suffer.

(c)
The second statutory factor, the nature of the copyrighted work, reflects the fact
that not all copyrighted works are entitled to the same level of protection. The protection
established by the Copyright Act for original works of authorship does not extend to the
ideas underlying a work or to the functional or factual aspects of the work. 17 U.S.C. §
102(b). To the extent that a work is functional or factual, it may be copied, Baker v. Selden,
101 U.S. (11 Otto) 99, 102–04, 25 [Link]. 841 (1879), as may those expressive elements of the

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work that “must necessarily be used as incident to” expression of the underlying ideas,
functional concepts, or facts, id. at 104. Works of fiction receive greater protection than
works that have strong factual elements, such as historical or biographical works,
Maxtone–Graham, 803 F.2d at 1263 (citing Rosemont Enterprises, Inc. v. Random House,
Inc., 366 F.2d 303, 307 (2d Cir. 1966), cert. denied, 385 U.S. 1009, 87 [Link]. 714, 17 [Link].2d
546 (1967)), or works that have strong functional elements, such as accounting textbooks,
Baker, 101 U.S. at 104. Works that are merely compilations of fact are copyrightable, but
the copyright in such a work is “thin.” Feist Publications, 499 U.S. at ––––, 111 [Link]. at
1289.
Computer programs pose unique problems for the application of the
“idea/expression distinction” that determines the extent of copyright protection. To the
extent that there are many possible ways of accomplishing a given task or fulfilling a
particular market demand, the programmer’s choice of program structure and design
may be highly creative and idiosyncratic. However, computer programs are, in essence,
utilitarian articles—articles that accomplish tasks. As such, they contain many logical,
structural, and visual display elements that are dictated by the function to be performed,
by considerations of efficiency, or by external factors such as compatibility requirements
and industry demands. Computer Assoc. Int’l, Inc. v. Altai, Inc., 1992 WL 372273, 23
U.S.P.Q.2d (BNA) 1241, 1253–56 (2d Cir. 1992) (“CAI”). In some circumstances, even the
exact set of commands used by the programmer is deemed functional rather than creative
for purposes of copyright. “[W]hen specific instructions, even though previously
copyrighted, are the only and essential means of accomplishing a given task, their later
use by another will not amount to infringement.” CONTU Report at 20; see CAI, 23
U.S.P.Q.2d at 1254.
Because of the hybrid nature of computer programs, there is no settled standard
for identifying what is protected expression and what is unprotected idea in a case
involving the alleged infringement of a copyright in computer software. We are in
wholehearted agreement with the Second Circuit’s recent observation that “[t]hus far,
many of the decisions in this area reflect the courts’ attempt to fit the proverbial square
peg in a round hole.” CAI, 23 U.S.P.Q.2d at 1257. In 1986, the Third Circuit attempted to
resolve the dilemma by suggesting that the idea or function of a computer program is the
idea of the program as a whole, and “everything that is not necessary to that purpose or
function [is] part of the expression of that idea.” Whelan Assoc., Inc. v. Jaslow Dental
Laboratory, Inc., 797 F.2d 1222, 1236 (3d Cir. 1986) (emphasis omitted). The Whelan rule,
however, has been widely—and soundly—criticized as simplistic and overbroad. See
CAI, 23 U.S.P.Q.2d at 1252 (citing cases, treatises, and articles). In reality, “a computer
program’s ultimate function or purpose is the composite result of interacting subroutines.
Since each subroutine is itself a program, and thus, may be said to have its own ‘idea,’
Whelan’s general formulation ... is descriptively inadequate.” Id. For example, the
computer program at issue in the case before us, a video game program, contains at least
two such subroutines—the subroutine that allows the user to interact with the video
game and the subroutine that allows the game cartridge to interact with the console.

10
Under a test that breaks down a computer program into its component subroutines and
sub-subroutines and then identifies the idea or core functional element of each, such as
the test recently adopted by the Second Circuit in CAI, 23 U.S.P.Q.2d at 1252–53, many
aspects of the program are not protected by copyright. In our view, in light of the
essentially utilitarian nature of computer programs, the Second Circuit’s approach is an
appropriate one.
Sega argues that even if many elements of its video game programs are properly
characterized as functional and therefore not protected by copyright, Accolade copied
protected expression. Sega is correct. The record makes clear that disassembly is
wholesale copying. Because computer programs are also unique among copyrighted
works in the form in which they are distributed for public use, however, Sega’s
observation does not bring us much closer to a resolution of the dispute.
The unprotected aspects of most functional works are readily accessible to the
human eye. The systems described in accounting textbooks or the basic structural
concepts embodied in architectural plans, to give two examples, can be easily copied
without also copying any of the protected, expressive aspects of the original works.
Computer programs, however, are typically distributed for public use in object code
form, embedded in a silicon chip or on a floppy disk. For that reason, humans often
cannot gain access to the unprotected ideas and functional concepts contained in object
code without disassembling that code—i.e., making copies. Atari Games Corp. v.
Nintendo of America, 975 F.2d at 843–44 ([Link]. 1992).
Sega argues that the record does not establish that disassembly of its object code
is the only available method for gaining access to the interface specifications for the
Genesis console, and the district court agreed. An independent examination of the record
reveals that Sega misstates its contents, and demonstrates that the district court
committed clear error in this respect.
First, the record clearly establishes that humans cannot read object code. Sega
makes much of Mike Lorenzen’s statement that a reverse engineer can work directly from
the zeros and ones of object code but “[i]t’s not as fun.” In full, Lorenzen’s statements
establish only that the use of an electronic decompiler is not absolutely necessary. Trained
programmers can disassemble object code by hand. Because even a trained programmer
cannot possibly remember the millions of zeros and ones that make up a program,
however, he must make a written or computerized copy of the disassembled code in
order to keep track of his work. See generally Johnson–Laird, Technical Demonstration
of “Decompilation”, reprinted in Reverse Engineering: Legal and Business Strategies for
Competitive Design in the 1990’s 102 (Prentice Hall Law & Business ed. 1992). The
relevant fact for purposes of Sega’s copyright infringement claim and Accolade’s fair use
defense is that translation of a program from object code into source code cannot be
accomplished without making copies of the code.
Second, the record provides no support for a conclusion that a viable alternative
to disassembly exists. The district court found that Accolade could have avoided a

11
copyright infringement claim by “peeling” the chips contained in Sega’s games or in the
Genesis console, as authorized by section 906 of the SCPA, 17 U.S.C. § 906. Even Sega’s
amici agree that this finding was clear error. The declaration of Dr. Harry Tredennick, an
expert witness for Accolade, establishes that chip peeling yields only a physical diagram
of the object code embedded in a ROM chip. It does not obviate the need to translate
object code into source code. Atari Games Corp., 975 F.2d at 843–44.
The district court also suggested that Accolade could have avoided a copyright
infringement suit by programming in a “clean room”. That finding too is clearly
erroneous. A “clean room” is a procedure used in the computer industry in order to
prevent direct copying of a competitor’s code during the development of a competing
product. Programmers in clean rooms are provided only with the functional
specifications for the desired program. As Dr. Tredennick explained, the use of a clean
room would not have avoided the need for disassembly because disassembly was
necessary in order to discover the functional specifications for a Genesis-compatible
game.
In summary, the record clearly establishes that disassembly of the object code in
Sega’s video game cartridges was necessary in order to understand the functional
requirements for Genesis compatibility. The interface procedures for the Genesis console
are distributed for public use only in object code form, and are not visible to the user
during operation of the video game program. Because object code cannot be read by
humans, it must be disassembled, either by hand or by machine. Disassembly of object
code necessarily entails copying. Those facts dictate our analysis of the second statutory
fair use factor. If disassembly of copyrighted object code is per se an unfair use, the owner
of the copyright gains a de facto monopoly over the functional aspects of his work—
aspects that were expressly denied copyright protection by Congress. 17 U.S.C. § 102(b).
In order to enjoy a lawful monopoly over the idea or functional principle underlying a
work, the creator of the work must satisfy the more stringent standards imposed by the
patent laws. Bonito Boats, Inc. v. Thunder Craft Boats, Inc., 489 U.S. 141, 159–64, 109 [Link].
971, 982–84, 103 [Link].2d 118 (1989). Sega does not hold a patent on the Genesis console.
Because Sega’s video game programs contain unprotected aspects that cannot be
examined without copying, we afford them a lower degree of protection than more
traditional literary works. See CAI, 23 U.S.P.Q.2d at 1257. In light of all the considerations
discussed above, we conclude that the second statutory factor also weighs in favor of
Accolade.

(d)
As to the third statutory factor, Accolade disassembled entire programs written by
Sega. Accordingly, the third factor weighs against Accolade. The fact that an entire work
was copied does not, however, preclude a finding a fair use. Sony Corp., 464 U.S. at 449–
50, 104 [Link]. at 792; Hustler, 796 F.2d at 1155 (“Sony Corp. teaches us that the copying of
an entire work does not preclude fair use per se.”). In fact, where the ultimate (as opposed

12
to direct) use is as limited as it was here, the factor is of very little weight. Cf. Wright v.
Warner Books, Inc., 953 F.2d 731, 738 (2d Cir. 1991).

(e)
In summary, careful analysis of the purpose and characteristics of Accolade’s use
of Sega’s video game programs, the nature of the computer programs involved, and the
nature of the market for video game cartridges yields the conclusion that the first, second,
and fourth statutory fair use factors weigh in favor of Accolade, while only the third
weighs in favor of Sega, and even then only slightly. Accordingly, Accolade clearly has
by far the better case on the fair use issue.
We are not unaware of the fact that to those used to considering copyright issues
in more traditional contexts, our result may seem incongruous at first blush. To
oversimplify, the record establishes that Accolade, a commercial competitor of Sega,
engaged in wholesale copying of Sega’s copyrighted code as a preliminary step in the
development of a competing product. However, the key to this case is that we are dealing
with computer software, a relatively unexplored area in the world of copyright law. We
must avoid the temptation of trying to force “the proverbial square peg in[to] a round
hole.” CAI, 23 U.S.P.Q.2d at 1257.
In determining whether a challenged use of copyrighted material is fair, a court
must keep in mind the public policy underlying the Copyright Act. “ ‘The immediate
effect of our copyright law is to secure a fair return for an “author’s” creative labor. But
the ultimate aim is, by this incentive, to stimulate artistic creativity for the general public
good.’“ Sony Corp., 464 U.S. at 432, 104 [Link]. at 783 (quoting Twentieth Century Music
Corp. v. Aiken, 422 U.S. 151, 156, 95 [Link]. 2040, 2044, 45 [Link].2d 84 (1975)). When
technological change has rendered an aspect or application of the Copyright Act
ambiguous, “ ‘the Copyright Act must be construed in light of this basic purpose.’“ Id.
As discussed above, the fact that computer programs are distributed for public use in
object code form often precludes public access to the ideas and functional concepts
contained in those programs, and thus confers on the copyright owner a de facto
monopoly over those ideas and functional concepts. That result defeats the fundamental
purpose of the Copyright Act—to encourage the production of original works by
protecting the expressive elements of those works while leaving the ideas, facts, and
functional concepts in the public domain for others to build on. Feist Publications, 499
U.S. at ––––, 111 [Link]. at 1290; see also Atari Games Corp., 975 F.2d at 842 – 43.
Sega argues that the considerable time, effort, and money that went into
development of the Genesis and Genesis-compatible video games militate against a
finding of fair use. Borrowing from antitrust principles, Sega attempts to label Accolade
a “free rider” on its product development efforts. In Feist Publications, however, the
Court unequivocally rejected the “sweat of the brow” rationale for copyright protection.
499 U.S. at –––– – ––––, 111 [Link]. at 1290–95. Under the Copyright Act, if a work is largely
functional, it receives only weak protection. “This result is neither unfair nor unfortunate.

13
It is the means by which copyright advances the progress of science and art.” Id. 499 U.S.
at ––––, 111 [Link]. at 1290; see also id. 499 U.S. at ––––, 111 [Link]. at 1292 (“In truth, ‘[i]t is
just such wasted effort that the proscription against the copyright of ideas and facts ... [is]
designed to prevent.’“) (quoting Rosemont Enterprises, Inc. v. Random House, Inc., 366
F.2d 303, 310 (2d Cir. 1966), cert. denied 385 U.S. 1009, 87 [Link]. 714, 17 [Link].2d 546 (1967));
CAI, 23 U.S.P.Q.2d at 1257. Here, while the work may not be largely functional, it
incorporates functional elements which do not merit protection. The equitable
considerations involved weigh on the side of public access. Accordingly, we reject Sega’s
argument.

(f)
We conclude that where disassembly is the only way to gain access to the ideas
and functional elements embodied in a copyrighted computer program and where there
is a legitimate reason for seeking such access, disassembly is a fair use of the copyrighted
work, as a matter of law. Our conclusion does not, of course, insulate Accolade from a
claim of copyright infringement with respect to its finished products. Sega has reserved
the right to raise such a claim, and it may do so on remand.

IV. Trademark Issues

Ordinarily in a trademark case, a trademark holder contends that another party is
misusing the holder’s mark or is attempting to pass off goods or services as those of the
trademark holder. The other party usually protests that the mark is not being misused,
that there is no actual confusion, or that for some other reason no violation has occurred.
This case is different. Here, both parties agree that there is a misuse of a trademark, both
agree that there is unlawful mislabeling, and both agree that confusion may result. The
issue, here, is—which party is primarily responsible? Which is the wrongdoer—the
violator? Is it Sega, which has adopted a security system governing access to its Genesis
III console that displays its trademark and message whenever the initialization code for
the security system is utilized, even when the video game program was manufactured
by a Sega competitor? Or is it Accolade, which, having discovered how to gain access to
the Genesis III through the initialization code, uses that code even though doing so
triggers the display of Sega’s trademark and message in a manner that leads observers to
believe that Sega manufactured the Accolade game cartridge? In other words, is Sega the
injured party because its mark is wrongfully attached to an Accolade video game by
Accolade? Or is Accolade wronged because its game is mislabeled as a Sega product by
Sega? The facts are relatively straightforward and we have little difficulty answering the
question.
Sega’s trademark security system (TMSS) initialization code not only enables
video game programs to operate on the Genesis III console, but also prompts a screen
display of the SEGA trademark and message. As a result, Accolade’s inclusion of the

14
TMSS initialization code in its video game programs has an effect ultimately beneficial
neither to Sega nor to Accolade. A Genesis III owner who purchases a video game made
by Accolade sees Sega’s trademark associated with Accolade’s product each time he
inserts the game cartridge into the console. Sega claims that Accolade’s inclusion of the
TMSS initialization code in its games constitutes trademark infringement and false
designation of origin in violation of sections 32(1)(a) and 43(a) of the Lanham Trademark
Act, 15 U.S.C. §§ 1114(1)(a), 1125(a), respectively. Accolade counterclaims that Sega’s use
of the TMSS to prompt a screen display of its trademark constitutes false designation of
origin under Lanham Act section 43(a), 15 U.S.C. § 1125(a).
Because the TMSS has the effect of regulating access to the Genesis III console, and
because there is no indication in the record of any public or industry awareness of any
feasible alternate method of gaining access to the Genesis III, we hold that Sega is
primarily responsible for any resultant confusion. Thus, it has not demonstrated a
likelihood of success on the merits of its Lanham Act claims. Accordingly, the preliminary
injunction it obtained must be dissolved with respect to the trademark claim also.
However, we decline to instruct the district court to grant Accolade’s request for
preliminary injunctive relief at this time. The decision whether to grant such relief
requires the making of factual and equitable determinations in light of the legal
conclusions we express here. Such determinations are best left in the first instance to the
district court.
[. . .]
The district court found that Accolade bore primary responsibility for any
consumer confusion that resulted from the display of the false Sega Message. However,
Accolade had no desire to cause the Sega Message to appear or otherwise to create any
appearance of association between itself and Sega; in fact, it had precisely the opposite
wish. It used the TMSS initialization code only because it wanted to gain access for its
products to the Genesis III, and was aware of no other method for doing so. On the other
hand, while it may not have been Sega’s ultimate goal to mislabel Accolade’s products,
the record is clear that the false labeling was the result of a deliberate decision on the part
of Sega to include in the Genesis III a device which would both limit general access and
cause false labeling. The decision to use the SEGA trademark as an essential element of a
functional device that regulates access and to cause the SEGA trademark and message to
be displayed whenever that functional device was triggered compels us to place primary
responsibility for consumer confusion squarely on Sega.
With respect to Accolade, we emphasize that the record clearly establishes that it
had only one objective in this matter: to make its video game programs compatible with
the Genesis III console. That objective was a legitimate and a lawful one. There is no
evidence whatsoever that Accolade wished Sega’s trademark to be displayed when
Accolade’s games were played on Sega’s consoles. To the contrary, Accolade included
disclaimers on its packaging materials which stated that “Accolade, Inc. is not associated
with Sega Enterprises, Ltd.” When questioned regarding the Sega Message and its

15
potential effect on consumers, Alan Miller testified that Accolade does not welcome the
association between its product and Sega and would gladly avoid that association if there
were a way to do so. Miller testified that Accolade’s engineers had not been able to
discover any way to modify their game cartridges so that the games would operate on
the Genesis III without prompting the screen display of the Sega Message.
In contrast, Sega officials testified that Sega incorporated the TMSS into the
Genesis console, known in Asia as the Mega–Drive, in order to lay the groundwork for
the trademark prosecution of software pirates who sell counterfeit cartridges in Taiwan
and South Korea, as well as in the United States. Sega then marketed the redesigned
console worldwide. Sega intended that when Sega game programs manufactured by a
counterfeiter were played on its consoles, the Sega Message would be displayed, thereby
establishing the legal basis for a claim of trademark infringement. [. . .]
Sega makes much of the fact that it did not adopt the TMSS in order to wage war
on Accolade in particular, but rather as a defensive measure against software
counterfeiters. It is regrettable that Sega is troubled by software pirates who manufacture
counterfeit products in other areas of the world where adequate copyright remedies are
not available. However, under the Lanham Act, which governs the use of trademarks and
other designations of origin in this country, it is the effect of the message display that
matters. Whatever Sega’s intent with respect to the TMSS, the device serves to limit
competition in the market for Genesis-compatible games and to mislabel the products of
competitors. Moreover, by seeking injunctive relief based on the mislabeling it has itself
induced, Sega seeks once again to take advantage of its trademark to exclude its
competitors from the market. The use of a mark for such purpose is inconsistent with the
Lanham Act.
[. . .]
It is indisputable that, in the case before us, part of “the actual benefit that the
consumer wishes to purchase” is compatibility with the Genesis III console. The TMSS
initialization code provides that compatibility. Sega argues that the modified cartridges
that were introduced in the district court establish the actual existence of technically and
commercially feasible alternative methods of gaining access to the Genesis III. The
cartridges were prepared by Nagashima, an employee in Sega’s Hardware Research and
Development Department who was “familiar with the TMSS system”. At most, the
Nagashima affidavit establishes that an individual familiar with the operation of the
TMSS can discover a way to engineer around it. It does not establish that a competitor
with no knowledge of the workings of the TMSS could do so. Nor is there any evidence
that there was any public or industry awareness of any alternate method for gaining
access to the Genesis III. Evidence that an individual, even an independent expert,
produced one or more cartridges is not sufficient proof that an alternate method exists.
What is needed for proof of that fact is proof of the method itself. Here, such proof is
totally lacking. What is also needed is proof that knowledge of the alternate method exists
or is readily available to knowledgeable persons in the industry. That proof also is totally

16
lacking here. Accordingly, the district court erred as a matter of law in concluding that
the Nagashima declaration and the modified cartridges were sufficient to establish
nonfunctionality.
Because the TMSS serves the function of regulating access to the Genesis III, and
because a means of access to the Genesis III console without using the TMSS initialization
code is not known to manufacturers of competing video game cartridges, there is an
insufficient basis for a finding of nonfunctionality. Moreover, we note that the only
evidence in the record (other than the Nagashima declaration) relating to Accolade’s
ability to gain access to the Genesis III through the use of any process other than the TMSS
is the affidavit of Alan Miller. Miller stated that Accolade’s software engineers—who,
absent any evidence to the contrary, we presume to be reasonably competent
representatives of their profession—have not been able to discover such a method. This
evidence supports our conclusion that Sega has not met its burden of establishing
nonfunctionality.
[. . .]
In summary, because Sega did not produce sufficient evidence regarding the
existence of a feasible alternative to the use of the TMSS initialization code, it did not
carry its burden and its claim of nonfunctionality fails. Possibly, Sega will be able to meet
its burden of proof at trial. We cannot say. However, we conclude that in light of the
record before the district court, Sega was not entitled to preliminary injunctive relief
under the Lanham Act.
[. . .]
AFFIRMED IN PART; REVERSED IN PART; AND REMANDED.

COMMENTS & QUESTIONS

1. Sega’s reasons for not wanting Accolade to develop Genesis-compatible

games seems obvious: It wants to control all the games played on its console. But why?
There’s a good argument that the more games available on a console, the more demand
there’ll be for the console. That seems particularly true during the days of consoles like
the Genesis and the NES, when in-game transactions were little to no part of a game
company’s bottom line – and much of the revenue came from selling the consoles
themselves. On the other hand, Sega may be like Nintendo in its focus on artistic and
brand integrity – and it wants to control the games played on the Genesis no matter the
boost in demand. Or it may see a market benefit to demanding exclusivity in its games,
particularly at a time when the Genesis was the dominant console.
Do you agree with the Sega court’s analysis of the fourth fair use factor? Hasn’t
Sega been injured because it can no longer control who produces games for its machine?
Won’t it lose the ability to charge a fee to game writers?

17
 The court touches on this idea when it discusses the public benefit flowing from
having more Genesis games out in the world. Of course, the public benefit is more clear
than the direct benefit to Sega. But this latter benefit should be part of any policy decision
on interoperability.
Is Sega entitled to control not only the sales of its copyrighted software-hardware
package but also video games that will run on the Sega system? The court’s decision
obliquely suggests that there are antitrust (or possibly copyright misuse) problems with
giving Sega such power: “an attempt to monopolize the market by making it impossible
for others to compete runs counter to the statutory purpose of promoting creative
expression and cannot constitute a strong equitable basis for resisting the invocation of
the fair use doctrine.” Sega, 977 F.2d at 1523-24. We discuss those antitrust issues in the
next section.
2. Sega’s trademark security system might remind you of the cat-and-mouse
game between MDY’s Glider and Blizzard’s Warden system in MDY v. Blizzard. There,
we discussed that it may make sense for the justice system to stay out of it, and let the
free market and the game companies’ respective technologies duke it out. But Sega’s TSS
is different from Warden in one critical respect: without court intervention, the TSS is
meaningless. The TSS doesn’t technically preclude copying or the development of
Genesis-compatible games. Instead, it merely creates the possibility of an eventual
trademark claim. This may in part explain the difference in outcomes between the two
cases.
The district court found the TSS code wasn’t functional because a Sega expert
could build a Genesis-compatible game without it. But why does functional = necessary
= the only way to do it? The only reason Accolade put that (very small) snippet of code
in its games was to make it readable by the Genesis system. That sure seems like the code
as included was functional. Thankfully, the appeals court found the TSS feature to be
functional, albeit without directly tackling the question of whether the existence of an
alternative precludes a finding of functionality.
3. The gaming world is very different today. But there are important values
and holdings underlying this case that could emerge today. Can you construct a realistic
hypothetical scenario today that would implicate the holdings and principles outlined in
this case? How might it turn out?
4. Virtually all courts, as well as most commentators, have endorsed the
legality of reverse engineering in some circumstances. In addition to Sega, see Assessment
Technologies of WI, LLC v. WIREdata, Inc. 350 F.3d 640, 644-45 (7th Cir. 2003); Sony
Computer Entertainment, Inc. v. Connectix Corp., 203 F.3d 596 (9th Cir. 2000); DSC
Communications v. DGI Technologies, 81 F.3d 597, 601 (5th Cir. 1996); Bateman v.
Mnemonics, Inc., 79 F.3d 1532, 1539 n.18 (11th Cir. 1995); Lotus Dev. Corp. v. Borland
Int’l, 49 F.3d 807, 817-18 (1st Cir. 1995) (Boudin, J., concurring); Atari Games Corp. v.
Nintendo of America, 975 F.2d 832, 843-44 (Fed. Cir. 1992); Sega, Inc. v. Accolade, 977

18
F.2d 1510, 1527-28 (9th Cir. 1992); Vault v. Quaid, 847 F.2d 255, 270 (5th Cir. 1988); Mitel
Inc. v. Iqtel Inc., 896 F. Supp. 1050 (D. Colo. 1995), aff’d on other grounds, 124 F.3d 1366
(10th Cir. 1997); Pamela Samuelson & Suzanne Scotchmer, The Law and Economics of
Reverse Engineering, 111 Yale L.J. 1575 (2002); Jonathan Band & Masanobu Katoh,
Interfaces on Trial (1995); Julie Cohen, Reverse Engineering and the Rise of Electronic
Vigilantism: Intellectual Property Implications of “Lock-Out” Technologies, 68 S. Cal. L.
Rev. 1091 (1995); Lawrence D. Graham & Richard O. Zerbe Jr., Economically Efficient
Treatment of Computer Software: Reverse Engineering, Protection, and Disclosure, 22
Rutgers Computer & Tech. L.J. 61 (1996); Dennis S. Karjala, Copyright Protection of
Computer Documents, Reverse Engineering, and Professor Miller, 19 U. Dayton L. Rev.
975, 1016-18 (1994); David A. Rice, Sega and Beyond: A Beacon for Fair Use Analysis...At
Least as Far as It Goes, 19 U. Dayton L. Rev. 1131, 1168 (1994); David Hayes, The Legality
of Disassembly of Computer Programs, 12 Computer/L.J. 1 (Oct. 1993); LaST Frontier
Conference Report on Copyright Protection of Computer Software, 30 Jurimetrics J. 15,
24-25 (1989).

