Lowenstein: Evolution of the app store business model

Apple is commemorating the almost one-year anniversary of the App Store launch with ads proclaiming 1 billion app downloads. App stores have been launched for Android, Blackberry and Nokia smartphone devices, and other, similar concepts are on the way from Palm and Microsoft. Clearly, there are lots to celebrate here: Barriers to entry have fallen; the developer ecosystem has been reinvigorated and is multiplying; people are making money from apps ranging from the obvious to the odd; and consumers are getting exposed to a huge variety of productivity, information and entertainment applications.

With so much investment and effort going into the app store ecosystem, I think it's an opportune moment to consider what the future might look like. In this column, I will focus on the evolution of the app store business model. My next column will focus on the evolution of app store features and capabilities.

First, let me be clear about one thing: Apple's App Store remains the benchmark for the rest of the industry. No other approach matches the total user experience, from the device to ease of purchase, integration with the PC, and use of iTunes as a distribution mechanism. There are some particular attributes and applications that are superior on other platforms. Android is especially impressive from an open development and tools perspective, and there are some apps that absolutely sing on the G1. Blackberry App World is, so far, a disappointment, but it is still early days. We are seeing a lot of companies developing for the iPhone first and other platforms thereafter.

OK, so where is the app store concept headed as a business? This is a complex question, because not everyone has the same agenda. Apple's primary objective is to sell devices, while Google's is to build an audience for paid search. The game for RIM and Microsoft is more delicate. On the one hand, they need app stores in order to remain competitive with Apple. But they must also balance the extent to which their app stores develop outside of operator involvement with their existing deep operator relationships. Navigation-centric apps are a good example of this complexity.

The path for the operators is becoming clearer. I think major operators have come to accept that they will be running wholesale and retail businesses simultaneously. AT&T's wholesale businesses are hosting prepaid operators such Tracfone, and of course the Apple relationship. Verizon is proceeding with its Open Device Initiative. Sprint supports many MVNOs and other ways of leveraging its network such as the Amazon Kindle.

Among the brands deploying applications, objectives vary as well. There are the prototypical "two guys in a garage" types, who might view this is a fun hobby or be very happy to find success with a couple of apps and make a nice little six-figure living, thank you very much. For others, like the Today Show, which just launched an iPhone app, it's a brand extension. The Wall Street Journal's app is free, at least initially, with the goal of building an audience for its paid online and print publications.

We are also seeing a proliferation of monetization paths. The "freemium" concept, in which a "light" version of the app is available for free, or is available at no cost for a trial period, is gaining in popularity. At the other end of the scale are premium apps, which charge significantly more than the typical iTunes micropayment, some as much as $30. In-app purchasing, which opens up all sorts of revenue approaches, will a key feature of the iPhone 3.0 release this summer. Over time, I expect that a smaller percentage of apps will be free, although I do not believe there will be significant efforts to sell subscription-based services.

Advertising will also start playing a more important role, particularly for information services whose primary business model is based on ad revenue. Initial data coming from the mobile ad firms such as Ad Mob are encouraging. Good device plus good network plus good browser equals much more Web viewing. But we need a larger audience for these apps (# of people with phone x # of people who download or view the app x do so regularly x % of people who click on a link) before ad revenues become meaningful. One must also consider that Apple, Google, and others will want a share of the ad revenues should once they start rolling in.

There are some other aspects of the app store business that I believe will become more complex. First, are the operators going to weigh in at some point on bandwidth consumption? The iPhone average is about 100 MB per month, and at $30 for a data plan, the economics are OK. But with more and richer apps, bandwidth consumption could explode. Would the operators start charging a premium for bandwidth-intensive apps, or steer customers to WiFi? I also wonder how long the $30 price point for a data plan will hold up in the midst of intensifying competition.

Finally, it is important to consider what kinds of sustainable, long-term businesses will result from app store mania. The two guys in a garage, hot app of the moment thing is great for developers and consumers, but it is hard to see $100 million-plus companies coming out of this, especially when one considers the fragmentation across some ten different operating systems. Venture capitalists see all sorts of innovation being unleashed, but are puzzled on how to invest in it. I do think there's a more substantial investment opportunity in the next generation of features, capabilities and tools for app stores, which will be the focus of Part 2 of this column, to be published in May.

Mark Lowenstein, a leading industry analyst, consultant, and commentator, is Managing Director of Mobile Ecosystem. Click here to subscribe to his free Lens on Wireless monthly newsletter.

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