Are iPhone Apps a Failed Business Model?

One of the numbers I told readers to look out for in 2010 was the date on which Apple (Nasdaq: AAPL  ) will announce that it has passed $1 billion in App Store sales. When Steve Jobs announced the iPhone 4, he revealed that Apple has now paid out $1 billion to app developers. As Apple keeps 30% of the revenues, that means that as of June 7, 2010 -- in a little less than two years from launch -- the total revenues generated by all iPhone apps sold since July 2008 has now passed $1.43 billion -- of which Apple has paid out $1.0 billion to the developers.

We also heard that the total cumulative downloads had passed 5 billion apps, so if we count that across all apps, we get an average of $0.29 earned per app downloaded. That is not exactly overwhelming.

Of course, the vast majority of all apps are free apps. The conventional wisdom -- based on no real facts, but some gut feelings and very small sample surveys -- has been saying that 70% of all apps are free, and thus 30% of all apps earn revenues from the consumers who download them. That is now not supported by the facts from Apple.

If we map out app revenues against the 30% of all downloaded apps, we get an average price of $0.95 paid per downloaded app. That is clearly not reasonable, where the minimum price of any iPhone app is $0.99 and many apps cost much more. We had Chetan Sharma's calculation of the average price of a paid app to be $1.90. Yankee Group measured it at $1.99. Both of these numbers were effective March 2010. If we assume the average price is the half point of those two -- at $1.95 per iPhone app, that means that to get $1.43 billion total revenues, there were 732 million apps that were paid apps, and almost 4.3 billion free apps. Thus, free apps would form 85% of all downloaded apps on the Apple iPhone App Store, and paid apps only 15% of all apps.

Sites such as 148Apps.Biz offer even higher values, and we would not recommend to use those.

Annual sales level
The number our readers most want to see is what the annual level of sales is. And for that, too, we now have the first indicator. We only have two data points -- it was zero dollars in June 2008, and it reached a cumulative level of $1.43 billion by June 2010. But until we get more data, we can plot a linear growth curve and estimate the sales, both per years from launch of the iPhone (July to June), and years as in calendar years (January to December). So let's split the linear growth into four halves of the year, to see how the sales have grown:

  • 2H 2008: total App Store Sales in half $143 million; annual sales calendar 2008 $143 million
  • 1H 2009: total App Store Sales in half $286 million; cumulative sales first year $429 million
  • 2H 2009: total App Store Sales in half $429 million; annual sales calendar 2009 $715 million
  • 1H 2010: total App Store Sales in half $572 million; cumulative sales second year $1 billion dollars

Total cumulative sales so far: $1.43 billion over 2 years.

Projected same pattern for the second half of 2010:

  • 2H 2010: total App Store Sales in half $858 million; annual sales calendar 2010 $1.4 billion

How much per user, per developer
So when we then look at the App Store installed user base -- and remember, in case of the iPhone, we have to add the iPod touch and iPad users as well -- we had, roughly speaking, about 90 million cumulative shipments of iPhones, iPod touches, and iPads. If we divide $1.43 billion of apps revenues by 90 million users, we get the average spent by an iPhone or equivalent user, of $15.89 spent by the average user over the two-year period. So the consumer buys a $600 super smartphone and then adds fewer than $16 of app sales. I do not see this as a radical change to the business in either apps or mobile. The proportion of spending on apps is under 3% of the amount spent on the device. The point gets ever more obvious that it's the free apps which drive the traffic, not the paid-apps business.

What of the developers? The latest count I've seen is 225,000 total apps on the App Store. So if we divide the $1.43 billion cumulative revenues earned by those 225,000 apps, we get average revenue earned of $6,355 per app (over two years).

Remembering that the average app development cost is between $15,000 and $50,000 (the lowest estimate for a casual game was $6,453), if we assume that an average app costs only the average of that development cost -- or $35,000 -- and assume the app is so successful it does get average downloads, it would take 10 years to recoup its development costs. And that is before any redevelopment costs (typically $10,000 for any rerelease of an app -- remember, we are assuming that in 10 years that the app is not changed) or any marketing costs. Is this a pointless economic pursuit?

There were tons of so-called experts who claimed the smartphone app stores were earning tons of money last year. They were not. The world's most successful smartphone app store (there are over 30 of them already) -- Apple's iPhone App Store -- earned about $715 million in calendar year 2009, of which Apple kept $215 million and paid out $500 million to developers. This is not a significant moneymaking opportunity. Not now in 2010. Maybe in a few years down the line, but not now. Just for contrast, non-messaging mobile-data services revenues in 2009 were more than $100 billion. MMS itself is considered a failure, and it is a $30 billion business. The real money lies in mobile services, not in smartphone apps. As I have been saying for a long time, smartphone apps are a false promise now in mobile.

More from Bright Side of News*:

Read more from Tomi Ahonen at Bright Side of News*.

This article was originally published by brightsideofnews.com and modified by The Motley Fool.

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Read/Post Comments (13) | Recommend This Article (6)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On June 21, 2010, at 1:00 PM, lovethelanguage wrote:

    Did I miss something, or does this article actually NOT take into account in-app ad revenue?

  • Report this Comment On June 21, 2010, at 1:02 PM, kansasphil wrote:

    Damn, you beat me to it...

  • Report this Comment On June 21, 2010, at 1:12 PM, lovethelanguage wrote:

    @kansasphil I re-read it only a couple of times to make sure. You must have gone back for thirds!