On the other hand, some early decisions rejected compatibility as a justification for
copying. See Apple Computer v. Franklin Computer, 714 F.2d 1240 (3d Cir. 1983); Digital
Communications Assoc. v. Softklone Distributing Corp., 659 F. Supp. 449 (N.D. Ga. 1987).
See also Anthony Clapes, Confessions of an Amicus Curiae: Technophobia, Law and
Creativity in the Digital Arts, 19 U. Dayton L. Rev. 903 (1994) (no right to reverse engineer
software should exist) and Arthur Miller, Copyright Protection for Computer Programs,
Databases, and Computer-Generated Works: Is Anything New Since CONTU?, 106 Harv.
L. Rev. 977 (1993) (same). Most of these decisions, unlike Sega, involve copied code that
appears in the defendant’s final product, rather than just intermediate copying. Should
the courts treat intermediate copying differently from copying for compatibility in a final
product?

SONY COMPUTER ENTERTAINMENT, INC.

v.
CONNECTIX CORPORATION
United States Court of Appeals for the Ninth Circuit
203 F.3d 596 (9th Cir. 2000)

CANBY, Circuit Judge:

In this case we are called upon once again to apply the principles of copyright law
to computers and their software, to determine what must be protected as expression and
what must be made accessible to the public as function. Sony Computer Entertainment,
Inc., which brought this copyright infringement action, produces and markets the Sony
PlayStation console, a small computer with hand controls that connects to a television

19
console and plays games that are inserted into the PlayStation on compact discs (CDs).
Sony owns the copyright on the basic input-output system or BIOS, which is the software
program that operates its PlayStation. Sony has asserted no patent rights in this
proceeding.
The defendant is the Connectix Corporation, which makes and sells a software
program called “Virtual Game Station.” The purpose of the Virtual Game Station is to
emulate on a regular computer the functioning of the Sony PlayStation console, so that
computer owners who buy the Virtual Game Station software can play Sony PlayStation
games on their computers. The Virtual Game Station does not contain any of Sony’s
copyrighted material. In the process of producing the Virtual Game Station, however,
Connectix repeatedly copied Sony’s copyrighted BIOS during a process of “reverse
engineering” that Connectix conducted in order to find out how the Sony PlayStation
worked. Sony claimed infringement and sought a preliminary injunction. The district
court concluded that Sony was likely to succeed on its infringement claim because
Connectix’s “intermediate copying” was not a protected “fair use” under 17 U.S.C. § 107.
The district court enjoined Connectix from selling the Virtual Game Station or from
copying or using the Sony BIOS code in the development of other Virtual Game Station
products.
Connectix now appeals. We reverse and remand with instructions to dissolve the
injunction. The intermediate copies made and used by Connectix during the course of its
reverse engineering of the Sony BIOS were protected fair use, necessary to permit
Connectix to make its non-infringing Virtual Game Station function with PlayStation
games. Any other intermediate copies made by Connectix do not support injunctive
relief, even if those copies were infringing.
The district court also found that Sony is likely to prevail on its claim that
Connectix’s sale of the Virtual Game Station program tarnishes the Sony PlayStation
mark under 15 U.S.C. § 1125. We reverse that ruling as well.

I. Background
A. The products
Sony is the developer, manufacturer and distributor of both the Sony PlayStation
and Sony PlayStation games. Sony also licenses other companies to make games that can
play on the PlayStation. The PlayStation system consists of a console (essentially a mini-
computer), controllers, and software that produce a three-dimensional game for play on
a television set. The PlayStation games are CDs that load into the top of the console. The
PlayStation console contains both (1) hardware components and (2) software known as
firmware that is written onto a read-only memory (ROM) chip. The firmware is the Sony
BIOS. Sony has a copyright on the BIOS. It has claimed no patent relevant to this
proceeding on any component of the PlayStation. PlayStation is a registered trademark
of Sony.

20
 Connectix’s Virtual Game Station is software that “emulates” the functioning of
the PlayStation console. That is, a consumer can load the Virtual Game Station software
onto a computer, load a PlayStation game into the computer’s CD–ROM drive, and play
the PlayStation game. The Virtual Game Station software thus emulates both the
hardware and firmware components of the Sony console. The Virtual Game Station does
not play PlayStation games as well as Sony’s PlayStation does. At the time of the
injunction, Connectix had marketed its Virtual Game Station for Macintosh computer
systems but had not yet completed Virtual Game Station software for Windows.

B. Reverse engineering
Copyrighted software ordinarily contains both copyrighted and unprotected or
functional elements. Sega Enters. Ltd. v. Accolade, Inc., 977 F.2d 1510, 1520 (9th Cir. 1992)
(amended opinion); see 17 U.S.C. § 102(b) (Copyright protection does not extend to any
“idea, procedure, process, system, method of operation, concept, principle, or discovery”
embodied in the copyrighted work.). Software engineers designing a product that must
be compatible with a copyrighted product frequently must “reverse engineer” the
copyrighted product to gain access to the functional elements of the copyrighted product.
See Andrew Johnson–Laird, Software Reverse Engineering in the Real World, 19 U.
Dayton [Link]. 843, 845–46 (1994).
Reverse engineering encompasses several methods of gaining access to the
functional elements of a software program. They include: (1) reading about the program;
(2) observing “the program in operation by using it on a computer;” (3) performing a
“static examination of the individual computer instructions contained within the
program;” and (4) performing a “dynamic examination of the individual computer
instructions as the program is being run on a computer.” Id. at 846. *600 Method (1) is the
least effective, because individual software manuals often misdescribe the real product.
See id. It would be particularly ineffective in this case because Sony does not make such
information available about its PlayStation. Methods (2), (3), and (4) require that the
person seeking access load the target program on to a computer, an operation that
necessarily involves copying the copyrighted program into the computer’s random
access memory or RAM.
Method (2), observation of a program, can take several forms. The functional
elements of some software programs, for example word processing programs,
spreadsheets, and video game displays may be discernible by observation of the
computer screen. See Sega, 977 F.2d at 1520. Of course, the reverse engineer in such a
situation is not observing the object code itself, only the external visual expression of this
code’s operation on the computer. Here, the software program is copied each time the
engineer boots up the computer, and the computer copies the program into RAM.
Other forms of observation are more intrusive. Operations systems, system
interface procedures, and other programs like the Sony BIOS are not visible to the user
when they are operating. See id. One method of “observing” the operation of these

21
programs is to run the program in an emulated environment. In the case of the Sony BIOS,
this meant operating the BIOS on a computer with software that simulated the operation
of the PlayStation hardware; operation of the program, in conjunction with another
program known as a “debugger,” permitted the engineers to observe the signals sent
between the BIOS and other programs on the computer. This latter method required
copying the Sony BIOS from a chip in the PlayStation onto the computer. The Sony BIOS
was copied again each time the engineers booted up their computer and the computer
copied the program into RAM. All of this copying was intermediate; that is, none of the
Sony copyrighted material was copied into, or appeared in, Connectix’s final product, the
Virtual Game Station.
Methods (3) and (4) constitute “disassembly” of object code into source code. In
each case, engineers use a program known as a “disassembler” to translate the ones and
zeros of binary machine-readable object code into the words and mathematical symbols
of source code. This translated source code is similar to the source code used originally
to create the object code4 but lacks the annotations drafted by the authors of the program
that help explain the functioning of the source code. In a static examination of the
computer instructions, method (3), the engineer disassembles the object code of all or part
of the program. The program must generally be copied one or more times to perform
disassembly. In a dynamic examination of the computer instructions, method (4), the
engineer uses the disassembler program to disassemble parts of the program, one
instruction at a time, while the program is running. This method also requires copying
*601 the program and, depending on the number of times this operation is performed,
may require additional copying of the program into RAM every time the computer is
booted up.

C. Connectix’s reverse engineering of the Sony BIOS

Connectix began developing the Virtual Game Station for Macintosh on about July
1, 1998. In order to develop a PlayStation emulator, Connectix needed to emulate both
the PlayStation hardware and the firmware (the Sony BIOS).
Connectix first decided to emulate the PlayStation’s hardware. In order to do so,
Connectix engineers purchased a Sony PlayStation console and extracted the Sony BIOS
from a chip inside the console. Connectix engineers then copied the Sony BIOS into the
RAM of their computers and observed the functioning of the Sony BIOS in conjunction
with the Virtual Game Station hardware emulation software as that hardware emulation
software was being developed by Connectix. The engineers observed the operation of the
Sony BIOS through use of a debugging program that permitted the engineers to observe
the signals sent between the BIOS and the hardware emulation software. During this
process, Connectix engineers made additional copies of the Sony BIOS every time they
booted up their computer and the Sony BIOS was loaded into RAM.

22
 Once they had developed the hardware emulation software, Connectix engineers
also used the Sony BIOS to “debug” the emulation software. In doing so, they repeatedly
copied and disassembled discrete portions of the Sony BIOS.
Connectix also used the Sony BIOS to begin development of the Virtual Game
Station for Windows. Specifically, they made daily copies to RAM of the Sony BIOS and
used the Sony BIOS to develop certain Windows-specific systems for the Virtual Game
Station for Windows. Although Connectix had its own BIOS at the time, Connectix
engineers used the Sony BIOS because it contained CD–ROM code that the Connectix
BIOS did not contain.
Early in the development process, Connectix engineer Aaron Giles disassembled
a copy of the entire Sony BIOS that he had downloaded from the Internet. He did so for
the purpose of testing a “disassembler” program he had written. The print-out of the
source code was not used to develop the Virtual Game Station emulator. Connectix
engineers initially used this copy of the Sony BIOS to begin the reverse engineering
process, but abandoned it after realizing that it was a Japanese-language version.
During development of the Virtual Game Station, Connectix contacted Sony and
requested “technical assistance” from Sony to complete the development of the Virtual
Game Station. Connectix and Sony representatives met during September 1998. Sony
declined Connectix’s request for assistance.
Connectix completed Virtual Game Station for Macintosh computers in late
December 1998 or early January 1999. Connectix announced its new product at the
MacWorld Expo on January 5, 1999. At MacWorld, Connectix marketed the Virtual Game
Station as a “PlayStation emulator.” The materials stated that the Virtual Game Station
permits users to play “their favorite Playstation games” on a computer “even if you don’t
yet have a Sony PlayStation console.”

D. Procedural history
On January 27, 1999, Sony filed a complaint alleging copyright infringement and
other causes of action against Connectix. Sony subsequently moved for a preliminary
injunction on the grounds of copyright and trademark infringement. The district court
granted the motion, enjoining Connectix: (1) from copying or using the Sony BIOS code
in the development of the Virtual Game Station for Windows; and (2) from selling the
Virtual Game Station for Macintosh or the Virtual Game Station for Windows. Order on
Mot. for Prelim. Inj. at 27. The district court also impounded all Connectix’s copies of the
Sony BIOS and all copies of works based upon or incorporating Sony BIOS. Id. at 27–28.
Connectix now appeals from this order.

II. Discussion
[. . .]

23
 Connectix admits that it copied Sony’s copyrighted BIOS software in developing
the Virtual Game Station but contends that doing so was protected as a fair use under 17
U.S.C. § 107. [. . .]

A. Fair use
The fair use issue arises in the present context because of certain characteristics of
computer software. The object code of a program may be copyrighted as expression, 17
U.S.C. § 102(a), but it also contains ideas and performs functions that are not entitled to
copyright protection. See 17 U.S.C. § 102(b). Object code cannot, however, be read by
humans. The unprotected ideas and functions of the code therefore are frequently
undiscoverable in the absence of investigation and translation that may require copying
the copyrighted material. We conclude that, under the facts of this case and our
precedent, Connectix’s intermediate copying and use of Sony’s copyrighted BIOS was a
fair use for the purpose of gaining access to the unprotected elements of Sony’s software.
The general framework for analysis of fair use is established by statute, 17 U.S.C.
§ 107. We have applied this statute and the fair use doctrine to the disassembly of
computer software in the case of Sega Enterprises Ltd. v. Accolade, Inc., 977 F.2d 1510
(9th Cir. 1992) (amended opinion). Central to our decision today is the rule set forth in
Sega:
[W]here disassembly is the only way to gain access to the ideas and
functional elements embodied in a copyrighted computer program and
where there is a legitimate reason for seeking such access, disassembly is a
fair use of the copyrighted work, as a matter of law.
Id. at 1527–28 (emphasis added). [. . .]
We turn then to the statutory fair use factors, as informed by our precedent in Sega.

1. Nature of the copyrighted work

Under our analysis of the second statutory factor, nature of the copyrighted work,
we recognize that “some works are closer to the core of intended copyright protection
than others.” Campbell v. Acuff–Rose Music, Inc., 510 U.S. 569, 586, 114 [Link]. 1164, 127
[Link].2d 500 (1994). Sony’s BIOS lies at a distance from the core because it contains
unprotected aspects that cannot be examined without copying. See Sega, 977 F.2d at 1526.
We consequently accord it a “lower degree of protection than more traditional literary
works.” Id. As we have applied this standard, Connectix’s copying of the Sony BIOS must
have been “necessary” to have been fair use. See id. at 1524–26. We conclude that it was.
There is no question that the Sony BIOS contains unprotected functional elements.
Nor is it disputed that Connectix could not gain access to these unprotected functional
elements without copying the Sony BIOS. Sony admits that little technical information
about the functionality of the Sony BIOS is publicly available. The Sony BIOS is an

24
internal operating system that does not produce a screen display to reflect its functioning.
Consequently, if Connectix was to gain access to the functional elements of the Sony BIOS
it had to be through a form of reverse engineering that required copying the Sony BIOS
onto a computer. Sony does not dispute this proposition.
The question then becomes whether the methods by which Connectix reverse-
engineered the Sony BIOS were necessary to gain access to the unprotected functional
elements within the program. We conclude that they were. Connectix employed several
methods of reverse engineering (observation and observation with partial disassembly)
each of which required Connectix to make intermediate copies of copyrighted material.
Neither of these methods renders fair use protection inapplicable. Sega expressly
sanctioned *604 disassembly. See id. at 1527–28. We see no reason to distinguish
observation of copyrighted software in an emulated computer environment. Both
methods require the reverse engineer to copy protected as well as unprotected elements
of the computer program. Because this intermediate copying is the gravamen of the
intermediate infringement claim, see 17 U.S.C. § 106(1); Sega, 977 F.2d at 1518–19, and
both methods of reverse engineering require it, we find no reason inherent in these
methods to prefer one to another as a matter of copyright law. Connectix presented
evidence that it observed the Sony BIOS in an emulated environment to observe the
functional aspects of the Sony BIOS. When this method of reverse engineering was
unsuccessful, Connectix engineers disassembled discrete portions of the Sony BIOS to
view directly the ideas contained therein. We conclude that intermediate copying in this
manner was “necessary” within the meaning of Sega.
We decline to follow the approach taken by the district court. The district court
did not focus on whether Connectix’s copying of the Sony BIOS was necessary for access
to functional elements. Instead, it found that Connectix’s copying and use of the Sony
BIOS to develop its own software exceeded the scope of Sega. See Order at 17 (“[T]hey
disassembled Sony’s code not just to study the concepts. They actually used that code in
the development of [their] product.”). This rationale is unpersuasive. It is true that Sega
referred to “studying or examining the unprotected aspects of a copyrighted computer
program.” 977 F.2d at 1520 (emphasis added). But in Sega, Accolade’s copying,
observation and disassembly of Sega’s game cartridges was held to be fair use, even
though Accolade “loaded the disassembled code back into a computer, and experimented
to discover the interface specifications for the Genesis console by modifying the programs
and studying the results.” Id. at 1515. Thus, the distinction between “studying” and “use”
is unsupported in Sega. Moreover, reverse engineering is a technically complex,
frequently iterative process. Johnson–Laird, 19 U. Dayton [Link]. at 843–44. Within the
limited context of a claim of intermediate infringement, we find the semantic distinction
between “studying” and “use” to be artificial, and decline to adopt it for purposes of
determining fair use.
We also reject the argument, urged by Sony, that Connectix infringed the Sony
copyright by repeatedly observing the Sony BIOS in an emulated environment, thereby
making repeated copies of the Sony BIOS. These intermediate copies could not have been

25
“necessary” under Sega, contends Sony, because Connectix engineers could have
disassembled the entire Sony BIOS first, then written their own Connectix BIOS, and used
the Connectix BIOS to develop the Virtual Game Station hardware emulation software.
We accept Sony’s factual predicate for the limited purpose of this appeal. Our doing so,
however, does not aid Sony.
Sony contends that Connectix’s reverse engineering of the Sony BIOS should be
considered unnecessary on the rationale that Connectix’s decision to observe the Sony
BIOS in an emulated environment required Connectix to make more intermediate copies
of the Sony BIOS than if Connectix had performed a complete disassembly of the
program. Under this logic, at least some of the intermediate copies were not necessary
within the meaning of Sega. This construction stretches Sega too far. The “necessity” we
addressed in Sega was the necessity of the method, i.e., disassembly, not the necessity of
the number of times that method was applied. See 977 F.2d at 1524–26. In any event, the
interpretation advanced by Sony would be a poor criterion for fair use. Most of the
intermediate copies of the Sony BIOS were made by Connectix engineers when they
booted up their computers and the Sony BIOS was copied into RAM. But if Connectix
engineers had left their computers turned on throughout the period during which they
were observing the Sony BIOS in an emulated environment, they would have made far
fewer intermediate copies of the Sony BIOS (perhaps as few as one per computer). Even
if we were inclined to supervise the engineering solutions of software companies in
minute detail, and we are not, our application of the copyright law would not turn on
such a distinction. Such a rule could be easily manipulated. More important, the rule
urged by Sony would require that a software engineer, faced with two engineering
solutions that each require intermediate copying of protected and unprotected material,
often follow the least efficient solution. (In cases in which the solution that required the
fewest number of intermediate copies was also the most efficient, an engineer would
pursue it, presumably, without our urging.) This is precisely the kind of “wasted effort
that the proscription against the copyright of ideas and facts ... [is] designed to prevent.”
Feist Publications, Inc. v. Rural Tel. Serv. Co., 499 U.S. 340, 354, 111 [Link]. 1282, 113 [Link].2d
358 (1991) (internal quotation marks omitted). Such an approach would erect an artificial
hurdle in the way of the public’s access to the ideas contained within copyrighted
software programs. These are “aspects that were expressly denied copyright protection
by Congress.” Sega, 977 F.2d at 1526 (citing 17 U.S.C. § 102(b)). We decline to erect such
a barrier in this case. If Sony wishes to obtain a lawful monopoly on the functional
concepts in its software, it must satisfy the more stringent standards of the patent laws.
See Bonito Boats, Inc. v. Thunder Craft Boats, Inc., 489 U.S. 141, 160–61, 109 [Link]. 971, 103
[Link].2d 118 (1989); Sega, 977 F.2d at 1526. This Sony has not done. The second statutory
factor strongly favors Connectix.

2. Amount and substantiality of the portion used

26
 With respect to the third statutory factor, amount and substantiality of the portion
used in relation to the copyrighted work as a whole, Connectix disassembled parts of the
Sony BIOS and copied the entire Sony BIOS multiple times. This factor therefore weighs
against Connectix. But as we concluded in Sega, in a case of intermediate infringement
when the final product does not itself contain infringing material, this factor is of “very
little weight.” Sega, 977 F.2d at 1526–27; see also Sony Corp. of Am. v. Universal City
Studios, Inc., 464 U.S. 417, 449–50, 104 [Link]. 774, 78 [Link].2d 574 (1984) (copying of entire
work does not preclude fair use).

3. Purpose and character of the use

Under the first factor, purpose and character of the use, we inquire into whether
Connectix’s Virtual Game Station merely supersedes the objects of the original creation,
or instead adds something new, with a further purpose or different character, altering the
first with new expression, meaning, or message; it asks, in other words, whether and to
what extent the new work is “transformative.” Campbell v. Acuff–Rose Music, Inc., 510
U.S. 569, 579, 114 [Link]. 1164, 127 [Link].2d 500 (1994) (internal quotation marks and
citations omitted). As an initial matter, we conclude that the district court applied an
erroneous legal standard; the district court held that Connectix’s commercial purpose in
copying the Sony BIOS gave rise to a “presumption of unfairness that ... can be rebutted
by the characteristics of a particular commercial use.” Order at 14–15 (citing Sega, 977
F.2d at 1522). Since Sega, however, the Supreme Court has rejected this presumption as
applied to the first and fourth factor of the fair use analysis. Acuff–Rose, 510 U.S. at 584,
594, 114 [Link]. 1164 (clarifying Sony, 464 U.S. at 451, 104 [Link]. 774). Instead, the fact that
Connectix’s copying of the Sony BIOS was for a commercial purpose is only a “separate
factor that tends to weigh against a finding of fair use.” Id. at 585, 114 [Link]. 1164 (internal
quotation marks omitted).
We find that Connectix’s Virtual Game Station is modestly transformative. The
product creates a new platform, the personal computer, on which consumers can play
games designed for the Sony PlayStation. This innovation affords opportunities for game
play in new environments, specifically anywhere a Sony PlayStation console and
television are not available, but a computer with a CD–ROM drive is. More important,
the Virtual Game Station itself is a wholly new product, notwithstanding the similarity
of uses and functions between the Sony PlayStation and the Virtual Game Station. The
expressive element of software lies as much in the organization and structure of the object
code that runs the computer as it does in the visual expression of that code that appears
on a computer screen. See 17 U.S.C. § 102(a) (extending copyright protection to original
works of authorship that “can be perceived, reproduced, or otherwise communicated,
either directly or with the aid of a machine or device”). Sony does not claim that the
Virtual Game Station itself contains object code that infringes Sony’s copyright. We are
therefore at a loss to see how Connectix’s drafting of entirely new object code for its VGS

27
program could not be transformative, despite the similarities in function and screen
output.
Finally, we must weigh the extent of any transformation in Connectix’s Virtual
Game Station against the significance of other factors, including commercialism, that
militate against fair use. See Acuff–Rose, 510 U.S. at 579, 114 [Link]. 1164. Connectix’s
commercial use of the copyrighted material was an intermediate one, and thus was only
“indirect or derivative.” Sega, 977 F.2d at 1522. Moreover, Connectix reverse-engineered
the Sony BIOS to produce a product that would be compatible with games designed for
the Sony PlayStation. We have recognized this purpose as a legitimate one under the first
factor of the fair use analysis. See id. Upon weighing these factors, we find that the first
factor favors Connectix.
The district court ruled, however, that the Virtual Game Station was not
transformative on the rationale that a computer screen and a television screen are
interchangeable, and the Connectix product therefore merely “supplants” the Sony
PlayStation console. Order at 15. The district court clearly erred. For the reasons stated
above, the Virtual Game Station is transformative and does not merely supplant the
PlayStation console. In reaching its decision, the district court apparently failed to
consider the expressive nature of the Virtual Game Station software itself. Sony’s reliance
on Infinity Broadcast Corp. v. Kirkwood, 150 F.3d 104 (2d Cir. 1998), suffers from the
same defect. The Infinity court reasoned that a “change of format, though useful, is not
technically a transformation.” Id. at 108 n. 2. But the infringing party in that case was
merely taking copyrighted radio transmissions and retransmitting them over telephone
lines; there was no new expression. Id. at 108. Infinity does not change our conclusion;
the purpose and character of Connectix’s copying points toward fair use.

