Martin: How to capitalize the impact of your app

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Josh Martin

       Josh Martin

The apps space was once so very simple. A developer met the needs of a carrier, who then took a very large cut of the developer's revenue to sell his or her app in its carrier branded store to the dozens of people who bought apps before 2008. While no one was making a lot of money or very happy, at least the process was straightforward once you got past coding for the hundreds of different handset operating systems. Today, though, there are a handful of premier platforms, even more app storefronts, and a bevy of business models which could potentially drive revenue. So, what is the best way for a developer to drive revenue? Well, it is anything but easy, but at least now some developers can profit from it. As the app world changes, the means for driving revenue changes as well. Here's how to take advantage of current and changing market conditions.

1.    Make a free app. This is sound advice for all but a select few large developers.

2.    Drive revenue from alternative business models.  Not all revenue is going to come from paid downloads.

3.    Be very wary about the ever increasing revenue need of app store owners. They will eventually need more revenue.

Paid apps are an excellent way to generate a short term cash infusion. Releasing a paid app, however, presents a number of greater challenges than releasing a free app.

1.    The top paid apps are much more consistent than the top free apps, making it ever harder to break in to the all important Top 100 in order to drive enough downloads to earn significant revenue. Angry Birds has millions of users that are downloading updates slowly and regularly which continuously keep Angry Birds and its variants in the top ranks. Until Apple and others change how they display their top app lists, this will continue to be a problem.

2.    To remain in the Top 100, or more specifically in the Top 10, you will need to provide regular updates as mentioned above. While remaining in the Top 10 will drive additional first time downloads, it will also require continued investment on the part of the developer.  Since users are reticent to see ads in paid apps, the developer will see an increasing percentage of downloads become revenue free (updates) while they continue to invest in updating the app, resulting in less revenue for each successive update.

3.    Advertising (and other revenue streams) present ways to drive continued revenue. As mentioned above, users are not interested in ads in paid apps, making download revenue a one-time infusion. Users are less likely to accept in-app advertising in paid apps, but an app with a high level of engagement is almost certain to generate more revenue from advertising than from a la carte downloads over the long haul.

4.    Free apps turn over more frequently. Consumers are fickle and thus less likely to keep a free app they don't like.

The good thing about these trends is that there are new ways to drive revenue from consumers. Revenue does not come down to just advertising or paid downloads. More than 70 percent of the top grossing iPhone apps (see chart below) are free apps driving revenue from virtual goods. Apple does not include ad-revenue in this list, but if factored in it would be easy to see that an ever larger number of app revenue is coming from these other revenue streams.

percent of top grossing free apps

The benefit of virtual goods, of course, is that there is a one-time expense for their creation but no recurring fixed cost for their distribution. In essence, this reduces the friction caused by the 30 percent margin Apple and other app stores charge. The same is true of advertising. Subscriptions incur a cost because content must be produced but this can be a viable business model. As ad networks get smarter, location becomes a factor and virtual goods increase in popularity, an ever increasing portion of app revenue will not be from paid downloads. This is a trend seen predominantly in games today.

percent of apps per category

But a slew of new free apps are likely to ruffle the feathers of app storefronts. Just this week, Apple fully implemented its strategy to prevent apps from linking to external storefronts. Apps such as Kindle for iPhone were negatively impacted by the decision. Now for Amazon to sell a book in its Kindle App it will need to sell it for 30 percent more than Apple does in the iBooks Store to recoup Apple's fee. This is untenable as e-books are already sold on razor thin margins or at a loss. So, Amazon will have to distribute directly through Amazon.com and send e-books to the Kindle app (until or unless Apple stops that practice as well).

Now, a quick note on Apple (and more broadly all app stores in general). The app store should be viewed as a retail store. Just like a physical store, an app store has costs (people to approve apps and market them, bandwidth to distribute apps, etc.) and therefore should in and of itself be allowed to at least operate at revenue neutral. So, Apple's decision to limit external linking isn't as nefarious as it seems because those apps are driving revenue from Apple's store without paying the freight. However, this feels less kosher in areas, like iBooks, where Apple is also competing because it gives Apple a competitive advantage. But how much they should charge is a topic for another article.

If we can accept that app stores should be able to drive revenue from their existence and an increasing number of apps are going to be free and driven by alternative business models, then it is reasonable to expect that app stores will want to drive revenue from these new business models. Already Apple collects 30 percent from sales of virtual goods. But to date--beyond iAD--Apple has not derived revenue from advertising. This could change as app stores continue to be expensive to run and maintain. App developers thinking they can get a free ride from app stores should always plan for the day when the terms and conditions will change and respond accordingly.

Overall, the app market is undergoing big changes in how consumers buy and use apps. As the emerging world becomes more app-centric over the next several years, the shifts in business models towards free downloads will continue. That isn't to say that paid downloads won't continue to play an important role in the app economy, but it is an ever changing role increasingly dominated by fewer players, which will continue to consolidate as acquisitions in the mobile space take hold. So, plan for the future today and expect long term revenue.

So, what can developers do with this information? Here are three ideas:

  • Consider an alternate business model (advertising, virtual goods, etc.) to paid downloads right now, and consider altering the business models of your existing applications. This will position you for growth in emerging markets where paid app downloads will be lower than mature markets.
  • Implement social networking features to increase usage and thus drive long-term revenue opportunities
  • Focus on virtual goods with have minimal costs, such as keys to unlocking more content or acquiring items more quickly. Infinity Blade accomplished this within a paid app and Smurfs Village did the same in a free app. These two apps drove extremely high margin transactions because the items had almost no overhead costs but also kept users engaged.

Josh Martin is the director of Apps Research at Strategy Analytics.