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Monetizing Mobile Applications: In-App Purchases

December 21st, 2009
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Yes, it is hard to create a venture-backable business model based on selling apps with an up-front perpetual license fee. As discussed before (Apps = Songs for Apple), Apple’s interests are not aligned with this. But, Apple is interested in the health of the mobile application developer landscape. And, paid application piracy is so rampant that usage of pirated paid apps dwarfs that of legitimate paid apps. This represents a significant problem for Apple, since they want a robust ecosystem of app developers out there.

In-App purchasing represents Apple’s response to the problem of widespread pirating of paid apps, since it is much harder to pirate an app that uses in-app sales than one that is an up-front perpetual license.  As huge side benefit, I believe there are positive consequences this has on the viability of venture-backable mobile application business models.

In the “old model” (before last month), we asked users to commit to the up-front perpetual license fee based on a few screen shots, and/or marketing efforts to educate them. This is typically a very challenging process, and leads a lot of complaints from developers. In the new model, it is possible to engage the user with a free application, and charge them for additional digital goods as they become more fully immersed in the application. As we have seen from the general success of the Asian game companies (which currently have a market cap of over double that of the western gaming companies), and the specific success of online social gaming companies like Zynga, Playdom, and Playfish, the sale of digital goods is a very powerful business model compared to charging an up-front perpetual license fee.

With the sale of digital goods within applications it also becomes possible to charge users with more willingness to pay more money. A social game developer I know told me that one of their users had spent $5,000 on digital goods within a single game over a period of time. With an up-front perpetual license model, it is hard to charge different users different prices. But, the in-app sale of digital goods allows the majority of users to pay nothing, and a minority of users to pay much more.

In-App purchases seem to be one of the most attractive monetization approaches out there for mobile applications.

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Monetizing Mobile Applications: Apps = Songs to Apple

December 16th, 2009
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Billions of Apps Served

Billions of Apps Served

Lots of folks are questioning the economic viability of being a mobile application developer for the iPhone, Android, or BlackBerry.  The basic story line is usually along the lines of “many iPhone app developers have very little revenue to show for their many hours of effort”, followed by some complaining about the way Apple (or Android, or BlackBerry) has set up their app store making it hard for developers to make money.  Apple should want to have developers sell apps, so they can make money from 30% cut on the apps, right?  WRONG!

I am big believer in the ability to build real businesses from iPhone (and Android, and BlackBerry) applications, but I don’t think it is likely to happen with apps that take the straight up the middle approach of trying to sell their app for an up-front perpetual license fee.  But, one has to understand Apple’s incentives before one can construct a reasonable business model.  Let’s look at the revenue numbers on where iPhone (and iPod Touch) makes money for Apple.

Apple’s Apps. There are about 200M apps downloaded per month at this point.  About 10% of these are paid apps, with an average price of about $2.50.  Therefore, after the 70% revenue share with the developer, Apple is making about $15M per month in revenue from apps.

Apple’s Hardware. There are about 2.5M iPhones sold per month, at about $500 per phone to the mobile operator, yielding Apple $1,250M per month in revenue from phone sales.  83 times as much revenue from hardware sales as app sales!  Of course, there are cost of goods sold for the hardware, which are on the order of 50%, but then there are all those Apple employees who are working feverishly on approving apps, so there are costs on that side too.

Bottom line. Profit from the sales of iPhones dwarfs profit from apps for Apple.

Apple has run this play before.  They completely disrupted the music business by doing an inverse “razors and blades” model. Much to the chagrin of the music industry, Apple “gave away” songs (ie, delivered them to end users at very low gross margin) as a way to sell high gross margin iPods.  If you want to understand Apple’s behavior with respect to apps in the App Store, just think of them in a directly analogous manner: Apps are a means to an end — selling more iPhones (and iPod Touches).

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Rise of the App Stores

December 6th, 2009
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Apple iPhone App Store

Apple iPhone App Store

It is axiomatic that we in the venture world tend to overestimate the amount of change that is possible in one or two years, and dramatically underestimate the change that is possible in five years.  And yet, it was only July of last year that Apple launched the iPhone App Store, which has changed the mobile landscape more than anyone could have predicted, and likely, more than most are anticipating even today.  We have Steve Jobs to thank for changing the basis of competition in the mobile ecosystem to the apps and services layer.  The end users are voting with their pocketbooks that they desire something other than the quality of the network (sorry Verizon), or the attractiveness of their spokeswoman (sorry T-Mobile USA), or the earnestness of their CEO (sorry Sprint).
Now, everyone wants an app store.  There are a bunch of released, or announced, app stores out there: iPhone, Android, BlackBerry, Palm, Verizon, Samsung, Vodafone, Nokia, Microsoft, GetJar, Handango (of course, those last two predate the iPhone App Store).  But, this seems like a market that will support significantly fewer real players than even this initial list.  I think the ultimate winners are likely to be Android, followed by iPhone.  But, these early messy days are great fun and a time of incredible innovation and opportunity.
It is hard to overstate the importance of the app store concept.  They represent an almost completely open distribution channel for the developers of mobile applications.  It is healthy to have vocal minority of developers complaining about the lack of openness in the iPhone app approval process.  And, compared to deploying something on the Internet, there is noticeably more overhead.  But, when compared with the joy of deploying an app through a mobile operator, there is literally between one and two orders of magnitude less overhead in going through the iPhone app approval process than the mobile operator courting, selection, vetting, integration, IOT, and deployment process.  I would argue that on both a relative and absolute basis, this is mobile distribution channel nirvana.
Of course, distribution channel nirvana is only a necessary, but not sufficient condition to success for a young mobile applications company.  Other key required parts of business model are:
  • Awareness/traffic.
    • Just like the Internet, simply being out there does not mean that people will magically gravitate to your brain child.
    • App store SEO is its own art/science that requires careful attention.
    • Good old fashion guerrilla techniques, and the occasional partner deal will help.
    • Focusing on driving downloads on that first day that your app is made available–to try to make it into the Top Downloads, which has its own inertia effect.
    • Virality.  If your users can effectively recruit other users through their natural use of your offering (a “tell your friends” button rarely works), this drives users, AND creates its own inherent barrier to entry.
    • Barriers to entry.
  • A monetization capability.  This may or may not be turned on on day one, but it should at least be consistent with your unique selling proposition and source of barriers to entry.
99+% of applications on the app stores don’t really have a sustainable business model.  Some industry observers complain that mobile app developers are laboring away without getting any reward, because people don’t buy enough apps.  No offense, but if one’s business model is “build an app that lots of people should want, and charge $2 per copy for it”, why would one expect that to work any more than you would expect “build a website that lots of people should want to use, and charge $2 up front to use it” to work?  Another compelling rejoinder to the complaints about the lack of compensation in mobile apps is to look at the nine-figure payday that Omar Hamoui reached with selling AdMob to Google, less than four years after founding the company, due in significant part to ads served in iPhone apps.

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