4. Effect of the use upon the potential market

We also find that the fourth factor, effect of the use upon the potential market,
favors Connectix. Under this factor, we consider not only the extent of market harm
caused by the particular actions of the alleged infringer, but also “whether unrestricted
and widespread conduct of the sort engaged in by the defendant ... would result in a
substantially adverse impact on the potential market” for the original. Acuff–Rose, 510
U.S. at 590, 114 [Link]. 1164 (quoting 3 M. Nimmer & D. Nimmer, Nimmer on Copyright, §
13.05[A][4], at 13–102.61 (1993)). Whereas a work that merely supplants or supersedes
another is likely to cause a substantially adverse impact on the potential market of the
original, a transformative work is less likely to do so. See id. at 591, 114 [Link]. 1164; Harper
& Row, Publishers, Inc. v. Nation Enters., Inc., 471 U.S. 539, 567–69, 105 [Link]. 2218, 85
[Link].2d 588 (1985).
The district court found that “[t]o the extent that such a substitution [of
Connectix’s Virtual Game Station for Sony PlayStation console] occurs, Sony will lose
console sales and profits.” Order at 19. We recognize that this may be so. But because the
Virtual Game Station is transformative, and does not merely supplant the PlayStation

28
console, the Virtual Game Station is a legitimate competitor in the market for platforms
on which Sony and Sony-licensed games can be played. See Sega, 977 F.2d at 1522–23.
For this reason, some economic loss by Sony as a result of this competition does not
compel a finding of no fair use. Sony understandably seeks control over the market for
devices that play games Sony produces or licenses. The copyright law, however, does not
confer such a monopoly. See id. at 1523–24 (“[A]n attempt to monopolize the market by
making it impossible for others to compete runs counter to the statutory purpose of
promoting creative expression and cannot constitute a strong equitable basis for resisting
the invocation of the fair use doctrine.”). This factor favors Connectix.
The four statutory fair use factors must be “weighed together, in light of the
purposes of copyright.” Acuff–Rose, 510 U.S. at 578, 114 [Link]. 1164. Here, three of the
factors favor Connectix; one favors Sony, and it is of little weight. Of course, the statutory
factors are not exclusive, Harper & Row, 471 U.S. at 560, 105 [Link]. 2218, but we are
unaware of other factors not already considered that would affect our analysis.
Accordingly, we conclude that Connectix’s intermediate copying of the Sony BIOS
during the course of its reverse engineering of that product was a fair use under 17 U.S.C.
§ 107, as a matter of law. With respect to its claim of copyright infringement, Sony has
not established either a likelihood of success on the merits or that the balance of hardships
tips in its favor. See Cadence Design Sys., Inc. v. Avant! Corp., 125 F.3d 824, 826 (9th Cir.
1997), cert. denied, 523 U.S. 1118, 118 [Link]. 1795, 140 [Link].2d 936 (1998). Accordingly, we
need not address defenses asserted by Connectix under 17 U.S.C. § 117(a)(1) and our
doctrine of copyright misuse. We reverse the district court’s grant of a preliminary
injunction on the ground of copyright infringement.
[...]
CONCLUSION
Connectix’s reverse engineering of the Sony BIOS extracted from a Sony
PlayStation console purchased by Connectix engineers is protected as a fair use. Other
intermediate copies of the Sony BIOS made by Connectix, if they infringed Sony’s
copyright, do not justify injunctive relief. For these reasons, the district *610 court’s
injunction is dissolved and the case is remanded to the district court. We also reverse the
district court’s finding that Connectix’s Virtual Game Station has tarnished the Sony
PlayStation mark.

COMMENTS & QUESTIONS

1. In both of the decades-old cases above, the courts’ holdings favor

interoperability and cross-platform gaming – in fact, Sony arguably extends Sega. And
yet, the gaming world today is very much segregated within their respective walled
gardens. Why might that be?

29
 2. In discussing transformativeness, the court appreciates the practical,
additive benefit of cross-platform use – and specifically that using Connectix’s Virtual
Game Station is a different experience from using the Playstation console. This is an
important note for practitioners arguing in favor of cross-platform technology and
interoperability.
3. It seems obvious that after Sega, Connectix’s use (and copying) of the
Playstation’s object code was fair use. And yet the district court found no fair use, and
the case had to wend its way all the way up to the Ninth Circuit for the right decision.
Why might that be? Is there a difference between reverse engineering to create a
compatible game and reverse engineering to create a compatible platform? Should there
be? How does the market impact of Connectix differ from Accolade?
4. The early games we studied – like Space Invaders, Donkey Kong, and Super
Mario Brothers – were either singleplayer or, at best, local multiplayer. When the internet
became a shared reality, online multiplayer games rose to prominence, like Second Life,
World of Warcraft, and the later iterations of Final Fantasy, all of which we studied in
previous chapters. Early multiplayer online games usually involved complex online
communities with their own currency, property, and virtual economies – with their own
systems of micro- and in-game transactions. They also generally limited their economies
and user data to a single platform and a single game – i.e., whatever you bought in Second
Life couldn’t be used in Final Fantasy XIV. More recently, some of the most successful
games have been cross-platform. This is true for one of the most popular games in history,
Fortnite; Fortnite is available across PCs, the web, mobile, and console – and you can access
your account across these different platforms. But just like the earliest online multiplayer
games, whatever you buy in Fortnite can’t be used in, say, Second Life, and vice versa.
Today, commentators question the walled garden baseline, and frequently discuss
interoperability in two separate (but often related) contexts: the metaverse and
blockchain technology. Arguably, we already have many discrete metaverses, with
worlds like Fortnite, Second Life, and Roblox. But when Facebook famously changed its
name to Meta, popular culture’s conception of what the metaverse could be involved rich
and complex worlds, advanced virtual reality technology, and an intimate connection
between the digital world and our everyday lives. Of course, whether this vision will
become reality is yet to be seen (as is whether Meta will be the one to do it), but its promise
has pushed many to question whether it makes sense to create discrete islands of
metaverses with little or no interoperability. That is, if the metaverse becomes an
everyday part of our reality, shouldn’t that reality extend across platforms? And if so,
what aspects of one metaverse should transfer? Your avatar? Digital tokens and items?
Contacts? Land? Purchasing history?
One item that might transfer well between and among games are NFTs. NFTs –
and their unique blockchain identities – might offer a convenient building block, so to
speak, for interoperability and web3 gaming. An NFT exists outside the game world, so
not only might the NFT transfer between games, an NFT that represents an in-game item

30
in one game might take another form when transferred to another. The options for
evolution and personalization are endless, and using NFTs in this way could provide
intergenerational persistence – i.e., a players’ items, status, and identity need not die with
the game.
Is what Cory Doctorow calls “adversarial interoperability” – the ability to make
one’s game or platform compatible with a competitor’s whether they want it or not –
feasible in the metaverse? Or will breaking out of walled gardens require agreement
between the platforms?
A third possibility is some sort of antitrust or regulatory requirement for
connection. We turn to that possibility in the next section.

B. Antitrust and Video Games

EPIC GAMES, INC., Plaintiff,

v.
APPLE INC., Defendant.

United States District Court for the Northern District of California

559 [Link].3d 898 (N.D. Cal. 2021)

Yvonne Gonzalez Rogers, United States District Court Judge

Plaintiff Epic Games, Inc. sued Apple, Inc. alleging violations of federal and state
antitrust laws and California’s unfair competition law based upon Apple’s operation of
its App Store. Broadly speaking, Epic Games claimed that Apple is an antitrust
monopolist over (i) Apple’s own system of distributing apps on Apple’s own devices in the
App Store and (ii) Apple’s own system of collecting payments and commissions of
purchases made on Apple’s own devices in the App Store. Said differently, plaintiff alleged
an antitrust market of one, that is, Apple’s “monopolistic” control over its own systems
relative to the App Store. Apple obviously disputed the allegations.

Antitrust law protects competition and not competitors. Competition results in

innovation and consumer satisfaction and is essential to the effective operation of a free
market system. Antitrust jurisprudence also evaluates both market structure and
behavior to determine whether an actor is using its place in the market to artificially
restrain competition.

31
 Central to antitrust cases is the appropriate determination of the “relevant
market.” Epic Games structured its lawsuit to argue that Apple does not compete with
anyone; it is a monopoly of one. Apple, by contrast, argues that the effective area of
competition is the market for all digital video games in which it and Epic Games compete
heavily. In the digital video game market, Apple argues that it does not enjoy monopoly
power, and therefore does not violate federal and state law.

The Court disagrees with both parties’ definition of the relevant market.

Ultimately, after evaluating the trial evidence, the Court finds that the relevant
market here is digital mobile gaming transactions, not gaming generally and not Apple’s
own internal operating systems related to the App Store. The mobile gaming market itself
is a $100 billion industry. The size of this market explains Epic Games’ motive in bringing
this action. Having penetrated all other video game markets, the mobile gaming market
was Epic Games’ next target and it views Apple as an impediment.

Further, the evidence demonstrates that most App Store revenue is generated by
mobile gaming apps, not all apps. Thus, defining the market to focus on gaming apps is
appropriate. Generally speaking, on a revenue basis, gaming apps account for
approximately 70% of all App Store revenues. This 70% of revenue is generated by less
than 10% of all App Store consumers. These gaming-app consumers are primarily
making in-app purchases which is the focus of Epic Games’ claims. By contrast, over 80%
of all consumer accounts generate virtually no revenue, as 80% of all apps on the App
Store are free.

Having defined the relevant market as digital mobile gaming transactions, the
Court next evaluated Apple’s conduct in that market. Given the trial record, the Court
cannot ultimately conclude that Apple is a monopolist under either federal or state
antitrust laws. While the Court finds that Apple enjoys considerable market share of over
55% and extraordinarily high profit margins, these factors alone do not show antitrust
conduct. Success is not illegal. The final trial record did not include evidence of other
critical factors, such as barriers to entry and conduct decreasing output or decreasing
innovation in the relevant market. The Court does not find that it is impossible; only that
Epic Games failed in its burden to demonstrate Apple is an illegal monopolist.

Nonetheless, the trial did show that Apple is engaging in anticompetitive conduct
under California’s competition laws. The Court concludes that Apple’s anti-steering
provisions hide critical information from consumers and illegally stifle consumer choice.
When coupled with Apple’s incipient antitrust violations, these anti-steering provisions
are anticompetitive and a nationwide remedy to eliminate those provisions is warranted.

The Court provides its findings of facts and conclusions of law below.

PART I

32
 FINDINGS OF FACT

To determine the relevant market, the Court must first understand the industry
and the markets in that industry. This is a heavily factual inquiry. Thus, in this Order, the
Court explains in detail, the facts underpinning each parties’ theory and other relevant
facts uncovered during the trial. These details include the background of the parties, their
products, the industry, and the markets in which they compete.2 To assist the reader,
given the length of this Order, an outline is included in an Appendix hereto.

I. THE PARTIES

A. Overview

Some basic background information may be helpful. Epic Games is a multi-billion

dollar video game company. It defines the relevant market by way of Apple’s own
internal operating system. Apple has maintained control of its own operating system for
mobile devices, called iOS, since its inception in 2007. Apple’s creation and cultivation of
the iOS device (and its ecosystem) has been described as a walled garden. Said differently,
it is a closed platform whereby Apple controls and supervises access to any software
which accesses the iOS devices (defined as iPhones and iPads; also referred to collectively
as iOS devices). Apple justifies this control primarily in the name of consumer privacy,
security, as well as monetization of its intellectual property. Evidence supports the
argument that consumers value these attributes. Due in part to this business model,
Apple has been enormously successful and its devices are now ubiquitous.

Both Apple and third-party developers like Epic Games have symbiotically
benefited from the ever-increasing innovation and growth in the iOS ecosystem. There is
no dispute in the record that developers like Epic Games have benefited from Apple’s
development and cultivation of the iOS ecosystem, including its devices and underlying
software. Nor is there any dispute that developers like Epic Games have enhanced the
experience for iOS devices and their consumers by offering a diverse assortment of
applications beyond that which Apple can or has provided.

Until this lawsuit, Epic Games’ flagship video game product, Fortnite, could be
played on iOS devices. The product generated an immensely profitable revenue stream
for Epic Games. However, Epic Games was also required by contract to pay Apple a 30%
commission on every purchase made through the App Store, whether an initial download
or an in-app purchase. Consequently, Fortnite generated a profitable revenue stream for
Apple as well. Epic Games tried to use Fortnite as leverage to force Apple to reduce its
commission fee and to open its closed platform. When Apple refused, Epic Games
breached its contract, which it concedes, and filed this lawsuit. Apple countersued for
breach of contract.

33
 Plaintiff focuses its challenge on Apple’s control over the distribution of apps to
its users and the requirement that developers of apps use Apple’s in-app purchases or in-
app payments (“IAP”) system3 if purchases are offered in the app. Under this IAP system
and under its agreements with app developers, Apple collects payments made to
developers, remits 70% to the developers, and keeps a 30% commission. This rate has
largely remained unchanged since the inception. The trial also contained evidence of
Apple’s use of anti-steering provisions to limit information flow to consumers on the
payment structure related to in-app purchases.

Once acceptable, Apple’s commission rate is now questioned by some consumers

and some developers, like Epic Games, as being overly burdensome and violative of
competition laws. Indeed, two related lawsuits were already pending before the Court
well before the commencement of this action. The first, In Re Apple iPhone Antitrust
Litigation, 4:11-cv-6714-YGR (Pepper), was filed in 2011 on behalf of a class of iOS device
consumers alleging harm from the commission rate. The second, filed in 2019 after Pepper
returned from the Supreme Court of the United States, Donald Cameron v. Apple Inc., 4:19-
cv-3074-YGR (Cameron), on behalf of a class of iOS app developers also alleging violations
of antitrust and competitions laws.

[. . .]

B. Plaintiff Epic Games

[. . .]

Fortnite uses the “freemium” game model, under which a game is largely free to
download and play but certain additional in-game features can be purchased. Epic
Games primarily generates revenue by selling V-Bucks, which can be used to obtain items
in Fortnite.67 V-Bucks can be purchased in-app or directly from Epic Games’ website.
Players can use V-Bucks to purchase digital content within the app, including a “Battle
Pass” (a feature that provides access to challenges and otherwise locked content) or
cosmetic upgrades. Unlike other games employing the freemium model, in-app
purchases do not buy game play advantages in Battle Royale. Instead, players can make
in-app purchases of different items that function as forms of self-expression, including
cosmetic enhancements or “skins” (i.e., in-game costumes), dance moves known as
“emotes,” and more.71 As of December 2020, players can also subscribe to Fortnite Group,
which provides users with the Battle Pass for each new Battle Royale season, a monthly
allotment of 1,000 V-Bucks and exclusive cosmetics.

Epic Games sells V-Bucks to consumers in various bundles and packages at

increasing prices: 1,000 V-Bucks for $9.99; 2,800 V-Bucks for $24.99 and so on—all the
way to 13,500 V-Bucks for $99.99. After Epic Games implemented its hotfix on iOS
(discussed at length below), Epic Games dropped V-Bucks pricing by 20% for purchases
made through Epic Games’ direct payment option on iOS and Google Play, as well as for

34
purchases on every other platform through which Fortnite was offered. Notably, there is
“no cost to [Epic Games for] V-Buck ... V-Bucks themselves don’t have a marginal cost.”

Although Epic Games claims that it would not have a viable way of monetizing
Fortnite without being able to sell in-app content, the record shows it monetizes Fortnite
in nine other ways:

Two are internal to the game. First, since December 2020, users “can subscribe to
Fortnite Crew, a subscription” service offered by Epic Games. Second, users can pay an
up-front fee to gain access to one of Fortnite’s game modes, Save the World, that also has
in-app content for purchase.

The remaining seven are external [. . .]

Based on the freemium model which relies upon in-app purchases, as well as these
alternative ways of monetization, Fortnite is quite lucrative and integral to Epic Games’
overall business operations. Given that Fortnite utilizes cross-platform technology to
capture a larger audience and appears on several different platforms, Epic Games faces
commission rates on its in-app purchases. Generally, plaintiff must pay 30% across most
platforms. Indeed, for example, Epic Games has agreed to such a rate on all Fortnite
transactions via the Microsoft (Xbox) Store, the PlayStation Store, the Nintendo eShop,
and Google Play. Epic Games has also agreed to extra payments for certain platform
holders above and beyond the standard 30% commission rate. For example, for all Fortnite
transactions via the PlayStation Store, Epic Games agreed to make additional payments
to Sony above this commission rate based on the amount of time that PlayStation users
play Fortnite cross-platform.

[. . .]

Once Fortnite itself was introduced, revenues from in-app purchase on Epic Games
apps through the App Store roughly doubled. Indeed, Epic Games saw iOS and other
mobile platforms as key to increasing Fortnite’s player base, as plaintiff had already
reached “a point of basically full penetration on console,” making acquisition of mobile
customers “hugely important.” Before Fortnite was removed from the iOS platform, more
than 115 million registered players had accessed Fortnite on an iOS device. Of this
amount, 64% of Fortnite for iOS players—approximately 73 million in total—had only
ever played Fortnite on iOS devices.

That said, despite this staggering number of iOS Fortnite players, the vast majority
of Epic Games’ Fortnite revenue (93%) is generated on non-iOS platforms. Of the users
who made a purchase between March 2018 and July 2020, only 13.2% made a purchase on
an iOS device—meaning that Epic Games was able to transact with 86.8% of paying Fortnite
users without paying any commissions to Apple.96 Still, in only two short years, and with
access to the iOS platform and Apple’s support, Fortnite on iOS earned Epic Games more
than $700 million across over 100 million iOS user accounts.97

35
[. . .]

4. Prior Relationship Between Apple and Epic Games

The relationship between Apple and Epic Games dates back to at least 2010.

In 2010, Epic Games agreed to and signed a Developer Product Licensing

Agreement (“DPLA”) with Apple. Epic International subsequently signed a Developer
Agreement and DPLA (for the account associated with Unreal Engine). At the time of the
signing of these contracts, Mr. Sweeney understood and agreed to key contractual terms
including, that Epic Games (i) was required to pay a commission on in-app purchases;
(ii) was prohibited from putting a store within the App Store; (iii) was prohibited from
sideloading apps on to iOS devices; and (iv) was required to use Apple’s commerce
technology for any payments. Knowing the terms, Epic Games chose to enter into those
contracts. According to Mr. Sweeney, Epic Games did not have a formal business dispute
with Apple or raise major objections or have existential-level concerns about the App
Store’s contract terms at the time. Since 2010, there has been no material change in the
terms of Epic Games’ agreements with Apple, nor in Apple’s business design.

Epic Games released three iOS games before Fortnite, and Apple featured each of
them at major events allowing Epic Games to make use of Apple’s brand. This began with
Epic Games’ first iOS game, Infinity Blade, in 2010, which it released for iOS because of
the “amazing 3D capabilities” on mobile platforms and the large number of iOS users.

These collaborations notwithstanding, Epic Games and Mr. Sweeney began

voicing discontent around the mid-2010s. In June 2015, Mr. Sweeney emailed Apple chief
executive officer Tim Cook urging Apple to consider “separating iOS App Store curation
from compliance review and app distribution,” and noting that “it doesn’t seem tenable
for Apple to be the sole arbiter of expression and commerce over an app platform
approaching a billion users.”127 A few years later, in January 2018, Mr. Sweeney sought a
meeting with Apple through Mark Rein, Epic Games’ Vice President, “to talk about the
potential for iOS and future Apple things to operate as open platforms” and discuss how
Epic Games has “a PC and Mac software store and would love to eventually support it
on iOS.” He added: “If the App Store we[re] merely the premier way for consumers to
install software, and not the sole way, then Apple could curate higher quality software
overall, without acting as a censor on free expression and commerce on the platform ....”

[. . .]

To Mr. Sweeney and Epic Games, the metaverse is the future of both gaming and
entertainment, and Apple’s policies and practices are a hurdle which pose a problem.
Indeed, for Mr. Sweeney, “reaching the entire base of Apple is 1 billion iPhone consumers
is a paramount goal for our company, as Fortnite expands beyond being a game into this
larger world of the metaverse.” Both Mr. Sweeney and Epic Games’ employees and

36
officers generally testified that “iOS is a vital platform for a business” and that it is “the
only way we can access a hundred percent of [a platform’s] users or at least have the
option of accessing a hundred percent of that market.”

[Epic developed a plan to allow its players to make in-game purchases directly
through the Epic Games store, bypassing Apple and its 30% cut of all in-game
transactions].

Epic Games assumed its breach would result in the removal of Fortnite from the
iOS and Android platforms. In fact, Mark Rein, Epic Games’ co-founder, predicted
“there’s a better than 50% chance Apple and Google will immediately remove the games
from their stores the minute we do this” and Daniel Vogel, the Chief Operating Officer,
predicted Google and Apple will immediately pull the build for new players.” “They may
also sue us to make an example,” he added.

[. . .]

On July 10, 2020, Apple Vice President and Associate General Counsel Douglas G.
Vetter responded to Mr. Sweeney’s email with a formal letter communicating, in essence:
No. As relevant here, Mr. Vetter wrote:

Apple has never allowed this. Not when we launched the App Store in 2008.
Not now. We understand this might be in Epic’s financial interests, but
Apple strongly believes these rules are vital to the health of the Apple
platform and carry enormous benefits for both consumers and developers.
The guiding principle of the App Store is to provide a safe, secure and
reliable experience for users and a great opportunity for all developers to
be successful but, to be clear, when it comes to striking the balance, Apple
errs on the side of the consumer.

[. . .]

C. Apple: Relevant History of the iOS and iOS Devices

[. . .]

The 2007 iPhone pales in comparison to today’s version. With 20-20 hindsight, we
can conclude that Apple’s gamble to save a languishing company paid off. The lens with
which to evaluate those early seminal years matters. Apple was not the monolith it is
today. It is easy, but not fair, to twist words today for self-serving reasons and forget the
landscape in which they were made.

As innovators in the early days, Apple executives were navigating trying to

determine what would work and what would not. A few key principles guided decision-

37
making, at least initially. First and foremost, the iPhone was a cellphone. If the cellphone
did not work or crashed, the product would not be successful regardless of all the bells
and whistles. Second, given the introduction of apps, securing the device from malicious
software was paramount.

Many developers responded to the iPhone launch by “jailbreaking phones and

writing native applications.” Jailbreaking occurs when a developer modifies Apple’s iOS
to enable the installation of unauthorized software, including applications from other
interfaces. Jailbreaking can create severe security risks regarding installation of malicious
apps and data exposure. Despite warnings regarding the risks, developers continued the
practice which precipitated renewed discussions within Apple to permit authorized
native apps to be developed by third-party developers.

As the discussions ensued, the core principles remained: reliability of the device
as a cellphone and device security. With these objectives in mind, on October 17, 2007,
Apple announced that it would allow third-party developers to create iOS apps by
licensing them with the interfaces and technology to do so. Apple then dedicated
resources to create, and then release on March 6, 2008, a software development kit or SDK
as well as information for a series of application programming interfaces or APIs to allow
developers to create apps which would work on Apple’s proprietary operating system.
The APIs unlocked features such as location awareness functionality, media applications,
video playback, and numerous other tools to enhance the developer’s ultimate product.

