Because most mobile apps are distributed for free or for a very low price, advertising is an essential ingredient in the business. Developers need to invest in marketing and advertising to create awareness of their apps, stimulate discovery and drive downloads. And they need to let other companies place ads within their apps to create a source of revenue.
But this advertising model can easily get out of synch if the app isn't compelling and the business is not carefully configured. Developers need to be diligent in planning their ad-based strategies to attract advertisers, but they also need to have additional sources of revenue from in-app purchases.
Achieving critical mass
Having other revenue sources is critical because for the advertising model to work, an app must have a huge following, according to John Malloy, general partner and co-founder of BlueRun Ventures. Malloy estimates that an advertising-based mobile app needs 8 million to 10 million users to be successful.
"There's a certain need for critical mass for an advertising model," Malloy said. He added that a new app might not have that critical mass right away, but developers need to plan and build for that type of scale if they want the advertising model to work.
Malloy's statement does represent an investor's perspective, and others might disagree. However, developers who want funding from his or other venture capital firms should keep that in mind.
Matt Gillis, Millennial Media
Nevertheless, most developers will not achieve this type of scale. "Success is relative," said Matt Gillis, senior vice president of global monetization solutions for Millennial Media.
Gillis said that rather than focusing on the number of end users, it's important for developers to focus on creating great apps and to think about how to monetize them from the very beginning.
"If you are going to build a business that is going to survive based on advertising revenue, then you need to build apps that consumers want to use more than once and ensure that advertisers can engage those users," said Gillis.
Audience is as important as scale
And while scale is important, Gillis said, the type of audience is equally if not more important. For example, he noted that an app targeted to finance enthusiasts would be very appealing to advertisers from credit card companies.
"If you have a very addressable, targeted audience that is relevant to advertisers, you may not need 10 million users," he said.
Developers that are working on apps in their spare time can also find success through advertising, Gillis said. "A developer who built a tip calculator app in his spare time might not have a million users, but he would probably consider earning $1,000 a month in advertising revenue a success," he said.
Craig Palli, Fiksu
How many users should a developer try to achieve? Craig Palli, vice president of business development at Fiksu, said that an entrepreneur that wants to build a business that supports three to four employees and pays them very good salaries can achieve that goal with an ad-based app that has one million users.
"With one million daily active users, someone can have a solid venture," he said. It may not be enough to get VC funding, but it could be quite successful for a small business."
Keeping customer acquisitions costs down
To have a successful business strategy a developer must craft the app and business model to generate a certain viral effect that promotes dedicated customer usage and engagement.
For example, Palli said that an app that has one million daily active users could expect to create $1.1 million in annual revenues if it attracts three million ads per day that are paid at a rate of $1 per thousand displayed ads. Palli considers those rates conservative and reasonable targets a business developer can strive for.
Yet acquiring those one million daily users could cost the developer more than their revenues due to advertising and marketing costs, depending on the type of app and advertising trends.
For example, based on Fiksu's service that tracks the cost to acquire loyal users for companies that actively market their apps, the cost to acquire a customer in March was $1.30. At that rate, a developer would end up paying $1.3 million for those one million users, more than they would receive in revenues.
Palli noted that half of the apps tracked in the index acquire users for less than that amount and that a developer could get that cost down to less than $1.30 and even below $1, however monthly fluctuations can shift these costs up or down.
Viral marketing is key to success
One way to improve upon this is to create an app that goes viral, meaning that users are acquired via word of mouth or other "organic" methods. An app's viral potential can be evaluated through customer trials and other research and developers can use their findings to refine their app and marketing initiatives.
For example, if every user acquired through advertising generates 1.25 additional users during the marketing test, the developer can see that his marketing investment will be highly leveraged, and the added audience will also yield better advertising revenues. If the advertising does not generate any viral effects, the developer may want to reinvent his app before investing further in it.
Developers also should look for ways to improve the number of ads shown in their app or increase the rate paid per thousand ads. And they need to figure out the revenues they can expect to receive from each user, during their lifetime as a user of the app, through advertising, in app purchases, subscriptions, registrations or other mechanisms.
"The entrepreneur should be able to see their way to the user being worth $1 or $2, whatever the appropriate number is," Palli said. That value, multiplied by the number of users minus the cost to acquire the users, will tell the developer if the product can work in the marketplace and financially.
Developers can invest gradually in their advertising and marketing efforts, but the evaluation must be done upfront. Palli said a budget of around $20,000 can yield the information a developer needs to understand their opportunity and expected costs.