  • Report this Comment On June 21, 2010, at 1:30 PM, DefunctAcct wrote:

    Why would App development cost $10,000 to $35,000?

    I bought a brand new high-power iMac and associated software and hardware (disks, cables, drives, etc) for $3500 total. I sign up for developer program for $99/year. I bought a $500 workstation desk, high-speed DSL line for $29/month. The iPhone 3GS I carry does not count as business cost because it is personal but I use it for testing my application. Now I have the pleasure, freedom and luxury of working from home. Not only that, I keep my day job and work on iPhone Apps at night or on weekends.

    Total cost to start development? $3500+500~=$4000. On-going monthly cost? $29+($99/12)= $38/month.

    Mac's last a long time, I still have 10 year old G3's and G4's Mac's running fine so my development machine lifespan is at least 5 years. Assuming developer program cost is constant and DSL off Verizon does not go up, I am looking at annual average cost of

    ($38x12 + $4000)/4 =~ $900.

    If I sell my application at $0.99 a pop and 1000 buyers buy it, I have earned $700 a year. If I cannot attract 1000 people to my application, it is my fault. If just 2000 people buy my application per year, I am earning $1400. In three years, I have earned enough to buy a new machine or an XServe. Do this for five to seven years, I can fully equipped an in-home IT and run a T1 line to sustain my business.

    While doing all this, I still hold down my day time job as a software engineer. So can you please explain how you arrive at $35,000 a year development cost?

    I think you have grossly underestimated the capabilities of Apple's SDK. You are also assuming developers are hugh corporations needing rental spaces, health cost, unemployment insurance and so on. While there are those, I am almost sure that a great many of us are doing this as a side-job.

    For those of us doing this on the side, the AppStore is a fantastic money making opportunity. It makes fantastic business sense. Upfront cost to start up is negligible. On-going cost is insignificant. The reward potential is immense. What is there not to like?

  • Report this Comment On June 21, 2010, at 1:34 PM, DefunctAcct wrote:

    Correct to my own post:

    Cost is spread out over 5 years, not 4.

    ($38x12 + $4000)/5 =~ $900.

  • Report this Comment On June 21, 2010, at 1:38 PM, AustinMobileDev wrote:

    Pretty interesting article in that I made similar calculations when Steve announced that $1 billion was paid to developers.

    That $6K earned / app is very low of course, but keep in mind that a large number of them are free. Also, keep in mind that a very large number of them are crap. There are people that submitted a white screen and called it a flashlight, which is less than 10 minutes worth of work. A very large portion of the apps are less than one day's worth of work, and a large portion of them make near $0/month.

    I have an application for the iPhone that took a large development effort on my part. It's a useful application that people are willing to pay for. I kept my costs very low by not hiring anyone else, and I initially did it next to a full-time software engineering job. Now, I'm working on it and other apps full-time. I don't make as much as I used to working for a company, but I'm sure I'll find a way to get there.

  • Report this Comment On June 21, 2010, at 1:40 PM, lovethelanguage wrote:

    "There are people that submitted a white screen and called it a flashlight ..."

    Don't forget the people that submitted a black screen and called it a mirror.

  • Report this Comment On June 21, 2010, at 3:14 PM, vrtourist wrote:

    Well put together thoughts on potentially the real mobile app opportunity. Yea, it may not be exact but it is a good extrapolation. The real economics are if you are in the top 100 apps. If you are not, than it is going to be very very modest. It is true that the opportunity is for talented programmers and the sky is the limit for these folks. I am not so sure its a great opportunity for game developers with higher cost infrastructure. Pop Cap seems to be the only real winner in this category with a consistent parade of hit titles.

  • Report this Comment On June 21, 2010, at 5:34 PM, texploration wrote:

    I think this article misses few more ways iPhone developers make money from. My blog captures some of the moentizations

    http://texploration.wordpress.com/2010/06/21/iphone-apps-bus...

  • Report this Comment On June 21, 2010, at 6:01 PM, Turfscape wrote:

    Author assumes that all app revenue is based on purchase price. Assumption is incorrect. Entire basis of article is flawed.

    The app store model is not inherently flawed or failed. Individual app developers may have a flawed strategy for development and distribution, but the store model works perfectly...in fact, it works more efficiently than most other markets, including stock exchanges, the housing market, and eBay. Your local farmer's market is probably the only other true model of efficient market theory that actually works besides the app store.

  • Report this Comment On June 21, 2010, at 7:27 PM, mhonarvar wrote:

    private companies pay for all the R+D for the games...Apple gets 30% of revenue...sounds pretty good for them.

  • Report this Comment On June 22, 2010, at 1:01 AM, joe951 wrote:

    Most apps cost way less than $10k to make.

  • Report this Comment On June 23, 2010, at 9:36 AM, wasmick wrote:

    It's a great model for Apple, which is all I care about. Of course it's a less than spectacular model for developers but as an Apple shareholder why would I care? Most apps are useless crap anyway and are generally free because frankly, no one with a brain would ever pay for them.

    Again, as an AAPL shareholder, I don't care. We get to say "and over 200,000 apps" in our ads and that adds a bit of value...no one ever stops to say "yeah but 199,984 of them are gargage" because it's not relevant. The apps add marketing value (and a little $$ to Apple) and the developer gets to use his/her success as an Apple app developer as a martketing tool for herself. What's not to like?

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