The creation, constant update, and modernization of the SDKs and APIs was not
insignificant. [. . .]

[. . .]

In 2010, Apple also created the App Guidelines which are more fully discussed
below. As a corollary to Section 3.3.3 of the DPLA, Section 3.1.1 of the App Guidelines
was the clearest articulation of the anti-steering provision with respect to in-app
purchases. It reads:

If you want to unlock features or functionality within your app, (by way
of example: subscriptions, in-game currencies, game levels, access to
premium content, or unlocking a full version), you must use in-app
purchase. Apps may not use their own mechanisms to unlock content
or functionality, such as license keys, augmented reality markers, QR
codes, etc. Apps and their metadata may not include buttons, external links,
or other calls to action that direct customers to purchasing mechanisms other
than in-app purchase.

Section 2.3.10 of the Guidelines reads: “... don’t include names, icons, or imagery of other
mobile platforms in your app or metadata, unless there is a specific, approved interactive
functionality” and Section 3.1.3 Other Purchase Methods states: “The following apps may

38
use purchase methods other than in-app purchase. Apps in this section cannot, either
within the app or through communications sent to points of contact obtained from
account registration within the app (like email or text) encourage users to use a
purchasing method other than in-app purchase.”

[..]

Over recent years, the evidence established that a significant portion of the App
Store revenue is built upon long-term relationships between developers and consumers
independent of Apple. [. . .]

Apple’s establishment of a 30% commission rate has remained static since the
onset. [. . .]

Over time, and given Apple’s success, some developers have actively complained
about the 30% commission. [. . .]

While Apple’s 30 percent commission began as a corollary to the 30 percent rate

being charged in the gaming industry, the evidence is substantial that the economic
factors driving that rate do not apply equally to Apple. Other gaming industry
participants operate under a distinctly different economic model, facing different levels
of competitive pressure. See infra Facts § II.D.2–4. For example, unlike those in the
computer gaming market, nothing other than legal action seems to motivate Apple to
reconsider pricing and reduce rates.

[. . .]

Games have played an integral part of the App Store since at least 2016. In 2016
for instance, despite game apps only accounting for approximately 33% of all app
downloads, game apps nonetheless accounted for 81% of all app store billings that
year. Further, based on Apple’s internal records, 2017 gaming revenues overall accounted
for 76% of Apple’s App Store revenues. These commissions are substantially higher than
average due to the prevalent and lucrative business model employed by most game
developers. Specifically, game apps are disproportionately likely to use in-app purchases
for monetization.

[. . .]

II. REVIEW OF PARTIES’ PROPOSED PRODUCT MARKET AND FINDING

The Court reviews the factual basis for each of the three proffered product
markets. Epic Games offers two aftermarkets, namely (i) an aftermarket for the
distribution of iOS apps and (ii) an aftermarket for payment processing for iOS apps. The
foremarket for each hinges on the existence of a market for operating systems for

39
smartphones. Apple proposes a market for digital games transactions. The Court outlines
the evidence for each in turn.

A. Epic Games: Facts Relevant to Foremarket for Apple’s Own iOS

Before reviewing each of the proposed markets, the Court considers whether Apple’s
operating system should be viewed as a foremarket. The Court finds that it should not.

[. . .]

In terms of substance, the Court agrees with Dr. Schmalensee that plaintiff’s
identification of a “foremarket” for Apple’s own operating system is “artificial.” The
proposed foremarket is entirely litigation driven, misconceived, and bears little
relationship to the reality of the marketplace. Quite simply, it is illogical to argue that
there is a market for something that is not licensed or sold to anyone. Competition exists
for smartphones which are more than just the operating system. Features such as battery
life, durability, ease of use, cameras, and performance factor into the market. Consumers
should be able to choose between the type of ecosystems and antitrust law should not
artificially eliminate them. In essence, Epic Games ignores these marketplace realities
because, as it presumably knows, Apple does not have market power in the smartphone
market. Rather Apple only has 15 percent of global market share in 2020.

[. . .]

B. Epic Games: iOS App Distribution Aftermarket

Given the Court’s rejection of the foremarket theory, the aftermarket theory fails
as it is tethered to the foremarket. Although the Court rejects plaintiff’s foremarket
construct, it nonetheless discusses additional factual problems with the aftermarket
theory given plaintiff’s focus on those issues. In effect, plaintiff really urges a single-brand
analysis because Apple’s exclusionary conduct impacts Epic Games’ ability to compete
in that space, both with respect to gaming and non-gaming apps.

Plaintiff claims that an aftermarket exists for four reasons. Each reason is tied to
the known legal framework in which antitrust cases are litigated and which is discussed
in the legal section below. That said, the four reasons are: One, the foremarket and
aftermarket are related but two separate markets. Two, there are restraints in the
aftermarket which are not in the foremarket. Three, the source of Apple’s market power
stems from its walled garden; not because of separate contractual agreements with
consumers. Four, competition in the initial market does not discipline Apple’s market in
the proposed aftermarket.

In terms of the trial record, the factual disputes reside in plaintiff’s fourth reason
which the Court addresses in this part of the Order. More specifically, the Court

40
addresses Epic Games’ evidence of (1) switching costs and alleged lock-in and (2)
substitution. The Court also considers Epic Games’ argument as to whether the Court
should consider all apps or only gaming apps.

[. . .]

From a broad perspective, Epic Games did not conduct any analysis of whether
consumers know that they are buying into a walled garden. Apple argues that its
business is successful precisely because of the reliability and security creating the walled
garden on the iOS devices and on which it competes (discussed below). Without a
consumer survey, there is no evidence that consumers are unaware of walled garden
before purchasing the smartphone. Thus, there is no “bait-and-switch.”

[. . .]

In terms of substitutes given the business realities of the market, the parties’
arguments hinge on their own respective definitions of the market. Epic Games spends
little time on this issue with respect to its definition. For Epic Games, there is an
aftermarket for iOS app distribution for which there is no substitute as it occupies the
entire field.

Given Apple’s proposed market of all digital game transactions, Apple argues that
all the other game transaction platforms are substitute platforms for the App Store. Those
platforms include ones accessed through all devices: mobile, tablets, consoles, and PCs.
Epic Games rebuts this claim. It makes two arguments. One, because developers create
apps for more than one platform, they do not view them as substitutes to reach the same
consumers. Two, economic and survey evidence show a lack of substitution.

[. . .]

In conclusion, the Fortnite data is basically mixed. Up to a third of iOS Fortnite

users already play on other devices, which makes their ability to substitute a given.
Another 20% undertook at least some substitution after Fortnite removal, including by
accessing devices on which they previously played Fortnite.

[. . .]

Consumers frequently own multiple devices and could in theory substitute across
them for game transactions. Surveys conducted by Apple show that gamers are especially
likely to use several devices, with 56% playing on both mobile and non-mobile platforms.

[. . .]

[T]he video gaming market appears highly eclectic and diverse. Indeed, neither
Mr. Sweeney’s nor Mr. Kosmynka’s descriptions, which focus on linear narratives and
competitive modes, captures the diversity of gaming that appears to exist in the gaming

41
industry today. Mr. Allison acknowledges that while some games are competitive, and
are appropriately labeled as such on the Epic Games Store’s website, other games are not
necessarily competitive. Given the genre of simulation games like The Sims or SimCity, or
open-ended sandbox games like Minecraft, the Court cannot conclude that any linear
narrative is required to qualify as a video game. Thus, the Court concludes that video
games include a diverse and eclectic genre of games, that are tied together at minimum
through varying degrees of interactivity and involvement from a game player.

[. . .]

The wider video game market appears dynamic, innovative, and competitive. This
wider market includes at least four distinct submarkets for digital game app distribution:

1. online mobile app transaction platforms (i.e., the App Store, the Google Play app
store, and the Samsung Galaxy Store);

2. online gaming stores found on desktop and personal computers (“PCs”), including
online transaction platforms focused on game distribution (e.g., Valve Steam), and
developers’ own stores that directly distribute their games (e.g., Epic Games Store);

3. digital stores on consoles (i.e., Sony PlayStation, Microsoft Xbox, and Nintendo
Switch); and,
4. more recently, streaming game services (e.g., Nvidia GeForce Now, Microsoft Xbox
Cloud Gaming, Google Stadia).
The gaming market today is the result of actions taken by competitors in the last two
decades. The first successful online platform focused on game distribution was Steam,
which launched in 2003. Steam By pioneering digital distribution on the PC, Steam
enjoyed “a real boom in both Steam’s business and just PC gaming and digital gaming in
general.” Steam “is a dominant player in the space and was in 2018 with 70 to 85 percent
market share depending on how you define the space.”

Steam’s success resulted in the rise of other PC-focused digital distribution

platforms. In addition, the console platform owners created their own digital
marketplaces: Microsoft launched Xbox Live Marketplace in 2005 (now Xbox Games
Store on Xbox Series X and S), Sony launched the PlayStation Store in 2006, and Nintendo
launched the Wii Shop Channel that same year (now the Nintendo eShop on the Switch).
Most of these platforms, including Steam, charged a 30% commission.

Since the App Store launched in 2008, the marketplace participants for game app
distribution increased. For example, Google announced the Android Market in 2008
(which later became Google Play in 2012), Nokia and Samsung launched their Ovi Store
and Galaxy Apps Store in 2009, and Nintendo launched its eShop for its 3DS device in
2011.

42
 Today, “[t]here are many ways to monetize [an] app on the App Store,” and Apple,
like other industry participants, facilitates a variety of business models for developers. At
least with respect to the App Store, there are at least five business models developers can
use to make money on their apps: the free, freemium, subscription, paid, and paymium
models. The record shows that under the “paid model,” (also called the “download and
install” model), for instance, a developer may charge a price for the user to download the
app. As discussed, a developer may instead choose the “freemium model,” allowing
users to download an app for free but permitting in-app purchases. Alternatively a
developer can offer subscriptions to users (for sale in the app, through a different
platform, or online), can sell users digital currencies that can be used in the app (for sale
in the app, through a different platform, or online), can sell advertisements in the app, or
can charge for in-app promotions and events.

[. . .]

Given the multitude and diversity of platforms available to consumers, it is not

surprising that there is, at a base and general level, some competition amongst them in the
overall video game market. As Mr. Sweeney remarked publicly in 2012:

[W]e have a lot of platforms coming together. There are the tablet platforms, there
are the smartphone platforms, and computers, you know, PC and Macintosh, and
then there are consoles, Xbox 360, PlayStation, Wii, and some new handheld
dedicated gaming devices, and God knows what else.

This is too many platforms. And we’re seeing now, iPad sales have surpassed the
sales of desktop PCs. That’s a real revelation to me. This is a product that wasn’t
invented until a few years ago, and it’s basically supplanting the personal
computer industry as we know it.

Over time, these platforms will be winnowed down into a much smaller set of
competing platforms. You know, there might be one or two or maybe three
winners worldwide across everything—computers, game platforms,
smartphones.
So we should expect a lot of consolidation here, and winners and losers according
to who picks the right directions and executes successfully on them.

[. . .]

Of course, the Court must determine where the actual competition lies between
these platforms based on the current state of play in the overall market. This is a close
question where the general video game market appears to be evolving and dynamic.
While there is some competition amongst the players in the general video game market,
the Court cannot say that this overall competition is sufficient for purposes of defining a
relevant product market—at least not at this time.

43
 What makes this determination difficult is that the market appears to be somewhat
in flux. With the recent success of truly cross-platform games like Microsoft’s Minecraft
and Epic Games’ own Fortnite, these disparate platforms, each with their own unique and
competitive advantages, are truly competing for consumers who wish to consume these
increasingly popular cross-platform games and any transactions made therein. Indeed,
video games can and are able to be ported across multiple devices. However, not all
games are like Minecraft or Fortnite; the market still reflects that video games are, for the
most part, cabined to certain platforms that take advantage of certain features of that
platform, such as graphics and processing, or mobility. The record reflects that the
industry players are only slowly and recently reacting to compete against the wider
gaming platforms.

With cross-platform games like Fortnite available on multiple devices, these

platforms are truly competing against one another for these in-app transactions. For
instance, an internal Epic Games email from September 2018 notes that “purchase
behavior may have changed with the addition of mobile, especially Apple and more
recently Android, where users are just logging onto their mobile app to purchase.” In
other words, “most players are still playing on PC/Epic platform[s] as they did before,
but purchasing on other platforms like mobile because it may be easier and more
convenient [i.e.] when the store updates.” This is despite the fact that iOS Fortnite players
consisted of only approximately 10% of daily active users, and Fortnite players generally
prefer playing on alternative platforms.

[. . .]

Using this same methodology, the Court can calculate Apple’s market share in the
mobile industry before 2017, as 52.9% in 2015 and 54.5% in 2016.

Similarly, for 2020, Apple estimates that its own global market share in the wider
video gaming industry is 28.2%, and cites on its internal business record to an external
Newzoo report that states that mobile gaming (including mobile and tablets) accounted
for 49% of global gaming revenue in 2020. Using these figures and the same methodology
as above, Apple would have 57.6% market share in the global mobile gaming industry in
2020.

[. . .]

IV. MARKET POWER IN RELEVANT MARKET

In addition to Apple’s market share in the relevant market of mobile gaming, the
Court examines other evidence of Apple’s market power in the mobile game transactions
market and considers pricing, nature of restrictions, operating margins, and barriers to
entry.

44
[. . .]

[T]he Court finds that operating margins are probative of market power. As
described above, the App Store operating margins are “extraordinarily high.” Thus, even
without comparison to other stores, the operating margins strongly show market power.

[. . .]

V. FACTS REGARDING ALLEGED ANTICOMPETITIVE EFFECT

[. . .]

A. Anticompetitive Effects: App Distribution Restrictions

1. Effects

With respect to Apple’s app distribution restrictions, Epic Games focuses on the
following alleged anticompetitive effects: (a) foreclosed competition; (b) increased
consumer app prices; (c) decreased output; (d) decreased innovation; and (e) effect on
other markets through the restrictions on app stores. Apple, in turn, argues that the
restrictions provide a safe and secure place to conduct game transactions and compensate
Apple for its procompetitive investments in iOS. The Court first addresses Epic Games’
evidence and then Apple’s procompetitive justifications in the next section.

a. Foreclosure of Competition

With respect to the issue of foreclosing competition, the contention is not in

dispute. Quite simply, Epic Games wanted to open a competing app store and could not.
The evidence is mixed as to the demand to do so. Epic Games relies on the experience of
Microsoft and Nvidia, which tried to offer native iOS game streaming apps (xCloud and
GeForce NOW) but were blocked by Apple’s restrictions. Both companies, however,
ultimately succeeded in making their apps available through the web. Although neither
party was fully satisfied with the results, their experiences do not show complete
foreclosure of competition.

Instead, Epic Games relies on comparative evidence with other markets. On

devices without app distribution restrictions, many app and game stores exist. For
instance, Windows and Mac computers host game publishers like Steam, Electronic Arts,
and Activision Blizzard who directly distribute through their own stores. Apple
executives have acknowledged that the Mac App Store matters primarily for Apple
software and smaller developers, while developers with market power are not on the
Mac store “because they don’t have to be.” According to Dr. Evans, there are at least ten
third-party stores on Mac and Windows, and most top apps are distributed directly from

45
the developer website. Indeed, several large game developers, like Google and Facebook,
have tried to distribute games on iOS in recent years.

[. . .]

b. Increased Consumer App Prices

Next, Epic Games argues that Apple’s app distribution restraints increase prices
for consumers. Epic Games’ argument is plausible. As Dr. Evans testified, “[w]e know
from economics, both theory but also practical experience, in situations where there are
barriers to competition and they’re removed that what typically happens [is] ... that prices
tend to fall [and] quality tends to improve.”

In the context of gaming, Dr. Evans’s observation has vivid illustration in the PC
market. The incumbent Steam store charged a 30% commission for decades before Epic
Games’ store entered with a 12% commission. Immediately before that time, Steam
lowered its commission to 20%, and its average commission rate declined to 10.7%.
Microsoft followed suit shortly after, with other stores offering pay-what-you-want. This
competition has affected platform margins, which are considerably smaller on PCs than
on other devices—5% compared to 45%.

Dr. Evans opines that the same would happen if Apple allowed third-party app
stores on iOS. He posits that numerous third-party app stores would enter iOS in the
absence of restraints and that these stores would compete for developers. The
competition would exert pressure on Apple, which would have to lower prices or
improve services. [. . . ]

Apple vigorously disputes this evidence. First, it points out that the 30%
commission is standard for other stores, including on competitive platforms. 483 For
instance, Apple charges 30% on Macs, which Dr. Evans agrees is competitive. However,
Apple’s argument is suspect. One, Apple relies on “headline” rates that Dr. Evans and
Dr. Schmalensee agree are frequently negotiated down. For example, the Amazon App
Store has a headline rate of 30%, but its effective commission is only 18.1%. Both Ms.
Wright and Mr. Sweeney testified that consoles frequently negotiate special deals for
large developers. Sealed evidence in this case confirms the same. Two, just because it is
the competitive rate for games in the console market, does not mean that the rate
translates to the mobile games market. As described above, the App Store has very
different operating margins than consoles, so even if the commission is the same, the
economics and the nature of the products are very different. Thus, ultimately, these
comparisons are not useful because the other stores do not operate in the same market.

46
Last, Apple argues that the 30% rate is commensurate with the value developers get from
the App Store. This claim is unjustified. One, as noted in the prior section, developers
could decide to stay on the App Store to benefit from the services that Apple provides.
Absent competition, however, it is impossible to say that Apple’s 30% commission
reflects the fair market value of its services. Indeed, at least a few developers testified that
they considered Apple’s rate to be too high for the services provided. Two, Apple has
provided no evidence that the rate it charges bears any quantifiable relation to the
services provided. To the contrary, Apple started with a proposition, that proposition
revealed itself to be incredibly profitable and there appears to be no market forces to test
the proposition or motivate a change.

Accordingly, the Court finds that Apple’s restrictions on iOS game distribution
have increased prices for developers. [. . .]

d. Decreased Innovation

Next, Epic Games argues that Apple’s app distribution restrictions harm
innovation.

[. . .]

Apple’s slow innovation stems in part from its low investment in the App Store.
As Mr. Barnes described, “[o]nly a small amount of direct and allocated R&D ... [flows]
... to the Apple App Store.” Apple argues that Epic Games fails to account for R&D that
affects multiple lines of the business, which counts as joint costs. Even Dr. Schmalensee
admitted that the estimates, which were put together specifically for Apple’s CEO, show
very little R&D allocated to the App Store. Thus, even if the Court accepts that some App
Store revenue goes to features that indirectly benefit developers, like hardware, the
evidence remains that “core” matchmaking features of the store see little investment.

Ultimately, the point is not that the Apple provides bad services. It does not: most
developers are satisfied with the App Store, particularly with its developer tools. Rather,
the point is that a third-party app store could put pressure on Apple to innovate by
providing features that Apple has neglected. Because this competition is currently
precluded, Apple’s restrictions reduce innovation in “core” game distribution services.

[. . .]

2. Business Justifications

Apple asserts two business justifications for its app distribution restrictions. First,
it argues that prohibitions on third-party app stores helps ensure a safe and secure
ecosystem. This benefits both users, who enjoy stronger security and privacy, and
developers, who benefit from a larger audience drawn by these features. It also benefits

47
Apple, which uses privacy and security as a competitive differentiator for its devices and
operating system.

Second, Apple claims that the distribution restrictions are part of its intellectual
property licensing arrangement for which it is entitled to be paid. As the owner of the
devices and operating system, Apple could choose not to license its IP and remain the
exclusive developer of iOS apps. Instead, Apple has actively licensed, developed, and
improved its IP for others, but only on the condition of iOS remaining a “walled garden.”
Thus, Apple argues that its contractual restrictions are necessary to protect its IP
investments and prevent free riding.

Epic Games responds that each of these justifications is pretextual. Apple’s

commission is wholly disconnected from—and not motivated by—its intellectual
property investments. Epic Games also contends that an exclusive app store is not
necessary to maintain security, which can be achieved through less restrictive means,
such as notarization.

[. . .]

When Apple first launched the App Store, it sought to “strike a really good path”
between the dependability of a closed device and the ability to run third-party apps of a
PC. As Mr. Jobs explained:

It is a dangerous world out there. There are mobile viruses of all sorts
that people have to put up with and so we’ve tried to strike a really good
path here. On one side you’ve got a closed device like the iPod, which
always works. You pick it up, it always works because you don’t have
to worry about third party apps mucking it up. And on the other side
you’ve got a Windows PC where people spend a lot of time every day
just getting it back up to where it’s usable and we want to take the best
of both. We want to take the reliability and the dependability of that
iPod and we want to take the ability to run third party apps from the PC
world but without the malicious applications.

Since then, security and privacy have remained a competitive differentiator for
Apple. Mr. Cook testified that privacy is “a very key factor, one of the top factors who
people choose Apple.” The documents bear this out: internal surveys show that security
and privacy was an important aspect of an iPhone purchasing decision for 50% to 62% of
users in most countries—and over 70% in India and Brazil—and an important part of an
iPad purchasing decision for 76% to 89% of users. Indeed, Mr. Sweeney himself owns an
iPhone in part because of its better security and privacy than Android.

Second, there is evidence that Apple’s restrictions benefit users. As noted above,
many users value their iOS devices for their privacy and security. As the result of having
a trusted app environment, users make greater use of their devices, including by storing

48
sensitive data and downloading new apps. The witnesses are unanimous that user
security and privacy are valid procompetitive justifications.

[. . .]

Epic Games argues that the security and privacy benefits described above can be
achieved without app distribution restrictions. As explained, most of the benefits derive
from app review, which screens for social engineering attacks, filters fraud and offensive
content, and impose heightened privacy requirements. Epic Games argues that the same
benefits can be achieved in other ways.

[. . .]

B. Anticompetitive Effects: In-App Payment Restrictions

[. . .]

Apple claims that IAP provides the most efficient method for collecting its
commission. Dr. Schmalensee opines that without IAP, Apple would have to rely on
sellers to remit its 30% commission, with little recourse other than a lawsuit if the money
was withheld. Due to the sheer volume of transactions on the App Store, this process
could quickly become unwieldy.

Epic Games does not directly dispute these claims. Instead, Epic Games challenges
Apple’s entitlement to a 30% commission in the first place.

[. . .]

c. Value of the Intellectual Property

As described above, Apple has not adequately justified its 30% rate. Merely
contending that its commission pays for the developer’s use of the App Store platform,
license to Apple’s intellectual property, and access to Apple’s user base only justifies a
commission, not the rate itself. Nor is the rate issue addressed when Apple claims that it
would be entitled to its commission even for games distributed outside the App Store
because it provides the device and OS that brings users and developers together.

[. . .]

Further, there is substantial evidence that Epic Games, and perhaps other larger
developers, bring their own audience to iOS. Fortnite was already popular when it
arrived on iOS and Apple sought exclusive Fortnite content to attract new users. See supra
Facts §§ I.B.2.d, I.B.4. That said, Epic Games wanted Apple’s user base, to which it did
not have access, as it had already saturated its other options. Also, Match Group found
that the majority of new users from the App Store organically searched for its apps (e.g.,

49
by typing in “Tinder”), while Apple contributed only 6% of discovery. For these
developers, Apple’s role in generating in-app purchases was “nothing” but it continued
to receive a 30% commission on in-app purchases.

C. Combined Effects

Because Apple has created an ecosystem with interlocking rules and regulations, it is
difficult to evaluate any specific restriction in isolation or in a vacuum. Thus, looking at
the combination of the challenged restrictions and Apple’s justifications, and lack thereof,
the Court finds that common threads run through Apple’s practices which unreasonably
restrains competition and harm consumers, namely the lack of information and
transparency about policies which effect consumers’ ability to find cheaper prices,
increased customer service, and options regarding their purchases. Apple employs these
policies so that it can extract supracompetitive commissions from this highly lucrative
gaming industry. While the evidence remains thin as to other developers, the conclusion
can likely be extended.

More specifically, by employing anti-steering provisions, consumers do not know

what developers may be offering on their websites, including lower prices. Apple argues
that consumers can provide emails to developers. However, there is no indication that
consumers know that the developer does not already have the email or what the benefits
are if the email was provided. For instance, Apple does not disclose that it serves as the
sole source of communication for topics like refunds and other product-related issues and
that direct registration through the web would also mean direct communication.
Consumers do not know that if they subscribe to their favorite newspaper on the web, all
the proceeds go to the newspaper, rather than the reduced amount by subscribing on the
iOS device.

While some consumers may want the benefits Apple offers (e.g., one-stop
shopping, centralization of and easy access to all purchases, increased security due to
centralized billing), Apple actively denies them the choice. These restrictions are also
distinctly different from the brick-and-mortar situations. Apple created an innovative
platform but it did not disclose its rules to the average consumer. Apple has used this
lack of knowledge to exploit its position. Thus, loosening the restrictions will increase
competition as it will force Apple to compete on the benefits of its centralized model or
it will have to change its monetization model in a way that is actually tied to the value of
its intellectual property.

PART II

APPLICATION OF FACTS TO THE LAW AND CONCLUSIONS THEREON

50
I. RELEVANT PRODUCT AND GEOGRAPHIC MARKET

A. Legal Framework

“A threshold step in any antitrust case is to accurately define the relevant market, which
refers to ‘the area of effective competition.’” FTC v. Qualcomm Inc., 969 F.3d 974, 992 (9th
Cir. 2020) (“Qualcomm”) (quoting Ohio v. Am. Express Co. (“Amex”), ––– U.S. ––––, 138 S.
Ct. 2274, 2285, 201 [Link].2d 678 (2018)); see also Image Tech. Servs., Inc. v. Eastman Kodak Co.,
125 F.3d 1195, 1202 (9th Cir. 1997) (“Image Tech Services II”) (“The relevant market is the
field in which meaningful competition is said to exist.”) (citation omitted). Monopoly
power under the first element can be defined as “the power to control prices or exclude
competition” and may be inferred from the defendant’s predominant market share in the
relevant market. United States v. Grinnell Corp., 384 U.S. 563, 571, 86 [Link]. 1698, 16 [Link].2d
778 (1966). In addition, “courts usually cannot properly apply the rule of reason without
an accurate definition of the relevant market.” Amex, 138 S. Ct. at 2285. Without a relevant
market definition, “there is no way to measure the defendant’s ability to lessen or destroy
competition.” Id. (simplified).

[. . .]

B. Analysis

1. Relevant Product Market

Epic Games constructs a framework to argue that there are three separate product
markets at issue. In the foremarket, Epic Games identifies the product market as one for
“Smartphone Operating Systems.” Epic Games contends in turn that there are two
derivative and relevant aftermarkets that flow from this initial foremarket, including the
“iOS App Distribution” market and “iOS In-App Payment Solutions.” Epic Games logic
flows as follows: the iOS in-app payment solutions market is an aftermarket of the iOS
app distribution market which is further an aftermarket of the smartphone operating
systems foremarket.

Apple, on the other hand, contends that there is only one relevant product: digital
game transactions. This includes any and all digital gaming transactions made on any
gaming platform. The Court has discussed the factual profiles of each of the proffer, see
supra Facts § II, and turns to the determination here.

[. . .]

The Court begins with Apple’s product market definition as it more closely aligns
with the Court’s conclusion. Then the Court discusses the reasons why Epic Games has
not properly defined the relevant product market.

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a. Apple’s Product Market Theory

[. . .]

i. Apps or Digital Game Transactions?

[. . .]

Having considered and reviewed the evidence, the Court concludes based on its
earlier findings of facts that the appropriate submarket to consider is digital game
transactions as compared to general non-gaming apps. See supra Facts § II.B.3. Indeed, the
Court concluded that there were nine indicia indicating a submarket for gaming apps as
opposed to non-gaming apps: (i) the App Store’s business model is fundamentally built
upon lucrative gaming transactions; (ii) gaming apps constitute a significant majority of
the App Store’s revenues; (iii) both the gaming, mobile, and software industry as well as
the general public recognize a distinction between gaming apps and non-gaming apps;
(iv) gaming apps and their transactions exhibit peculiar characteristics and users; (v)
game app developers often employ specialized technology inherent and unique to that
industry in the development of their product; (vi) game apps further have distinct
producers—game developers—that generally specialize in the production of only gaming
apps; (vii) game apps are subject to distinct pricing structures as compared to other
categories of apps; (viii) games and gaming transactions are sold by specialized vendors;
and (ix) game apps are subject to unique and emerging competitive pressures, that differs
in both kind and degree from the competition in the market for non-gaming apps. The
Court does not reiterate here the detail except to note the following significant points:

The evidence was undisputed that over 80% of apps in the App Store are free. For
those apps, the user pays nothing either inside the app or at the initial download. The
developer also pays nothing aside from an up-front $99 developer fee. Apple thus does
not collect commissions on those transactions. Moreover, many of those apps are subject
to special treatment, such as the “reader” rule, that allows them to bypass Apple’s
restrictions and commissions altogether. These differences create economic distinctions
between the two categories. Finally, there is insufficient evidence that most apps are
impacted by Apple’s alleged anticompetitive conduct.

By contrast, game apps are disproportionately likely to use in-app purchases for
monetization. Over 98% of Apple’s in-app purchase revenue came from games in 2018 to
2019. Moreover, game transactions overall accounted for 76% of Apple’s App Store
revenues in 2017, 62.9% in 2018, and 68% in 2020. Game commissions are also
substantially higher than average. Thus, in most economic ways, and in particular with
respect to the challenged conduct, the App Store is primarily a game store and secondarily
an “every other” app store.

52
 Game transactions are also widely recognized as belonging to a separate market.
The App Store, Google Play, and Amazon Appstore all include separate “tabs” for apps
and games which reflects that consumers view them differently. Apple analyzes them
separately with different heads of business for games and non-game apps. The
developers for game apps also tend to be distinct, specializing in games with little
revenue from non-game apps.

Finally, the App Store is also built upon specialized consumers—those iOS
consumers who play video games on iOS devices. As summarized above, it is iOS
consumers who make frequent in-app purchases within gaming apps who account for
the large majority of Apple’s revenues in the App Store. See supra Facts § 1.C.6.574 In other
words, there is a specialized subset of iOS gaming consumers who are generating and
accounting for a significantly disproportionate number of App Store billings and
revenue.

Accordingly, between digital game transactions and all app transactions, the
relevant product is game transactions. Contrary to Epic Games’ suggestion, that is not
because plaintiff sells games. Rather, it is because game transactions are
disproportionately affected by Apple’s challenged conduct, overwhelmingly subsidize
other apps, and are recognized as a distinct submarket. Obviously, Epic Games and
Apple compete in that market space. That Epic Games is in the market was the impetus
for the analysis, not the reason for the conclusion.

ii. All Gaming Transactions or Mobile Gaming Transactions?

The last metric the Court considers is whether to limit the product market to all
gaming transactions or only mobile gaming transactions. Apple argues for the former;
Epic Games argues (as an alternative) for the latter. The Court is again guided by the
“practical indicia” framework articulated in Newcal and Brown Shoe. The Court considers
these factors in its evaluation.

Having considered and reviewed the evidence, the Court concludes based on its
earlier findings of facts that the appropriate submarket to consider is the mobile gaming
transactions market. See supra Facts § II.D. This relevant product market would include
mobile game transactions on both mobile phone and tablet devices, which have the
competitive advantage of mobility or portability as compared to other platforms and
devices. Id. Indeed, as the Court summarized and found there, mobile gaming exhibits
several of the practical indicia discussed in Newcal and Brown Shoe including industry
and public recognition of the submarket as a separate economic entity, peculiar
characteristics and uses, distinct customers and producers, and specialized vendors. The
Court again does not repeat the entirety of the findings previously made, but discusses
the more significant and relevant findings here:

53
 Substantial evidence was presented showing that mobile gaming is a distinct
submarket. As an initial matter, Apple’s own documents recognize mobile gaming as a
submarket. One industry report describes mobile gaming as a “$100 billion industry by
itself” that accounts for 59% of global gaming revenue. While PC and console gaming has
grown more slowly, mobile gaming has experienced double-digit growth driven by “the
free-to-play model” with in-app purchases. “Remarkably,” this rapid growth “has not
significantly cannibalized revenues from the PC or console gaming markets,” which
suggests that consumers are not necessarily substituting among them.575 Another
industry report describes distinct user bases for mobile gaming: young children, teenage
girls, and older adults are disproportionally likely to be mobile gamers only.
Multiplatform gaming, by contrast, is driven by teenage boys and young adults under
25.

Even without Apple documents, the experts largely agree that mobile and non-
mobile platforms provide different types of games. Dr. Hitt—whom Apple
commissioned to show that game transactions are substitutable—ended up showing the
opposite. In his original written direct testimony (which Apple withdrew after cross-
examination), Dr. Hitt showed that only 12% and 16% of the most popular App Store
games are available on consoles. Both Dr. Hitt’s and Dr. Cragg’s trial testimony remain
in the record, and each shows that console games are largely separate from mobile games.
Moreover, while Dr. Hitt originally opined that mobile games are available on PCs, his
work could not be entirely reproduced during trial, as some of the games he listed as
available on both platforms (PC and mobile platforms) could not be found. The fact that
Apple tried and failed to show cross-availability of mobile games with PC indicates that
they are distinct.

This conclusion is bolstered in part by evidence from Dr. Cragg. Dr. Cragg finds
that the most popular games on mobile are only available on mobile, with a few games
also available on PCs. The types of games are also different, with many more casual
games on mobile and core games on PC and console platforms. For those games that are
available on multiple platforms, such as Fortnite, Dr. Cragg finds that the playing and
spending on different platforms is complementary, rather than substitution-focused,
because playing on another device increases the playtime and spending on the previous
devices.

[. . .]

Finally, as the Court concluded in the findings of facts, the Court would not at this
time find that the Switch or game streaming services are part of the mobile game
transactions market. This is in part due to the underdeveloped record on these products,
and in part on the relative recent introduction of these products to the market. While the
record supports a finding that these are new entrants into the same market space as Apple
and Google, whether these products ultimately are substitutable and reasonably
interchangeable by consumers remain to be seen.

54
 Accordingly, for the same reasons that game transactions, rather than app
transactions in general, are the proper focus in this case, the Court finds that mobile
gaming, including mobile devices and tablets, is a separate market from gaming in
general. Thus, the relevant product market is mobile gaming transactions.

b. Epic Games’ Approach: Foremarket/Aftermarket Market Definition

[. . .]

Determining whether a single-brand market is proper requires “a factual inquiry

into the ‘commercial realities’ faced by consumers.” Eastman Kodak Co. v. Image Tech.
Servs., 504 U.S. 451, 482, 112 [Link]. 2072, 119 [Link].2d 265 (1992) (“Eastman Kodak”) (quoting,
Grinnell Corp., 384 U.S. at 572, 86 [Link]. 1698). “Single-brand markets are, at a minimum,
extremely rare” and courts have rejected such market definitions “[e]ven where brand
loyalty is intense.” Apple, Inc. v. Psystar Corp., 586 F. Supp. 2d 1190, 1198 (N.D. Cal. 2008)
(internal quotation marks and citation omitted). But see id. (“Antitrust markets consisting
of just a single brand, however, are not per se prohibited .... In theory, it may be possible
that, in rare and unforeseen circumstances, a relevant market may consist of only one
brand of a product.”). Indeed, “[a] single brand is never a relevant market when the
underlying product is fungible.” Areeda & Hovenkamp § 563d. “It is an understatement
to say that single-brand markets are disfavored. From nearly the inception of modern
antitrust law, the Supreme Court has expressed skepticism of single-brand markets[.]” In
re Am. Express Anti-Steering Rules Antitrust Litig., 361 F. Supp. 3d 324, 343 (E.D.N.Y. 2019);
Herbert J. Hovenkamp, Markets in IP & Antitrust, 100 Geo. L.J. 2133, 2137 (2012)
(“[A]ntitrust law has found that a single firm’s brand constitutes a relevant market in
only a few situations.”).

Despite the foregoing, “in some instances one brand of a product can constitute a
separate market.” See Eastman Kodak, 504 U.S. at 482, 112 [Link]. 2072; see also Newcal, 513
F.3d at 1048 (“[T]he law permits an antitrust claimant to restrict the relevant market to a
single brand of the product at issue ....”). Antitrust law has continued to develop since
Eastman Kodak. Beginning there, the Supreme Court considered whether summary
judgment was appropriate for Kodak on a Sections 1 and 2 claims where the plaintiffs
had argued that Kodak possessed monopoly power in the aftermarket of sales of parts
and repair services, despite not having such power in the foremarket of equipment sales.
504 U.S. at 466–471, 112 [Link]. 2072. In affirming the Ninth Circuit’s reversal of summary
judgment, the Supreme Court identified two factors that supported the aftermarket
framework: the existence of significant (i) “information” costs and (ii) “switching costs.”
Id. at 473, 112 [Link]. 2072.

As to the first, information costs, the Supreme Court noted that “[f]or the service-
market price to affect equipment demand, consumers must inform themselves of the total
cost of the ‘package’—[in Eastman Kodak] equipment, service, and parts—at the time of
purchase; that is, consumers must engage in accurate lifecycle pricing.” Id. “Much of this

55
information is difficult—some of it impossible—to acquire at the time of purchasing,”
and that “even if consumers were capable of acquiring and processing the complex body
of information, they may choose not to do so [as a]cquiring [such] information is
expensive.” Id. at 473, 474, 112 [Link]. 2072. Indeed, “[i]f the costs of service are small
relative to the equipment price, or if consumers are more concerned about equipment
capabilities than service costs, they may not find it cost efficient to compile the
information.” Id. at 474–75, 112 [Link]. 2072.

As to the second factor, switching costs, the Supreme Court stated that “[i]f the
cost of switching is high, consumers who already have purchased the equipment, and are
thus ‘locked in,’ will tolerate some level of service-price increases before changing
equipment brands.” Id. at 476, 112 [Link]. 2072. “Under this scenario, a seller profitably
could maintain supracompetitive prices in the aftermarket if the switching costs were
high relative to the increase in service prices, and the number of locked-in customers were
high relative to the number of new purchasers.” Id. The Supreme Court further noted that
this strategy was “likely to prove profitable” especially where a “seller could simply
charge new customers below-marginal cost on the equipment and recoup the charges in
service,” or offer specific packages including “lifetime warranties or long-term service
agreements that are not available to locked-in customers.” Id. at 476–477, 112 [Link]. 2072.

In sum, given the presence of these two factors, the Supreme Court found a
question of fact “foil[ed] the simple assumption that the equipment and service markets
act as pure complements to one another.” Id. at 477, 112 [Link]. 2072.

Since 1992, five circuit courts and numerous district courts refused to find a Kodak-
type single-brand aftermarket where customers had knowledge of the alleged restrictive
policies and were not subject to a post-purchase policy change. Big tech may ultimately
convince the Supreme Court to change the calculus, but for now the state of antitrust law
has that distinct parameter.

[. . .]

The breadth of antitrust law on the issue has counseled that currently “to establish
a single-brand aftermarket under Kodak and Newcal, the restriction in the aftermarket
must not have been sufficiently disclosed to consumers in advance to enable them to bind
themselves to the restriction knowingly and voluntarily.” Datel Holdings Ltd. v. Microsoft
Corp., 712 F. Supp. 2d 974, 987 (N.D. Cal. 2010). Indeed, “[m]arket imperfections” may
“prevent consumers from discovering” that purchasing a product in the initial market
could restrict their freedom to shop in the aftermarket. Newcal, 513 F.3d at 1048; see also
Red Lion Med. Safety, Inc. v. Ohmeda, Inc., 63 F. Supp. 2d 1218, 1231 (E.D. Cal. 1999)
(“Information costs may be high, and a manufacturer may thus have considerable market
power in the aftermarket, even in the absence of a change in policy.”); Ward v. Apple Inc.,
Case No. 12-cv-05404-YGR, 2017 WL 1075049, at *7 (N.D. Cal. Mar. 22, 2017) (agreeing
with Red Lion, 63 F. Supp. 2d at 1231–32, that a policy change is not necessary to find a

56
valid single-brand market under Newcal). In other words, a plaintiff must show evidence
“to rebut the economic presumption that [defendant’s] consumers make a knowing
choice to restrict their aftermarket options when they decide in the initial (competitive)
market to” purchase in the foremarket. Newcal, 513 F.3d at 1050.

With these principles in mind, the Court analyzes the evidence presented.

As noted, Epic Games created a construct that largely satisfies the Newcal test. By
definition, distribution of iOS apps and iOS payment processing derive from Apple’s
operating system (first factor). Next, Epic Games only identified restraints that related to
the distribution and payment processing, so again, by design, they do not relate to the
“market for Apple’s operating system” (second factor). Similarly, given that (i)
consumers do not contractually agree to obtain apps only through the App Store when
they purchase an iPhone; (ii) developers are contractually restricted in the aftermarket;
and (iii) in light of the technical restrictions on iOS devices, Apple’s market power flows
from its relationship with its consumers and Apple did not achieve market power in the
aftermarket through contractual provisions that it obtains in the initial market (third
indicator). Thus, three of the four indicators are fulfilled.

It is within the last indicator that problems arise for Epic Games given antitrust
jurisprudence. Issues of lock-in or switching costs, and notice or consumer knowledge,
fall under the analysis of evaluating whether competition in the initial market suffices to
discipline anticompetitive practices in the aftermarkets.

First, the evidence shows no material change in the conditions for accessing the
App Store for either side of the platform. In the Sixth Circuit, the absence of a change in
policy following the consumers’ initial purchase in the alleged foremarket, which locked
consumers into the alleged aftermarket (i.e., the concept of lock-in), was fatal. See PSI
Repair Servs., Inc., 104 F.3d at 820. For consumers, iOS has always been a closed system,
and the App Store has been a “walled garden” with respect to native apps from its
inception; even prior to any time in which Apple was alleged to have become a
monopolist. Indeed, it is undisputed by the parties that a key distinguishing feature of
the iOS platform is its closed platform model, as compared to the open Android platform
maintained by its main competitor Google. At the very least, previous consumers of iOS
devices would have been familiar with the iOS platform and the App Store model when
they repurchased a device prior to 2011.

[. . .]

Second, Epic Games failed to prove lock-in, even absent a policy shift. Given the
weak showing, plaintiff either found itself with an unachievable task or insufficient time
to address the issue. In short, there is no evidence in the record demonstrating that
consumers are unaware that the App Store is the sole means of digital distribution on the
iOS platform. Specifically, there is no evidence in the form of consumer survey data
demonstrating the extent of consumers knowledge when purchasing of an iOS device,

57
much less that they are unaware they are purchasing into a closed ecosystem that is
tightly controlled by Apple.

Instead of addressing the issue head-on, Epic Games pivots to argue that the
market imperfections prevent consumers from discovering the true costs of downloading
apps. In other words, even those consumers who know the facts about Apple’s practices
in the iOS app distribution market typically do not or cannot effectively take those facts
into account when choosing a smartphone and operating system because the cost of
distributing apps is low compared to the overall cost of a smartphone and because it is
difficult to calculate and compare the lifecycle costs of smartphones between smartphone
operating systems.

These arguments are not supported by the record. Epic Games fails to quantify the
actual cost to consumers on downloading and purchasing apps and in-app purchases.
Indeed, if anything, the record reflects that cross-platform functionality and apps have
only proliferated since the early 2010s, where middleware like streaming services and
cross-platform games have only made switching platforms and devices easier and more
convenient. That is, the market is responding and evolving.

Epic Games’ sole focus on iOS devices simply ignores the market reality that is
available to consumers. The Court’s definition of the product as “digital mobile game
transactions” takes into account that the App Store competes against other platforms for
both consumers and developers. Indeed, as discussed in the findings of facts, several
recent entrants into the mobile gaming submarket, from Nintendo, Microsoft, and
Nvidia, show that this submarket is presently evolving and is dynamic. Moreover, the
continued rise and popularity of cross-platform games like Fortnite and Minecraft offered
on a variety of platforms, even beyond mobile gaming devices, are making switching
between platforms seamless because a consumer can carry over rewards and progress
between the diverse platforms. As a result, neither consumers nor developers are
“locked-in” to the App Store for digital mobile game transactions—they can and do
pursue game transactions on a variety of other mobile platforms and increasingly other
game platforms. Although the state of the wider gaming market is not at a level where
the entirety of these gaming platforms can truly be characterized as competing for
purposes of antitrust law (e.g., substitutes), the continued rise of cross-platform games,
technologies, and innovative ways in which to reach consumers only demonstrate that
these differing platforms are converging and ever intertwining.

In sum, with seasoned antitrust counsel at the helm, Epic Games created a market
definition which theoretically made a strong showing within the Newcal and Eastman
Kodak framework. For the reasons explained above, the market definition was
fundamentally flawed, and in any event, does not satisfy all four of the Newcal factors.
With respect to the Court’s ultimate finding that the relevant market is mobile gaming
transactions, the Court further finds that, at a minimum, the fourth Newcal factor would
similarly not be adequately satisfied on the record before the Court.

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[. . .]

II. SECTIONS 1 AND 2 OF THE SHERMAN ACT (COUNTS 1, 3, 4, 5)

[. . .]

B. Assessing Apple’s Market Power in the Relevant Product and Geographic Market

1. Legal Framework

Market power and monopoly power are related but distinct concepts. As the
Supreme Court has stated: “market power is the ability to raise prices above those that
would be charged in a competitive market.” NCAA v. Bd. of Regents of the Univ. of
Oklahoma, 468 U.S. 85, 109 n.38, 104 [Link]. 2948, 82 [Link].2d 70 (1984). Monopoly power is
“the power to control prices or exclude competition.” Grinnell Corp., 384 U.S. at 571, 86
[Link]. 1698.

The difference between the two is a matter of degree. “Monopoly power under §
2 requires, of course, something greater than market power under § 1.” Eastman Kodak,
504 U.S. at 481, 112 [Link]. 2072; see also Image Tech. Servs. II, 125 F.3d at 1206 (same). Courts
have described the distinction as “substantial” market power or an “extreme degree” of
market power. See, e.g., Bacchus Indus., Inc. v. Arvin Indus., Inc., 939 F.2d 887, 894 (10th Cir.
1991) (defining monopoly power as “substantial” market power); Deauville Corp. v.
Federated Dep’t Stores, Inc., 756 F.2d 1183, 1192 n.6 (5th Cir. 1985) (defining monopoly
power as an “extreme degree of market power”); Safeway Inc. v. Abbott Lab’ys, 761 F. Supp.
2d 874, 886 n.2 (N.D. Cal. 2011) (defining monopoly power as a substantial degree of
market power). Courts have also required that the monopoly power be beyond fleeting
or ephemeral which the Court understands to be durable and sustaining. See United States
v. Syufy Enters., 903 F.2d 659, 665–66 (9th Cir. 1990) (“In evaluating monopoly power, it
is not market share that counts, but the ability to maintain market share.” (emphasis in
original)); Colo. Interstate Gas Co. v. Nat. Gas Pipeline Co. of Am., 885 F.2d 683, 695–96 (10th
Cir. 1989) (finding a firm lacked monopoly power because its “ability to charge monopoly
prices will necessarily be temporary”).

“[M]arket share is just the starting point for assessing market power.” Hunt-
Wesson Foods, Inc. v. Ragu Foods, Inc., 627 F.2d 919, 925 (9th Cir. 1980). It “should not be
equated with monopoly power” but instead is “evidence from which the existence of
monopoly power may be inferred ....” Hunt-Wesson, 627 F.2d at 924. Indeed, as the Ninth
Circuit has cautioned, “[b]lind reliance upon market share, divorced from commercial
reality, could give a misleading picture of a firm’s actual ability to control prices or
exclude competition.” Id. In other words, “market share, while being perhaps the most
important factor, does not alone determine the presence or absence of monopoly power.”

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Pac. Coast Agr. Export Ass’n v. Sunkist Growers, Inc., 526 F.2d 1196, 1204 (9th Cir. 1975)
(affirming jury finding where defendant controlled anywhere from 45-70% of the market
and competitors were fragmented with less than 12 to 18% of the market).

The threshold of market share for finding a prima facie case of monopoly power is
generally no less than 65% market share. See Image Tech. Servs. II, 125 F.3d at 1206 (“Courts
generally require a 65% market share to establish a prima facie case of market power.”);
Hunt-Wesson, 627 F.2d at 924–25 (“market shares on the order of 60 percent to 70 percent
have supported findings of monopoly power”).592 A more conservative threshold would
require a market share of 70% or higher for monopoly power. See Kolon Indus. Inc. v. E.I.
DuPont de Nemours & Co., 748 F.3d 160, 174 (4th Cir. 2014) (“Although there is no fixed
percentage market share that conclusively resolves whether monopoly power exists, the
Supreme Court has never found a party with less than 75% market share to have
monopoly power. And we have observed that when monopolization has been found the
defendant controlled seventy to one hundred percent of the relevant market.” (citations
omitted)); Syufy Enters. v. Am. Multicinema, Inc., 793 F.2d 990, 995 (9th Cir. 1986) (“[A]s
far as we know, neither the Supreme Court nor any other court has ever decided whether
a market share as low as 60-69% is sufficient, standing alone, to sustain such a finding.”).
Relatedly, “numerous cases hold that a market share of less than 50 percent is
presumptively insufficient to establish” the requisite level of market power under a
Section 2 claim. Rebel Oil Co., Inc. v. Atl. Richfield Co., 51 F.3d 1421, 1438 (9th Cir. 1995).

By contrast, Section 1 claims can be satisfied with less market power. For instance,
the Ninth Circuit affirmed a finding of a Section 1 violation where the market share was
as low as 24% but has also found market share above 30% insufficient. See, e.g., Twin City
Sportservice, Inc. v. Charles O. Finley & Co., 512 F.2d 1264 (9th Cir. 1975). But see also Jefferson
Parish, 466 U.S. at 26 & n.43, 104 [Link]. 1551 (30 percent market share insufficient); Pilch v.
French Hosp., No. CV 98-9470 CAS(CWX), 2000 WL 33223382, at *7 (C.D. Cal. Apr. 28,
2000) (33.2 percent market share insufficient).

Here, the Court considers other market factors in the form of direct and indirect
evidence. First, direct evidence is evidence “of the injurious exercise of market power”
such as “evidence of restricted output and supracompetitive prices.” Rebel Oil Co., 51 F.3d
at 1434. This kind of evidence is “direct proof of the injury to competition which a
competitor with market power may inflict, and thus, [direct proof] of the actual exercise
of market power.” Id. (citing FTC v. Indiana Fed’n of Dentists, 476 U.S. 447, 460–61, 106 [Link].
2009, 90 [Link].2d 445 (1986)).

The second and “more common type of proof is circumstantial evidence

pertaining to the structure of the market.” Id. To demonstrate market power indirectly, a
plaintiff must: “(1) define the relevant market, (2) show that the defendant owns a
dominant share of that market, and (3) show that there are significant barriers to entry
and show that existing competitors lack the capacity to increase their output in the short
run.” Id.[1]

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 Because “[a] mere showing of substantial or even dominant market share alone
cannot establish market power sufficient to carry out a predatory scheme,” a plaintiff
“must show that new rivals are barred from entering the market and show that existing
competitors lack the capacity to expand their output to challenge the predator’s high
price.” Rebel Oil Co., 51 F.3d at 1438–39, n.10 (“telltale factors” include “market share,
entry barriers and the capacity of existing competitors to expand output”). Entry barriers
are market characteristics “that prevent new rivals from timely responding to an increase
in price above the competitive level.” FTC v. Qualcomm Inc., 411 F. Supp. 3d 658, 684 (N.D.
Cal. 2019) (quotation marks omitted), rev’d on other grounds, 969 F.3d 974 (9th Cir. 2020).
They include “additional long-run costs that were not incurred by incumbent firms but
must be incurred by new entrants,” or “factors in the market that deter entry while
permitting incumbent firms to earn monopoly returns.” L.A. Land Co. v. Brunswick Corp.,
6 F.3d 1422, 1427–28 (9th Cir. 1993) (quotation marks omitted).

2. Analysis

As a starting point, the Court has found Apple’s market share in mobile gaming
transactions appears to fluctuate anywhere from approximately 52% to 57% over the
course of the three years in evidence. See supra Facts § II.E. While the prior figures suggest
that Apple’s share in mobile gaming is increasing, the more recent year reflects some
stability in the market between Apple and its main competitor, Google. That Apple has
more than a majority in a mostly duopolistic, and otherwise highly concentrated, market
indicates that Apple has considerable market power.

Apple’s market share is below the general ranges of where courts found monopoly
power under Section 2. Nonetheless, the Court considers additional direct and indirect
evidence to determine whether that market share should be sufficient under Section 2 or,
under any event, sufficient under Section 1.

In considering direct evidence of monopoly power, Epic Games has failed to

demonstrate that there is a necessary restriction in the output of the relevant product—
here, mobile game transactions. The record contains substantial evidence that output has
increased in mobile gaming transactions. See supra Facts §§ IV–V. Even though the Court
has concerns about the 30% rate and its appearance of being artificially higher (i.e.,
supracompetitive) than it would be in a more competitive market, there has not been the
corollary impact on output. This could be because of the technological nature of the
dispute. Id.; see also supra Facts § V.A.1.c. Nonetheless, given the manner in which this
case was litigated, Epic Games failed to produce evidence that this rate has had any
impact on the output of mobile gaming transactions.

“[S]upracompetitive pricing, on its own, is not direct evidence of monopoly

power.” Safeway Inc., 761 F. Supp. 2d at 887 (N.D. Cal. 2011) (citing Forsyth v. Humana,
Inc., 114 F.3d 1467, 1476 (9th Cir. 1997)) (“The plaintiffs submitted evidence that
[defendant] routinely charged higher prices than other [competitors] while reaping high

61
profits. With no accompanying showing of restricted output, however, the plaintiffs have
failed to present direct evidence of market power [under Section 2].”), overruled on other
grounds by Lacey v. Maricopa County, 693 F.3d 896 (9th Cir. 2012); see also Harrison Aire, Inc.
v. Aerostar Int’l, Inc., 423 F.3d 374, 381 (3d Cir. 2005); Geneva Pharmas. Tech. Corp. v. Barr
Lab’ys Inc., 386 F.3d 485, 500 (2d Cir. 2004); Blue Cross & Blue Shield United of Wisconsin v.
Marshfield Clinic, 65 F.3d 1406, 1412 (7th Cir. 1995). Indeed, “[t]o prove monopoly power
directly, supracompetitive pricing must be accompanied by restricted output.” Safeway
Inc., 761 F. Supp. 2d at 887 (citing Rebel Oil Co., 51 F.3d at 1434). In other words, “[b]oth
are required to prove monopoly power directly.” Id. Given the Court has found the
record, at best, incomplete, the lack of evidence of decreased output for mobile gaming
transactions and mobile game apps is fatal in demonstrating monopoly power using
direct evidence.

With respect to indirect evidence, a more mixed result emerges. A share between
52 and 57 percent is not high enough to sustain a prima facia case of a monopoly, but is
enough to permit the Court to evaluate the state and durability of the market. This
evaluation includes whether (i) new rivals are barred from entering the market (i.e., the
degree of entry barriers) and (ii) whether existing competitors lack the capacity to expand
their output to challenge the predator’s high price. In general, entry barriers are
“additional long-run costs that were not incurred by incumbent firms but must be
incurred by new entrants” or “factors in the market that deter entry while permitting
incumbent firms to earn monopoly returns.” L.A. Land Co., 6 F.3d at 1427–28. Such
barriers include “(1) “legal license requirements, (2) control of an essential or superior
resource, (3) entrenched buyer preferences for established brands; (4) capital market
evaluations imposing higher capital costs on new entrants; and, in some situations, (5)
economies of scale.” Rebel Oil Co., 51 F.3d at 1439 (citing L.A. Land Co., 6 F.3d at 1428 n.4).

Here, the evidence is both undeveloped and mixed. Given that mobile gaming was
not a proposed product market for either party, neither party has adequately presented
evidence of these barriers or competitors’ ability to challenge monopolistic actions. The
Court nonetheless considers the limited evidence in record.

On the one hand, only a small number of platforms, and their attendant licenses
on which to distribute mobile games, exist—namely iOS and Android. Moreover,
economies of scale in the form of network effects favor these established digital gaming
stores and platforms over new entrants. Finally, new entrants may face information
barriers to entry, as users may not know that cheaper game distribution may be available
on alternative platforms.596 Although these factors do not create “lock-in,” they are
evidence of some entry barriers for new companies providing mobile game transactions.

On the other hand, there are significant changes in both the wider gaming market
and the mobile gaming market—both appear to be in flux. Indeed, the evidence reflects
that the wider gaming market is both dynamic and evolving. Mobile gaming transactions
do not appear to be immune to this dynamism. The introduction of the hybrid platform

62
the Nintendo Switch in 2017 provides some evidence that the barriers of entry are not so
high as to deter competitors in related markets from entering the mobile gaming
transactions market.597 Moreover, Microsoft and Nvidia’s efforts into mobile game
streaming are further evidence that these entry barriers are not so substantial to prevent
new market entrants. Indeed, these competitors are moving into the same lucrative
mobile gaming submarket without facing substantial market barriers to entry. In short,
these competitors appear to be leveraging either existing intellectual property in the form
of hardware and gaming content as well as existing established networks, including its
own consumer and developer bases, to break into this market space. Given this recent
movement by competitors, it is hard to characterize the entry barriers as oppressive or
high on this record.

The evidence is further mixed on whether existing competitors, here Google, could
increase output in the short run in order to erode Apple’s market share. See Pacific Coast,
526 F.2d at 1204 (affirming jury’s finding of monopoly power where defendant had a
market share of 45 to 70% in the relevant years, and the remaining competitors “were
relatively small, with no single competitor controlling over 18% [or] 12%” of the market).
Beyond similar market share in this market, neither party explored mobile gaming and
the record is inconclusive on Google’s actual capabilities in disciplining and competing
with Apple in this sphere.

In sum, given the totality of the record, and its underdeveloped state, while the
Court can conclude that Apple exercises market power in the mobile gaming market, the
Court cannot conclude that Apple’s market power reaches the status of monopoly power
in the mobile gaming market. That said, the evidence does suggest that Apple is near the
precipice of substantial market power, or monopoly power, with its considerable market
share. Apple is only saved by the fact that its share is not higher, that competitors from
related submarkets are making inroads into the mobile gaming submarket, and, perhaps,
because plaintiff did not focus on this topic.

C. Section 1 of the Sherman Act: Apple’s Unlawful Restraint of the iOS App
Distribution Market (Count 3) and Unlawful Restraint on the iOS In-App Payment
Solutions Market (Count 5)

Epic Games brings two counts under Section 1 of the Sherman Act for unlawful
restraint of trade in the iOS app distribution aftermarket (Count 3) and in the iOS in-app
payment solutions aftermarket (Count 5). The legal framework is the same for both.

1. Legal Framework

Section 1 of the Sherman Act prohibits “[e]very contract, combination in the form
of trust or otherwise, or conspiracy, in restraint of trade or commerce among the several

63
States, or with foreign nations.” 15 U.S.C. § 1. Section 1 is understood “to outlaw only
unreasonable restraints.” Amex, 138 S. Ct. at 2283 (internal quotation marks and emphasis
omitted); State Oil Co. v. Khan, 522 U.S. 3, 10, 118 [Link]. 275, 139 [Link].2d 199 (1997); Standard
Oil Co. of N.J. v. United States, 221 U.S. 1, 59–60, 31 [Link]. 502, 55 [Link]. 619 (1911). “To
establish liability under § 1, a plaintiff must prove (1) the existence of an agreement, and
(2) that the agreement was in unreasonable restraint of trade.” Aerotec Int’l, Inc. v.
Honeywell Int’l, Inc., 836 F.3d 1171, 1178 (9th Cir. 2016).

Despite the broad language of the statute, antitrust law has developed to find that
“[t]he essence of a Section 1 claim is concerted action.” E.W. French & Sons v. Gen. Portland,
885 F.2d 1392, 1397 (9th Cir. 1989). “[E]xpress ‘agreements’” are “direct evidence of
‘concerted activity.’“ Paladin Assocs., Inc. v. Montana Power Co., 328 F.3d 1145, 1153 (9th
Cir. 2003); see also Sun Microsystems Inc. v. Hynix Semiconductor Inc., 608 F. Supp. 2d 1166,
1192 (N.D. Cal. 2009) (“One way of proving concerted action is by express agreement.”).
A plaintiff “need not prove intent to control prices or destroy competition to demonstrate
the element of an agreement among two or more entities.” Paladin Assocs., 328 F.3d at
1153–54 (internal quotation marks and alterations omitted). “Unilateral conduct by a
single firm, even if it appears to restrain trade unreasonably, is not unlawful under
Section 1 of the Sherman Act.” The Jeanery, Inc. v. James Jeans, Inc., 849 F.2d 1148, 1152 (9th
Cir. 1988) (internal quotation marks omitted); see also Monsanto Co. v. Spray-Rite Serv.
Corp., 465 U.S. 752, 761, 104 [Link]. 1464, 79 [Link].2d 775 (1984) (“Independent action is not
proscribed.”). Thus, in evaluating the first element, the Sherman Act distinguishes
between concerted conduct and unilateral conduct and “treat[s] concerted behavior more
strictly than unilateral behavior.” Copperweld Corp. v. Indep. Tube Corp., 467 U.S. 752, 768,
104 [Link]. 2731, 81 [Link].2d 628 (1984).

With respect to the second element, some restraints are per se unreasonable. Where
they are not, they are “judged under the ‘rule of reason.’” Amex, 138 S. Ct. at 2284. “The
rule of reason requires courts to conduct a fact-specific assessment of ‘market power and
market structure to assess the restraint’s actual effect’ on competition.” Id. (quoting
Copperweld Corp., 467 U.S. at 768, 104 [Link]. 2731) (alterations omitted). “Under this rule,
the factfinder weighs all of the circumstances of a case in deciding whether a restrictive
practice should be prohibited as imposing an unreasonable restraint on competition.”
Leegin Creative Leather Prods., Inc. v. PSKS, Inc., 551 U.S. 877, 885–86, 127 [Link]. 2705, 168
[Link].2d 623 (2007) (internal quotation marks and citation omitted). “Appropriate factors
to consider include specific information about the relevant business and the restraint’s
history, nature, and effect.” Id. “Whether the businesses involved have market power is
a further, significant consideration.” Id. (citation omitted). “In its design and function the
rule distinguishes between restraints with anticompetitive effect that are harmful to the
consumer and restraints stimulating competition that are in the consumer’s best interest.”
Id.

As the Supreme Court recently explained:

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 To determine whether a restraint violates the rule of reason, ... a three-step,
burden shifting framework applies. Under this framework, the plaintiff has
the initial burden to prove that the challenged restraint has a substantial
anticompetitive effect that harms consumers in the relevant market. If the
plaintiff carries its burden, then the burden shifts to the defendant to show
a procompetitive rationale for the restraint. If the defendant makes this
showing, then the burden shifts back to the plaintiff to demonstrate that the
procompetitive efficiencies could be reasonably achieved through less
anticompetitive means.

Amex, 138 S. Ct. at 2284 (citations omitted); see also Qualcomm, 969 F.3d at 989. The three
steps “do not represent a rote checklist” and are not “an inflexible substitute for careful
analysis.” NCAA v. Alston (“NCAA”), ––– U.S. ––––, 141 S. Ct. 2141, 2160, 210 [Link].2d 314
(2021). Rather, their purpose is “to furnish ‘an enquiry meet for the case, looking to the
circumstances, details, and logic of a restraint.’” Id. (quoting Cal. Dental Ass’n v. FTC, 526
U.S. 756, 781, 119 [Link]. 1604, 143 [Link].2d 935 (1999)).

2. Count 3: iOS App Distribution Market Analysis

a. Existence of an Agreement

Count 3 alleges that Apple “require[s] iOS developers distribute their apps
through the App Store.” Compl. ¶ 210. Starting with the first element, Epic Games relies
on the DPLA to demonstrate an agreement. As noted, express agreements provide “direct
evidence” of concerted activity. Paladin Assocs., 328 F.3d at 1153. Apple argues, however,
that the DPLA does not qualify because Apple unilaterally imposes it on developers. See
Costco Wholesale Corp. v. Maleng, 522 F.3d 874, 898 (9th Cir. 2008) (no “meeting of the
minds” from unilateral rules).

As explained above, the Sherman Act distinguishes between unilateral and

concerted activity. Jeanery, 849 F.2d at 1152. “Concerted activity subject to § 1 is judged
more sternly than unilateral activity under § 2” because it “deprives the marketplace of
the independent centers of decisionmaking that competition assumes and demands.”
Copperweld Corp., 467 U.S. at 768–69, 104 [Link]. 2731. It thus “warrant[s] scrutiny even in
the absence of incipient monopoly.” Id. Unilateral conduct, by contrast, may simply
represent “robust competition.” Id. at 767–68, 104 [Link]. 2731; see Qualcomm, 969 F.3d at
1005 (“hypercompetitive behavior” is not illegal under antitrust laws). Thus, even
unreasonable unilateral restraints are not subject to antitrust scrutiny unless “they pose
a danger of monopolization.” Copperweld Corp., 467 U.S. at 768, 104 [Link]. 2731.

Given this distinction, a business may set conditions for dealing unilaterally and
refuse to deal with anyone who does not meet those conditions. See Monsanto, 465 U.S. at

65
761, 104 [Link]. 1464. However, where the conduct extends beyond announcing a policy
and refusing to deal with non-compliant partners to coercing an agreement, the conduct
falls under Section 1. See id. at 765, 104 [Link]. 1464; see also Dimidowich v. Bell & Howell, 803
F.2d 1473, 1478 (9th Cir. 1986) (recognizing an exception to the “unilateral refusal to deal”
rule where a party “imposes restraints on dealers or customers by coercive conduct and
they involuntarily adhered to those restraints”).

For example, in Jeanery, a jeans manufacturer had set suggested prices for retailers
and made clear that those who set prices below the suggested price would be terminated
or receive less favorable treatment. 849 F.2d at 1150. A distributor undercut those prices
and was promptly terminated. Id. at 1151. The Ninth Circuit found no Section 1 violation
based on insufficient evidence of an agreement. Id. at 1155. Specifically, the Ninth Circuit
found no evidence that the manufacturer “coerced” the distributors into adherence or
that the distributors “communicated acquiescence to such an agreement.” Id. at 1158–60
(reasoning that manufacturer did not nothing more than inform distributors of its policy).
Conversely, such evidence was found in Monsanto, in which case an agricultural
manufacturer threatened to withhold herbicide at a time of short supply and even
complained to a distributor’s parent company to force compliance, which the distributor
expressly communicated in return. 465 U.S. at 764–65 & nn.9–10, 104 [Link]. 1464.

Here, the DPLA is a unilateral contract which the parties agree that a developer
must accept its provisions (including the challenged restrictions) to distribute games on
iOS. Thus, under antitrust jurisprudence, element one would not be satisfied. See Toscano
v. Prof. Golfers Ass’n, 258 F.3d 978 (9th Cir. 2001) (because the sponsors “did not help
create anticompetitive rules” but only “agreed to purchase products” under “conditions
set by the other party,” they were not liable for concerted conduct under Section 1). Id.

That said, the Court addresses here the potential conflicts with the goals of
antitrust law given this narrow view. The jurisprudence assumes that unilateral conduct
may simply be the result of robust competition. That may not always be the case. Ending
the analysis on that basis alone does not allow for those assumptions to be tested,
especially where, as here, the Court is faced with a highly concentrated market.

Nor is the jurisprudence particularly consistent with tying claims which are
allowed under Section 1. For example, a tying claim involves a seller exploiting “its
control over the tying product to force the buyer into the purchase of a tied product.”
Jefferson Parish, 466 U.S. at 12, 104 [Link]. 1551. The buyer plays no role beyond purchasing
the goods under conditions set by the seller. Similarly, an exclusive dealing claim
involves “agreement between a vendor and a buyer that prevents the buyer from
purchasing a given good from any other vendor.” Aerotec, 836 F.3d at 1180. Again, the
buyer passively accepts conditions set by the vendor. More recently, Amex involved an
anti-steering provision as a vertical restraint imposed by American Express on
merchants. 138 S. Ct. at 2277. The merchants accepted the provision as a condition of
dealing with American Express without further involvement. Id.

66
 Thus, while the Court does not find the DPLA provides sufficient evidence of an
agreement, it nonetheless continues the analysis to inform the issues relating to
anticompetitive and incipient antitrust conduct, especially given the anti-steering
provision therein.

b. Reasonableness of the Restraint

For the reasons stated, the Court turns to the second element using the rule of
reason test. Amex, 138 S. Ct. at 2284; see also Copperweld Corp., 467 U.S. at 768, 104 [Link].
2731 (explaining that vertical agreements “hold the promise of increasing a firm’s
efficiency and enabling it to compete more effectively” and so “are judged under a rule
of reason”). As the Court described in Amex:

The rule of reason requires courts to conduct a fact-specific assessment of “market

power and market structure ... to assess the [restraint]’s actual effect” on competition.
Copperweld Corp. v. Independence Tube Corp., 467 U.S. 752, 768, 104 S. Ct. 2731, 81 [Link].2d
628 (1984). The goal is to “distinguis[h] between restraints with anticompetitive effect
that are harmful to the consumer and restraints stimulating competition that are in the
consumer’s best interest.” Leegin Creative Leather Products, Inc. v. PSKS, Inc., 551 U.S. 877,
886, 127 S. Ct. 2705, 168 [Link].2d 623 (2007).

Amex, 138 S. Ct. at 2284. Recognizing that the rule of reason is not a “rote checklist,”
NCAA, 141 S. Ct. at 2160, the Court examines the app distribution restrictions and
considers their anticompetitive effects, procompetitive rationales, and less restrictive
alternatives. Amex, 138 S. Ct. at 2284.

i. Anticompetitive Effects

“To demonstrate anticompetitive effects on the two-sided [mobile gaming] market

as a whole,” plaintiff must prove that Apple’s app distribution provisions increased the
cost of mobile gaming transactions “above a competitive level, reduced the number of
[mobile gaming] transactions, or otherwise stifled competition in the [mobile gaming]
market.” See Amex, 138 S. Ct. at 2287. Evidence of this nature is considered direct
evidence. Id. at 2284 (simplified). Indirect evidence is also admissible and would involve
“proof of market power plus some evidence that the challenged restraint harms
competition.” Amex, 138 S. Ct. at 2284.

Here, the Court recognizes significant challenges in assessing the anticompetitive

effects of the app distribution restrictions. The market in mobile game transactions has
grown dramatically over recent years due to growth in gaming generally, smartphone
ownership, and digital transactions as a whole. Apple’s commission rate has remained
static throughout even though Google, Apple’s main competitor (and who also charges
a 30% commission rate), does not have the same app distribution restrictions. These facts
suggest prices are artificially high given Apple’s growing market power and growing

67
demand. Evaluating competitive effects under these circumstances would require
isolating the effects of a particular restriction. This is particularly difficult in light of the
expansive market growth caused by innovation in the field. It is for these reasons that
“novel business practices—especially in technology markets—should not be ‘conclusively
presumed to be unreasonable and therefore illegal without elaborate inquiry as to the
precise harm they have caused or the business excuse for their use.’“ Qualcomm, 969 F.3d
at 990–91 (emphasis in original) (quoting Microsoft Corp., 253 F.3d at 91).

Having carefully considering the evidence, the Court finds that Apple’s app
distribution restrictions do have some anticompetitive effects. The evidence here shows
that, unlike the increased merchant fees in Amex, Apple’s maintenance of its commission
rate stems from market power, not competition in changing markets. As explained above,
Apple set its 30% commission rate almost by accident when it first launched the App
Store without considering operational costs, benefit to users, or value to developers, that
is, both sides of the platform. That commission has enabled Apple to collect extraordinary
profits as Mr. Barnes credibly shows that the operating margins have exceeded 75% for
years. Yet the 30% commission rate has barely budged in over a decade despite developer
complaints and regulatory pressure. High commission rates certainly impact developers,
and some evidence exists that it impacts consumers when those costs are passed on.

With respect to indirect evidence, the Court discusses these effects in Facts §
V.A.1., but summarizes them here. Apple holds considerable market share, 55 percent.
Its restrictions harm competition by precluding developers, especially larger ones, from
opening competing game stores on iOS and compete for other developers and users on
price. Given this but-for-world, increased competition could result in a reduction of
Apple’s commissions charged to developers, who could then pass on savings to users.
Competing game stores could compete on features, including “search and
discoverability,” in-app payment processing, and security. This could improve the
innovation in and perhaps quality of “matchmaking” to increase output. Further,
competing game stores could provide specialized stores tailored to particular groups and
otherwise innovate to meet user and developer needs.

Accordingly, Epic Games has put proffered both direct and indirect evidence of
anticompetitive effects under Section 1.

ii. Procompetitive Justifications

In response, Apple offers three procompetitive justifications: security, intrabrand

competition, and protecting intellectual property investment. A procompetitive rationale
is a “nonpretextual claim that [defendant’s] conduct is indeed a form of competition on
the merits because it involves, for example, greater efficiency or enhanced consumer
appeal.” Qualcomm, 969 F.3d at 991. It is not enough that “conduct ‘has the effect of
reducing consumers’ choices or increasing prices to consumers.’” Id. at 990 (quoting
Brantley v. NBC Universal, Inc., 675 F.3d 1192, 1202 (9th Cir. 2012)). That is because these

68
effects may arise for procompetitive reasons, such as increased interbrand competition.
See Leegin, 551 U.S. at 891–93, 127 [Link]. 2705. In a two-sided transaction market, a court
must consider procompetitive effects on both sides of the market. Amex, 138 S. Ct. at 2287.

Here, the Court finds Apple’s security justification to be a valid and nonpretextual
business reason for restricting app distribution. As previously discussed, see supra Facts
§ V.A.2., centralized app distribution enables Apple to conduct app review, which
includes both technical and human components. Human review in particular helps
protect security by preventing social engineering attacks, the main vector of malware
distribution. Human review also helps protect against fraud, privacy intrusion, and
objectionable content beyond levels achievable by purely technical measures. By
providing these protections, Apple provides a safe and trusted user experience on iOS,
which encourages both users and developers to transact freely and is mutually beneficial.
As a result, Apple’s conduct “enhance[s] consumer appeal.” See Qualcomm, 969 F.3d at
991.

As a corollary of the security justification, the app distribution restrictions promote

interbrand competition. The Supreme Court has recognized that limiting intrabrand
competition can promote interbrand competition. Leegin, 551 U.S. at 890, 127 [Link]. 2705.
For example, restricting price competition among retailers who sell a particular product
can help the manufacturer of that product compete against other manufacturers. Id. at
890–91, 127 [Link]. 2705. It is this interbrand competition that “the antitrust laws are
designed primarily to protect.” Id. at 895, 127 [Link]. 2705. Here, centralized app
distribution and the “walled garden” approach differentiates Apple from Google. That
distinction ultimately increases consumer choice by allowing users who value open
distribution to purchase Android devices, while those who value security and the
protection of a “walled garden” to purchase iOS devices. This, too, is a legitimate
procompetitive justification.

Epic Games does not persuasively rebut the security justification nor shows it to
be pretextual. Instead, it focuses on the lack of app distribution restrictions (besides code
signing) on Mac computers. See supra Facts §§ V.A.1.a, [Link]. However, Apple
submits some evidence that Mac computers have more malware than iOS and, in any
case, provides a compelling explanation for app review’s increased effectiveness against
certain types of attacks. Epic Games also questions the effectiveness of app review in
practice. See supra Facts § V.A. That hardly provides a reason against app review. Epic
Games’ security expert agrees that “mayhem” would result if unfettered app distribution
were allowed. Thus, plaintiff’s proffer is really one of the “effectiveness” of Apple’s
security procedures, not the need for them. Whether the precise restrictions Apple has
selected could be replicated through less restrictive means is more properly addressed in
the next section. Given the trial record, the Court finds that Apple’s security rationale is
a valid business justification for the app distribution restrictions.

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 As for the intellectual property justification, the specific commission rate is
pretextual, as the Court previously found. As discussed in Facts § V.A.2.b, there is no
evidence that Apple set or maintains its specific commission rate with any consideration
of the value or cost of intellectual property in mind.609 Indeed, the Supreme Court
recently rejected a justification without “any direct connection” to the challenged
restraint in NCAA. 141 S. Ct. at 2162. There, a sport association argued that restrictions
on student athlete compensation were necessary to preserve amateurism and related
consumer demand. Id. at 2152. The Court rejected this justification based on the district
court’s findings that the association set those rules without any reference to
considerations of consumer demand. Id. at 2162–63 (quoting In re NCAA Athletic Grant-
in-Aid Antitrust Litig., 375 F. Supp. 3d 1058, 1070, 1075, 1100 (N.D. Cal. 2019)).

Eastman Kodak is further instructive. There, the photocopier maker argued that
companies providing repair services for its machines were “exploiting the investment
Kodak has made in product development, manufacturing and equipment sales.” Eastman
Kodak, 504 U.S. at 485, 112 [Link]. 2072. The Supreme Court declined to accept this argument
and find in Kodak’s favor as a matter of law. Id. at 486, 112 [Link]. 2072. Ultimately, on
remand, the Ninth Circuit affirmed a jury finding of pretext. The evidence showed that
“patents ‘did not cross [Kodak’s] mind at the time Kodak began its parts policy” and that
Kodak did not distinguish patented and unpatented parts in its policy. Image Tech. Servs.
II, 125 F.3d at 1219–20.

Like the defendants in those cases, Apple did not consider intellectual property in
setting its specific commission rate, nor does it list any specific intellectual property in
the DPLA. Thus, the justification with respect to the 30% commission rate is pretextual.

That said, while the Court has found the rate itself pretextual, the Court cannot
conclude that Apple’s protection of its intellectual property is pretextual. Courts have
found similar justifications based on the protection of intellectual property rights valid,
albeit rebuttable, procompetitive justifications. See, e.g., Tech. Res. Servs., Inc. v. Dornier
Med. Sys., Inc., 134 F.3d 1458, 1467 (11th Cir. 1998) (jury could have credited defendant’s
“need to protect its trade secrets and proprietary information”). Indeed, as the Court has
found, Apple is entitled to license its intellectual property for a fee, and to guard its
intellectual property from uncompensated use by others. The restrictions on app
distribution on the iOS platform accomplishes that aim, whereas Epic Games’ proposed
alternatives (discussed in more length below) would weaken it. In short, Epic Games has
failed to show that Apple’s proffered intellectual property justification is pretextual as it
relates to the restrictions on app distribution.

Accordingly, Apple has shown procompetitive justifications based on security and

the corollary interbrand competition, as well as generally with respect to intellectual
property rights.

iii. Less Restrictive Alternatives

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 Turning to the last step, the parties dispute whether these procompetitive
justifications could be achieved through less restrictive means. Generally, “antitrust law
does not require businesses to use anything like the least restrictive means of achieving
legitimate business purposes.” NCAA, 141 S. Ct. at 2161. “To the contrary, courts should
not second-guess degrees of reasonable necessity so that the lawfulness of conduct turns
upon judgments of degrees of efficiency.” Id. (simplified).

Thus, under the third step, an alternative must be “a significantly (not marginally)
less restrictive means for achieving the same procompetitive benefits.” Id. at 2164. It must
be “virtually as effective in serving the procompetitive purposes” as current rules
“without significantly increased cost.” In re NCAA Athletic Grant-in-Aid Cap Antitrust
Litig., 958 F.3d 1239, 1260 (9th Cir. 2020) (simplified), aff’d 141 S. Ct. at 2161. Where a
restraint is “patently and inexplicably stricter than is necessary to accomplish” the proffered
procompetitive objective, “an antitrust court can and should invalidate it and order it
replaced with a viable [less restrictive alternative].” Id. (quoting O’Bannon v. NCAA, 802
F.3d 1049, 1075 (9th Cir. 2015) (emphasis in original)).

Here, Epic Games argues that the app distribution restrictions can be replaced
with the enterprise model or the notarization model. As discussed above, see supra Facts
§ [Link]., Apple already implements both of these models on iOS and Mac,
respectively. The enterprise model enables Apple to certify organizations, such as
companies, to distribute apps to their own employees. This model could be extended to
certify app stores. The notarization model allows Apple to sign apps to verify security
while allowing them to be distributed as the developer wishes. Epic Games argues that
these models could be implemented on iOS with minimal technical difficulty.

However, missing from both the enterprise and notarization models is human app
review which provides most of the protection against privacy violations, human fraud,
and social engineering. These proposed alternatives would require Apple to either add
human review to the notarization model or leave app review to third-party app stores.
Apple executives suggested that the first option would not scale well. Under the second
option, Apple could in theory set minimum guidelines for app stores to provide a “floor”
for privacy, security, and quality. However, security could increase or decrease
depending on the quality and diligence of the store. Evidence shows that at least on
Android, the experiment shows less security.

In evaluating remedies, no court should “impose a duty that it cannot explain or

adequately and reasonably supervise.” NCAA, 141 S. Ct. at 2163 (quoting Verizon, 540
U.S. at 415, 124 [Link]. 872). Here, Epic Games has provided requests for its remedy which
principally appear to eliminate app review. The requests also leave unclear whether
Apple can collect licensing royalties and, if so, how it would do so. At closing argument,
Epic Games’ counsel suggested that “Apple can charge” for its license, so long as it does
not discriminate among developers. However, it has sought to require Apple to give
competing app stores access to the same “iOS functionality that the App Store has access

71
to,” which is more than the DPLA currently licenses. Thus, the Court need not consider
these possibilities because Epic Games has not sufficiently developed them.

In short, Epic Games has not met its burden to show that its proposed alternatives
are “virtually as effective” as the current distribution model and can be implemented
“without significantly increased cost.” In re NCAA Athletic Grant-in-Aid Cap Antitrust
Litig., 958 F.3d at 1260 (quoting O’Bannon, 802 F.3d at 1074). Nor has it shown that the
restraints are “patently and inexplicably stricter than is necessary.” Id. (quoting O’Bannon,
802 F.3d at 1074). “[A]ntitrust courts must give wide berth to business judgments before
finding liability.” NCAA, 141 S. Ct. at 2163. Here, Apple’s business choice of ensuring
security and protecting its intellectual property rights through centralized app
distribution is reasonable, and the Court declines to second-guess that judgment on an
underdeveloped record. See In re Citric Acid Litig., 191 F.3d 1090, 1101 (9th Cir. 1999)
(“Courts have recognized that firms must have broad discretion to make decisions based
on their judgments of what is best for them ....”).

Accordingly, the Court finds that Apple’s app distribution restrictions do not
violate Section 1 of the Sherman Act.

3. Count 5: iOS In-App Payment Solutions Market Analysis

In Count 5, Epic Games avers that Apple has unreasonably restrained trade in the “iOS
In-App Payment Processing Market” by requiring developers to “use Apple’s In-App
Purchase for in-app purchases of in-app content to the exclusion of any alternative
solution or third-party payment processor.” This claim fails for substantially the same
reasons that Count 3 fails. [. . .]

III. SECTION 1 OF THE SHERMAN ACT: TYING CLAIM (COUNT 6)

Epic Games’ Count 6 alleges a violation of Section 1 of the Sherman Act based on
the existence of a tie between app distribution, on the one hand, and IAP on the other.

A. Legal Standard

Tying involves the linking of two separate products from two separate product
markets. Jefferson Parish, 466 U.S. at 21, 104 [Link]. 1551. “[T]he essential characteristic of an
invalid tying arrangement lies in the seller’s exploitation of its control over the tying
product to force the buyer into the purchase of a tied product that the buyer either did
not want at all, or might have preferred to purchase elsewhere on different terms.” Id. at
12, 104 [Link]. 1551.

Tying arrangements may be evaluated under Section 1 of the Sherman Act under
either per se or rule of reason analysis. See id. at 29, 104 [Link]. 1551. The per se rule applies

72
“only after considerable experience with certain business relationships,” Broad. Music,
Inc. v. Columbia Broad. Sys., Inc., 441 U.S. 1, 9, 99 [Link]. 1551, 60 [Link].2d 1 (1979) (citation
omitted), shows that a restraint “always or almost always tend to restrict competition and
decrease output,” Amex, 138 S. Ct. at 2283 (citation omitted).

“For a tying claim to suffer per se condemnation, a plaintiff must prove: (1) that
the defendant tied together the sale of two distinct products or services; (2) that the
defendant possesses enough economic power in the tying product market to coerce its
customers into purchasing the tied product; and (3) that the tying arrangement affects a
not insubstantial volume of commerce in the tied product market.” Cascade Health Sols. v.
PeaceHealth, 515 F.3d 883, 913 (9th Cir. 2008); see also Jefferson Parish, 466 U.S. at 12–18, 104
[Link]. 1551; Eastman Kodak, 504 U.S. at 461–62, 112 [Link]. 2072.

The first element requires that the plaintiff must prove that the alleged tying
product and the alleged tied product are “separate and distinct” products. Rick-Mik
Enters., Inc. v. Equilon Enters. LLC, 532 F.3d 963, 974 (9th Cir. 2008). Further, if tied, the tie,
would link “two separate product markets.” Jefferson Parish, 466 U.S. at 21, 104 [Link]. 1551;
see also Microsoft Corp., 253 F.3d at 85 (“[U]nless products are separate, one cannot be ‘tied’
to the other.”).

“[T]he answer to the question whether one or two products are involved turns not
on the functional relation between them, but rather on the character of the demand for
the two items.” Jefferson Parish, 466 U.S. at 19, 104 [Link]. 1551; see also Rick-Mik, 532 F.3d at
975. There must be “sufficient demand for the purchase of [the tied product] separate
from [the tying product] to identify a distinct product market in which it is efficient to
offer [the tied product] separately from [the tying product].” Jefferson Parish, 466 U.S. at
21–22, 104 [Link]. 1551; see also Rick-Mik, 532 F.3d at 975.

“[T]he ‘purchaser demand’ test of Jefferson Parish examine[s] direct and indirect
evidence of consumer demand for the tied product separate from the tying product.
Direct evidence addresses the question whether, when given a choice, consumers
purchase the tied good from the tying good maker, or from other firms. Indirect evidence
includes the behavior of firms without market power in the tying good market,
presumably on the notion that (competitive) supply follows demand.” Rick-Mik, 532 F.3d
at 975 (internal quotation marks and citations omitted); see also id. (“If competitive firms
always bundle the tying and tied goods, then they are a single product.”).

With respect to the second element, a tie exists where “sale of the desired (‘tying’)
product is conditioned on purchase of another (‘tied’) product.” Aerotec, 836 F.3d at 1178.
“[T]he essential characteristic of an invalid tying arrangement lies in the seller’s
exploitation of its control over the tying product to force the buyer into the purchase of a
tied product that the buyer either did not want at all, or might have preferred to purchase
elsewhere on different terms.” Jefferson Parish, 466 U.S. at 12, 104 [Link]. 1551. “A plaintiff
must present evidence that the defendant went beyond persuasion and coerced or forced

73
its customer to buy the tied product in order to obtain the tying product.” Paladin Assocs.,
328 F.3d at 1159.

Finally, “the Supreme Court has condemned tying arrangements when the seller
has the market power to force a purchaser to do something that he would not do in a
competitive market.” Cascade Health Sols., 515 F.3d at 915. “[I]n all cases involving a tying
arrangement, the plaintiff must prove that the defendant has market power in the tying
product.” Illinois Tool Works Inc., 547 U.S. at 46, 126 [Link]. 1281; Rick-Mik, 532 F.3d at 972.

B. Analysis

At the outset, the parties dispute whether the per se analysis or the rule of reason
analysis should control the Court’s analysis. The Court need not decide this dispute. Epic
Games’ claim fails under either framework because a tying claim cannot be sustained
where the alleged good is not a “separate and distinct product.” Rick-Mik, 532 F.3d at 974;
Microsoft Corp., 253 F.3d at 85 (“[U]nless products are separate, one cannot be ‘tied’ to the
other.”). Here, Epic Games argues that a tying claim exists because Apple is forcing
distributors who use the iOS app distribution platform (the alleged tying product) to also
use IAP (the alleged tied product). As discussed above, supra Facts § II.C., IAP is not a
product. Two core factual issues lead to this conclusion: integration and consumer
demand.

With respect to integration, the Court described in detail how IAP functions and
the Court does not reiterate it here. Suffice it to say, IAP is not merely a payment
processing system, as Epic Games suggests, but a comprehensive system to collect
commission and manage in-app payments. This IAP system is not bought or sold but it
is integrated into the iOS devices. “[I]ntegration [is] common” among technological
products and services.” Microsoft Corp., 253 F.3d at 93.

Rick-Mik supports this conclusion. There, the Ninth Circuit found that Equilon’s
(also known as Shell Oil Co.) requirement that franchisees process all credit and debit
card transactions through Equilon’s own system did not involve two separate products.
Rick-Mik, 532 F.3d at 967, 974. Said differently, the purchase of an oil company’s franchise
(the tying product) and the requirement that it use Equilon’s credit-card processing
system (the tied product) were not two distinct products. Id. Rather, the Court found that
franchises are “almost by definition” a bundle of related products and services. Id. at 674.
The proper inquiry was whether the allegedly tied products were “integral components
of the business method being franchised.” Id.

Here, as there, IAP is but one component of the full suite of services offered by iOS
and the App Store. Moreover, and as discussed above, the App Store is a two-sided
transaction platform. See Amex, 138 S. Ct. at 2286 n.8 (noting that “a two-sided platform”
is one that “offers different products or services to two different groups who both depend
on the platform to intermediate between them”). By definition, the platform has two

74
sides: the developer on one side providing gaming apps and the consumer on the other,
purchasing the apps. This is a single platform which cannot be broken into pieces to create
artificially two products. See, e.g., Serv. & Training, Inc. v. Data Gen. Corp., 737 F. Supp.
334, 343 (D. Md. 1990) (rejecting tying claim because alleged tied product was “one
feature of [defendant’s] integrated and unified product”); Areeda & Hovenkamp § 1741a
(“a car with tires attached might be deemed a single product because a vehicle that can
be driven is the essence of what the customer buys”).

Moreover, with respect to consumer demand, Epic Games presented no evidence

showing that demand exists for IAP as a standalone product. As discussed above, supra
Facts § II.C., Epic Games’ argument mischaracterizes IAP and its functionality. Payment
processing is simply an input into the larger bundle of services provided by the IAP
system. While there may be a market for payment processing, that fact is irrelevant as
IAP is not just payment processing.

In sum, whether analyzed as an integrated functionality or from the perspective

of consumer demand, IAP is not a separate product from iOS app distribution. Thus, Epic
Games’ Count 6 fails to show the existence of an illegal tie under Section 1.

[. . .]

VI. CALIFORNIA’S UNFAIR COMPETITION LAW (COUNT 10)

Antitrust law does not end with the Sherman Act. “States have regulated against
monopolies and unfair competition for longer than federal government, and federal law
is intended only ‘to supplement, not to displace, state antitrust remedies.’“ In re Cipro
Cases I & II, 61 Cal. 4th at 160, 187 [Link].3d 632, 348 P.3d 845 (quoting Cal. v. ARC Am.
Corp., 490 U.S. 93, 102, 109 [Link]. 1661, 104 [Link].2d 86 (1989)); see also Areeda &
Hovenkamp §§ 216, 2401 (describing legislative history).

California’s Unfair Competition Law (“UCL”) prohibits business practices that

constitute “unfair competition,” which is defined, in relevant part, as “any unlawful,
unfair or fraudulent business act or practice.” Cal. Bus. & Prof. Code § 17200. Each of
these descriptions provides a separate “variety” of unfair competition. Thus, “a practice
may be deemed unfair even if not specially proscribed by some other law” and even if
not violating an antitrust statute. See Cel-Tech Commc’ns, Inc. v. L.A. Cellular Tel. Co., 20
Cal. 4th 163, 180, 187, 83 [Link].2d 548, 973 P.2d 527 (1999).

The UCL permits claims to be brought by any “person,” which includes “natural
persons, corporations, firms, partnerships, joint stock companies, associations and other
organizations of persons.” Cal. Bus. & Prof. Code §§ 17201, 17204. To bring a claim under
the UCL, a plaintiff must “(1) establish a loss or deprivation of money or property
sufficient to quantify as injury in fact, i.e., economic injury, and (2) show that the economic
injury was the result of, i.e., caused by, the unfair business practice.” Kwikset Corp. v.

75
Superior Court, 51 Cal. 4th 310, 322, 120 [Link].3d 741, 246 P.3d 877 (2011) (emphasis in
original); see also Cal. Bus. & Prof. Code § 17204.

Epic Games challenges Apple’s conduct under the “unlawful” and “unfair”
provisions of the UCL. Apple disputes both claims and further argues that Epic Games
lacks “customer” standing. The Court addresses standing and then each claim.

[. . .]

C. “Unfair” Practices

The “unfair” prong of the UCL may differ for consumer and competitor suits. As
a competitor who claims to have suffered injury from Apple’s unfair practices, Epic
Games must show that Apple’s conduct (1) “threatens an incipient violation of an
antitrust law,” (2) “violates the policy or spirit of one of those laws because its effects are
comparable to or the same as a violation of the law,” or (3) “otherwise significantly
threatens or harms competition.” Cel-Tech, 20 Cal. 4th at 187, 83 [Link].2d 548, 973 P.2d
527. These findings must be “tethered to some legislatively declared policy or proof of
some actual or threatened impact on competition.” Id. at 186–87, 83 [Link].2d 548, 973
P.2d 527; see also Hodsdon v. Mars, Inc., 891 F.3d 857, 866 (9th Cir. 2018).

As a quasi-consumer, on the other hand, Epic Games has several tests available for
showing unfairness. Although some courts have continued to apply the “tethering” test
stated above, others have applied a “balancing” test that requires the challenged business
practice to be “immoral, unethical, oppressive, unscrupulous, or substantially injurious
to consumers” based on the court’s weighing of “the utility of the defendant’s conduct
against the gravity of the harm to the alleged victim.”630 Drum v. San Fernando Valley Bar
Ass’n, 182 Cal. App. 4th 247, 257, 106 [Link].3d 46 (2010) (citations omitted). Stated
otherwise, the balancing test “involves an examination of that practice’s impact on its
alleged victim, balanced against the reasons, justifications and motives of the alleged
wrongdoer.” Nationwide Biweekly Admin., Inc. v. Superior Court of Alameda Cnty., 9 Cal. 5th
279, 303 n.10, 261 [Link].3d 713, 462 P.3d 461 (2020) (internal quotation marks and
citation omitted).

These tests “are not mutually exclusive.” Lozano v. AT&T Wireless Servs., Inc., 504
F.3d 718, 736 (9th Cir. 2007); see also Davis v. HSBC Bank Nevada, N.A., 691 F.3d 1152, 1169–
70 (9th Cir. 2012) (applying both tests). Accordingly, the Court considers both.

1. Tethering Test

Under the “tethering” test, “California courts require a close nexus between the
challenged act and the legislative policy.” Hodsdon, 891 F.3d at 866 (citation omitted). That
is because “courts may not apply purely subjective notions of fairness” or “determine the
wisdom of any economic policy,” which “rests solely with the legislature.” Cel-Tech, 20

76
Cal. 4th at 184, 83 [Link].2d 548, 973 P.2d 527 (internal quotation marks and citation
omitted). However, unfair practices under this test are not limited to violations of existing
laws. Id. at 180, 83 [Link].2d 548, 973 P.2d 527. Instead, California courts distinguish
between conduct made lawful (or for which relief is barred) by a statute and conduct not
prohibited by any statute. See id. at 183, 83 [Link].2d 548, 973 P.2d 527. The latter may
be actionable under the “unfair” prong. Id.

Here, Epic Games seeks relief for the same conduct that it challenged under the
Sherman and Cartwright Acts. Apple argues that separate consideration under the UCL
is inappropriate. The Court disagrees. Cel-Tech expressly recognizes that “incipient”
violations of antitrust laws and violations of the “policy or spirit” of those laws with
“comparable” effects are prohibited. 20 Cal. 4th at 187, 83 [Link].2d 548, 973 P.2d 527.
Under Apple’s interpretation, that standard would be rendered meaningless because any
conduct that fails under the Sherman Act failed would also fail the UCL. The UCL,
however, has “broad, sweeping language[ ] precisely to enable judicial tribunals to deal
with the innumerable new schemes which the fertility of [one’s] invention would
contrive.” Id. at 181, 83 [Link].2d 548, 973 P.2d 527 (simplified). Thus, it warrants
separate consideration apart from antitrust laws.

On the present record, however, Epic Games’ claims based on the app distribution
and in-app payment processing restrictions fail for the same reasons as stated for the
Sherman Act. As explained, Epic Games has demonstrated real anticompetitive effects,
but Apple has proffered mostly valid and non-pretextual procompetitive justifications.
To a large extent that makes the conduct more than “not anticompetitive” but potentially
beneficial to consumers. However, as the Court demonstrated, the procompetitive
justifications were only tethered as to certain restrictions. With respect to those
restrictions, under the Cel-Tech framework, Apple’s conduct is protected. 20 Cal. 4th at
183, 83 [Link].2d 548, 973 P.2d 527.

That does not, however, end the matter. “A UCL action is equitable in nature.”
Korea Supply Co., 29 Cal. 4th at 1144, 131 [Link].2d 29, 63 P.3d 937. Courts have “broad
discretion” to fashion equitable remedies to serve the needs of justice. Zhang v. Superior
Court, 57 Cal. 4th 364, 371, 159 [Link].3d 672, 304 P.3d 163 (2013); see also Nationwide
Biweekly Admin., 9 Cal. 5th at 300, 261 [Link].3d 713, 462 P.3d 461. The statute reinforces
that discretion by permitting courts to “make such orders or judgments ... as may be
necessary to prevent the use or employ by any person of any practice which constitutes
unfair competition.” Cal. Bus. & Prof. Code § 17203.

Epic Games did challenge and litigate the anti-steering provisions albeit the record
was less fulsome. While its strategy of seeking broad sweeping relief failed, narrow
remedies are not precluded. As discussed at length, the evidence presented showed
anticompetitive effects and excessive operating margins under any normative measure.
The lack of competition has resulted in decrease information which also results in
decreased innovation relative to the profits being made. The costs to developer are higher

77
because competition is not driving the commission rate. As described, the commission
rate driving the excessive margins has not been justified. Cross-reference to a historic
gamble made over a decade ago is insufficient. Nor can Apple hide behind its self-created
web of interlocking rules, regulations, and generic intellectual property claims; or the lack
of transparency among various businesses to feign innocence.

Apple’s own records reveal that two of the top three “most effective marketing
activities to keep existing users coming back” in the United States, and therefore
increasing revenues, are “push notifications” (no. 2) and “email outreach” (no. 3). Apple
not only controls those avenues but acts anticompetitively by blocking developers from
using them to Apple’s own unrestrained gain. As explained before, Apple uses anti-
steering provisions prohibiting apps from including “buttons, external links, or other
calls to action that direct customers to purchasing mechanisms other than in-app
purchase,” and from “encourag[ing] users to use a purchasing method other than in-app
purchase” either “within the app or through communications sent to points of contact
obtained from account registrations within the app (like email or text).” Thus, developers
cannot communicate lower prices on other platforms either within iOS or to users
obtained from the iOS platform. Apple’s general policy also prevents developers from
informing users of its 30% commission.

These provisions can be severed without any impact on the integrity of the
ecosystem and is tethered to legislative policy. As an initial matter, courts have long
recognized that commercial speech, which includes price advertising, “performs an
indispensable role in the allocation of resources in a free enterprise system.” Bates v. State
Bar of Arizona, 433 U.S. 350, 364, 97 [Link]. 2691, 53 [Link].2d 810 (1977) (citation omitted).
Restrictions on price information “serve to increase the difficulty of discovering the
lowest cost seller ... and [reduce] the incentive to price competitively[.]” Id. at 377, 97 [Link].
2691. Thus, “where consumers have the benefit of price advertising, retail prices often are
dramatically lower than they would be without advertising.” Id. Antitrust scholars have
recognized the same: “The less information a consumer has about relative price and
quality, the easier it is for market participants to charge supracompetitive prices or
provide inferior quality.” Areeda & Hovenkamp § 2008c.

In the context of technology markets, the open flow of information becomes even
more critical. As explained above, information costs may create “lock-in” for platforms
as users lack information about the lifetime costs of an ecosystem. Users may also lack
the ability to attribute costs to the platform versus the developer, which further prevents
them from making informed choices.637 In these circumstances, the ability of developers
to provide cross-platform information is crucial. While Epic Games did not meet its
burden to show actual lock-in on this record, the Supreme Court has recognized that such
information costs may create the potential for anticompetitive exploitation of consumers.
Eastman Kodak, 504 U.S. at 473–75, 112 [Link]. 2072.

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 Thus, although Epic Games has not proven a present antitrust violation, the anti-
steering provisions “threaten[ ] an incipient violation of an antitrust law” by preventing
informed choice among users of the iOS platform. Cel-Tech, 20 Cal. 4th at 187, 83
[Link].2d 548, 973 P.2d 527; cf. FTC v. Neovi, Inc., 604 F.3d 1150, 1158 (9th Cir. 2010)
(requiring that “consumers ha[ve] a free and informed choice” under the FTC test for
unfairness). Moreover, the anti-steering provisions violate the “policy [and] spirit” of
these laws because anti-steering has the effect of preventing substitution among
platforms for transactions. Id.

Accordingly, the Court finds that the anti-steering provisions violate the UCL’s
unfair prong under the tethering test.

2. Balancing Test

Under the balancing test, the Court must weigh “the utility of the defendant’s
conduct against the gravity of the harm to the alleged victim.” Drum, 182 Cal. App. 4th
at 257, 106 [Link].3d 46. Under this test the focus is on the injury to consumers. Here,
the harm to users and developers who are also quasi-consumers, is considerable. This
trial has exposed numerous anticompetitive effects which need not be recounted in detail.
The only justification Apple offers is an analogy: just like a store such as Nordstrom does
not advertise prices at Macy’s on its goods, Apple should not have to advertise prices on
the web or on Android. Apple also cites Amex, 138 S. Ct. at 2280, which also involved
anti-steering, to justify its anti-steering provisions.

Both are distinguishable. In Amex, American Express prohibited merchants from

dissuading customers from using Amex cards as a way of avoiding its merchant fees. Id.
at 2283. It did so because merchants would often advertise Amex acceptance to attract
users who used American Express’s rewards program, but then would steer them
towards cards with lower merchant fees, such as Visa or Mastercard. Id. at 2289. The
Court found that this was not anticompetitive because there was strong evidence of
procompetitive effects (as discussed above) and “[p]erhaps most importantly,
antisteering provisions do not prevent Visa, MasterCard, or Discover from competing against
Amex by offering lower merchant fees or promoting their broader merchant acceptance.”
Id. at 2289–90 (emphasis supplied).

Here, the information base is distinctly different. In retail brick-and-mortar stores,

consumers do not lack knowledge of options. Technology platforms differ. Apple created
a new and innovative platform which was also a black box. It enforced silence to control
information and actively impede users from obtaining the knowledge to obtain digital
goods on other platforms. Thus, the closer analogy is not American Express’ prohibiting
steering towards Visa or Mastercard but a prohibition on letting users know that these
options exist in the first place. Apple’s market power and resultant ability to control how
pricing works for digital transactions, and related access to digital products,
distinguishes it from the challenged practices in Amex. The same would extend to the

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Nordstrom/Macy’s analogy.641 Apple has not offered any justification for the actions
other than to argue entitlement. Where its actions harm competition and result in
supracompetitive pricing and profits, Apple is wrong. Accordingly, the harm from the
anti-steering provisions outweighs its benefits, and the provision violates the UCL under
the balancing test.

D. Remedies

[. . .]

Based on the reasoning discussed above, the Court finds the elements for equitable
relief are satisfied. While Apple’s conduct does not fall within the confines of traditional
antitrust law, the conduct falls within the purview of an incipient antitrust violation with
particular anticompetitive practices which have not been justified. Apple contractually
enforces silence, in the form of anti-steering provisions, and gains a competitive
advantage. Moreover, it hides information for consumer choice which is not easily
remedied with money damages. The injury has occurred and continues and can best be
remedied by invalidating the offending provisions. In terms of balancing, Apple’s
business justifications focus on other parts of the Apple ecosystem and will not be
significantly impacted by the increase of information to and choice for consumers. Rather,
this limited measure balances the justification for maintaining a cohesive ecosystem with
the public interest in uncloaking the veil hiding pricing information on mobile devices
and bringing transparency to the marketplace.

COMMENTS AND QUESTIONS

1. A nice analysis of the market impact of the ruling is here:

[Link]
yvonne-gonzalez-rogers-final-ruling-injunction-breakdown.
2. Apple wins in large part because the court concludes there is no market for
apps specific to Apple phones. Is it really the case that consumers can easily switch
between phone operating systems? Would they do so in order to play Fortnite? When
Apple kicked Epic off the App Store, could it simply switch to Android? Note that
Android had the same restriction on in-app purchases, and Epic is involved in parallel
litigation against them too. For a detailed discussion of why an iPhone is a practical
necessity in the U.S. today, and why that’s bad for the Internet, see
[Link]
Is the right market focused on Apple (apps) or on Fortnite (gaming)? Does it
matter that most Fortnite players use consoles to play? Might that change in the absence
of restrictions like Apple’s?

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 Judge Gonzalez Rogers says that “nothing other than legal action seems to
motivate Apple to reconsider pricing and reduce rates.” Isn’t that an indication they have
market power?
3. The court points to a robust game market with many different types of
platforms. But it also notes that most of those platforms charge the same 30% rate. Is that
an antitrust problem? Why or why not?

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 4. What justification is there for demanding that all in-game purchases go
through Apple’s payment system? Won’t that make it harder to run a game like Fortnite,
requiring anyone who buys a skin to step out of the game to complete the purchase? On
the other hand, if Apple can’t collect directly, will it be able to get paid at all in a freemium
model like Fortnite? Note that the court upholds the 30% fee but invalidates the anti-
steering provisions. That ruling has been stayed pending appeal as of this writing.
5. The court says antitrust law doesn’t prevent Apple from kicking Epic off
the App Store. But under Sega and Sony, could Epic side-load its game onto the phone
while bypassing the App Store? Would that be an adequate alternative? [Apple prevents
sideloading, but Android allows it. The court finds some but not all of Apple’s
justifications for requiring apps to run through the App Store pretextual.]
6. In what sense is there no agreement at issue here? If developers didn’t
follow the DPLA (which calls itself an agreement), could Apple sue for breach of contract?
7. The court found no antitrust violation. So why does Epic win under
California law? What exactly do they win? Here’s Matt Ball’s take:

In August 2020, Epic Games updated its Fortnite app such that users could use
Epic’s in-app payment solution, rather than the App Store’s. Within hours, Apple
removed the Fortnite app for the App Store, claiming policy violations, and Epic
Games in turn sued Apple arguing monopoly power (among other issues).

Not long after, Apple announced it would suspend Epic’s access to iOS’s
development tools and, as a result, Epic would no longer be able to update the
Unreal Engine. This put thousands of active iOS developers (i.e. businesses) in
immediate jeopardy — even impacting those whose games were licensed by
Apple for its Arcade subscription service. At any moment, a new bug could
emerge — potentially one resulting from a standard iOS update — and Epic would
be unable to patch it. And as long as Epic’s license was suspended, the iOS
implementation of Unreal would never be able to improve or be updated for
compatibility with newer iOS devices. This meant that every Unreal-based
developer had to make a choice: wait and hope that Apple and/or Epic would
settle before their game broke, or begin an entirely unnecessary, time consuming,
costly, and difficult process of rebuilding their games in another engine. And, in
stark contrast to Flash, Apple had long touted Unreal and Unreal-based games to
developers and players when unveiling its newest devices.
[Link] Note that none of this
requires Apple to let Epic back into the App Store, and they are still not on Apple devices
as of this writing.

WOLFIRE GAMES, LLC, on behalf of all others similarly situated, Plaintiffs,

82
 v.
VALVE CORPORATION, Defendant.
United States District Court for the Western District of Washington
2021 WL 5415305 (W.D. Wash. Nov. 19, 2021)

John C. Coughenour, UNITED STATES DISTRICT JUDGE

This matter comes before the Court on Defendant’s motion to dismiss. Having
thoroughly considered the parties’ briefing and the relevant record, the Court finds oral
argument unnecessary and hereby GRANTS in part and DENIES in part the motion for
the reasons described below.

I. BACKGROUND

Plaintiff Wolfire Games, LLC alleges, in a Consolidated Amended Class Action

Complaint (“CAC”), that Defendant utilizes anticompetitive practices and its monopoly
power to force Wolfire and similarly situated personal computer (“PC”) desktop game
publishers to pay Defendant supracompetitive fees for the sale of their games. The CAC
also contains allegations and claims for relief from game consumers. [. . .]

Defendant operates a PC desktop gaming platform (the “Steam Platform”) and a

retail electronic game store (the “Steam Store”). Wolfire asserts, through the CAC, that
Defendant forces game publishers to sell their games through the Steam Store, which
results in anti-competitive injury to Wolfire and similarly situated game publishers.
According to the CAC, Defendant initially created the Steam Platform to facilitate the
delivery of patches and updates for its own games. Defendant later launched the Steam
Store. At the time, it sold its own games through the Steam Store, which could only be
played on the Steam Platform. This is because PC desktop games are generally not
compatible across platforms due to the “unique functionality” of each platform.

At some point, Defendant opened up the Steam Platform to third-party game

publishers. However, like Defendant’s own games, those third-party games, if
compatible with the Steam Platform, were generally not compatible with other platforms.
Also, like Defendant’s own games, absent the limited use of Steam Keys, those games had
to be purchased through the Steam Store. Defendant does not charge a direct fee for
consumers’ use of the Steam Platform or its hosting of a third-party publishers’ games.
Instead, it generates revenue through a fee that it charges for each third-party game sold
in the Steam Store and for in-app purchases. Defendant initially set the fee at 30% but
now provides limited discounts to high-volume developers and/or publishers.

The initial appeal of the Steam Platform to game consumers was the ability to
maintain and update their game libraries in one location, regardless of which device they

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use to access the game. However, over time, Defendant added more functionality to the
platform. This included social networking features and other services, including a game
achievement tracking service. Based in part on this increased functionality, demand for
the platform steadily rose. Today, the “vast majority of all PC [d]esktop [g]ames are
played [ ] on the Steam Gaming Platform.” (Id. at 32.) As a result, Steam compatibility is
considered to be a “must-have.” (Id.)

According to the CAC, Defendant uses this market dominance to unlawfully tie
Steam Store sales to use of its Steam Platform and to impose price controls through
contractual provisions and coercion. (See generally id.) The CAC asserts that these
practices violate Sections 1 and 2 of the Sherman Act as well as the Washington Consumer
Protection Act (“CPA”). (Id.) Defendant moves to dismiss, at least with respect to Wolfire,
pursuant to Federal Rule of Civil Procedure 12(b)(6). (Dkt. No. 37.) It argues, inter alia,
that CAC’s tying claims are not supportable, given the integrated platform and
distribution market described in the CAC, and that the CAC fails to allege facts
supporting an antitrust injury. (See generally id.)

II. DISCUSSION

[. . .]

B. Relevant Market

According to the CAC, by 2020, Defendant reported 45,000 Steam-compatible

games and 120 million monthly active Steam Platform users. The Steam Store, where
those games are generally purchased, presently accounts for 75% of the $10 billion PC
desktop game market.

“A threshold step in any antitrust case is to accurately define the relevant market.”
Fed. Trade Commn. v. Qualcomm Inc., 969 F.3d 974, 992 (9th Cir. 2020). Here, the CAC
presents two different market theories. Under the first, the Steam Platform and Steam
Store operate in separate markets: a PC desktop platform market and a PC desktop game
transaction market. Under the second, they operate as a single product in an integrated
game transaction platform market. This distinction matters—only a separate market
theory would support the CAC’s causes of action based on tying claims.

In defining the relevant market, Wolfire and Defendant debate the import of
Jefferson Parish Hosp. Dist. No. 2 v. Hyde, 466 U.S. 2 (1984). In Jefferson Parish, the Court
articulated a consumer demand test to assess tying allegations. If separate independent
consumer demand exists for tied products, then the markets encompassing those
products are separate; otherwise, they are not. See 466 U.S. at 19–20. Defendant takes issue
with the application of Jefferson Parish’s consumer demand standard, arguing that it is
inappropriate in a case such as this involving “novel technological contexts.” (Dkt. No.
37 at 26.) Defendant suggests this Court rely on Rick-Mik Enterp., Inc. v. Equilon Enterp.

84
LLC, 532 F.3d 963 (9th Cir. 2008). In Rick-Mik, the Ninth Circuit found that the consumer
demand test did not apply when the allegedly tied product “is an essential ingredient of
the overall ‘method of business’ with customers.” Epic Games, Inc. v. Apple Inc., 493 F.
Supp. 3d 817, 842 (N.D. Cal. 2020) (quoting Rick-Mik Enterp., Inc., 532 F.3d at 974).

The Court need not weigh in on the debate because, under either standard, the
CAC’s allegations do not support Wolfire’s contention that the game platform and game
transaction markets are, in fact, separate. According to the CAC, games developed for a
particular platform cannot be played on another platform and, with limited exceptions,
game platforms generally do not charge for their use; instead, they generate revenue to
support the platform through the sale of platform-compatible games and in-app
purchases. Granted, Steam-enabled games can be purchased on a limited basis elsewhere.
But those games are of no value unless the publisher includes a Steam Key, which
Defendant provides at no charge and only serves to allow the game to be played on the
Steam Platform. Therefore, under either Jefferson Parish’s consumer demand standard or
Rick-Mik’s essential ingredient standard, the CAC’s allegations suggest that the Steam
Platform and Steam Store are a single product within the integrated game platform and
transaction market.

C. Antitrust Injury

To support an antitrust claim, a plaintiff must allege “(1) unlawful conduct, (2)
causing an injury to the plaintiff, (3) that flows from that which makes the conduct
unlawful, and (4) that is of the type the antitrust laws were intended to prevent.” Am. Ad
Mgt., Inc. v. Gen. Tel. Co. of California, 190 F.3d 1051, 1055 (9th Cir. 1999). Defendant’s
motion to dismiss focuses on the CAC’s failure to establish the second element. The CAC
asserts that Defendant’s utilization of its monopoly power and platform most-favored-
nation provision2 injures Wolfire through its payment of Defendant’s supracompetitive
fee. It further asserts that Defendant’s coercive conduct reduces output and stifles
competition in the marketplace, resulting in fewer, lower quality games as well as other
ancillary anti-competitive effects.

Turning to the issue of a supracompetitive fee—according to the CAC,

Defendant’s fees far exceed what it could charge in a competitive marketplace. For
support, it describes Defendant’s cost structure and the (lower) fees charged by some of

2 According to Defendant’s publishing rules, if it finds that publishers are selling Steam-enabled
games through third-party distribution channels at terms less favorable than what can be found
at the Steam Store, Defendant may stop providing that publisher with Steam Keys or take other
punitive action, including the termination of the publisher’s game on the Steam Store. This is
described in the CAC as a platform most-favored-nation (“PMFN”) requirement. The CAC
alleges that Defendant’s stated purpose for the PMFN, to ensure that Steam customers get the
best deal possible, is pretextual. Defendant’s ultimate goal is really to control prices of all PC
desktop games—not just those sold through the Steam Store—and, in doing so, to maximize game
sales through the Steam Store.

85
its competitors. But as the CAC also indicates, Defendant has always charged the same
fee to game publishers—30%. This began not long after 2001, when the PC desktop game
“digital distribution” market was in a “fledgling stage,” yet Defendant did not become
“dominant” in the market until 2013.

Plaintiff’s allegations are not meaningfully different from Sommers v. Apple, where
the Ninth Circuit found implausible the allegation that Apple’s 99 cent music download
fee was supracompetitive. See 729 F.3d 953, 964–65 (9th Cir. 2013). There, as here, the price
remained the same throughout, even during periods of intense competition in the
marketplace. While Wolfire suggests that a reliance on Sommers ignores the Supreme
Court’s discussion of evolving “market realities,” (quoting Natl. Collegiate Athletic Assn.
v. Alston, 141 S. Ct. 2141, 2158 (2021)), the CAC does not support this assertion. The
market reality, at least as plead in the CAC, is that, in spite of Defendant’s
“supracompetitive” fee, others who charge less have failed, even though they had
significant resources at their disposal. Therefore, it would appear that the market reality,
at least as plead, is that Defendant’s fee is commensurate with the Steam Platform’s value
to game publishers.

The CAC also asserts that Defendant’s coercive practices result in non-price
antitrust injuries, namely a reduction in output and quality. But the CAC lacks
allegations supporting this assertion. If anything, the facts provided by the CAC, at least
with respect to output, suggest the opposite—a consistent increase in the number of
games available in the market and on the Steam Platform. Moreover, as discussed above,
to the extent that this injury is predicated on Wolfire’s payment of Defendant’s allegedly
supracompetitive fee, (see id. at 4, 8–9, 79 (describing knock-on anti-competitive harms
resulting from Defendant’s allegedly inflated price)), it is not adequately plead. And
finally, the CAC does not provide facts describing how Wolfire directly suffered from an
alleged reduction in output and/or quality. See Am. Ad Mgt., Inc., 190 F.3d at 1055
(requiring “injury to the plaintiff”). Instead, it only addresses the impact on the industry.
(See Dkt. No. 34 at 88.)

In addition, the CAC describes other harms arising from Defendant’s practices,
namely cybersecurity issues and a failure to police game consumers’ inappropriate
behavior. (See id. at 80–81.) But it does not describe how those harms “flow[ ] from that
which makes the conduct unlawful” or are “the type the antitrust laws [a]re intended to
prevent.” Am. Ad Mgt., Inc., 190 F.3d at 1055.

To summarize: While the CAC provides a viable alternative market to support its
Sherman Act and CPA causes of action—the integrated game platform and transaction
market—it does not articulate sufficient facts to plausibly allege an antitrust injury based
on that market. Accordingly, the CAC fails to state a claim upon which relief can be
granted.

III. CONCLUSION

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 For the foregoing reasons, Defendant’s motion to dismiss is GRANTED in part and
DENIED in part. Wolfire’s causes of action in the CAC are DISMISSED without prejudice
and with leave to amend.

COMMENTS AND QUESTIONS

1. In the wake of antitrust litigation against Apple, Google, and Steam, both
Google and Apple have dropped their revenue share for some or all apps dramatically,
to 15% for the first $1 million in revenue. And each has concluded side deals with big
players that drop the revenue share further. Is this an indication that the competitive
market is working? Or is it an an indication that antitrust enforcement has had positive
effects? In addition to the cases discussed in this chapter, see Caccuri v. Sony Interactive
Entertainment, No. 21-cv-03361-RS (N.D. Cal. Feb. 7, 2023) (refusing to dismiss claim that
Sony unlawfully terminated a profitable course of dealing by ceasing to sell digital
PlayStation game download cards to third party retailers).

PROBLEM 9-1

Microsoft’s XBox currently has 20% of the console game market, behind Sony’s
PlayStation with 43% and Nintendo’s Switch with 37%. To bolster its game business,
Microsoft recent bought Bethesda Softworks, maker of such high-profile game franchises
as Fallout, Doom, and Elder Scrolls. After purchasing Bethesda, Microsoft announced
that new games from Bethesda would launch as XBox exclusives.

Microsoft proposes to buy Activision Blizzard, which makes some of the world’s
most popular games, including the Call of Duty franchise, World of Warcraft, Diablo,
Hearthstone and Guitar Hero. Right now most of those games can be played cross-
platform (that is, people with different platforms can play together). Others are available
on multiple platforms but can only be played together with others using the same
platform).

Should the antitrust division block the merger? On what theory? Would it matter
if Microsoft committed to release some of those games on other platforms?

87