These Headwinds Could Dethrone Apple's App Store

Margie is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

In Part 1 of this series, we examined the competitive advantages Apple (NASDAQ: AAPL) has with its App Store, and how this translates both to recruitment of developers and consumers to the iOS platform. Now as we continue our interview with Network Anomaly, developers of the app “Relay Stuff,” we'll discuss whether this prime source of profit comes with an Achilles heel.

Revenue

Me: How does Apple derive revenue from the app store?

Relay: Right now, there are two ways. The first is the purchase of an app itself. Whatever the selling price, Apple takes 30% of the revenue.

Me: So millions of app purchases at $0.99 start to add up.

Relay: Exactly.

Me: What’s the second way that Apple derives revenue from the app store?

Relay: What’s referred to as “In-app purchases.” Let’s say you download Zynga’s (NASDAQ: ZNGA) Scramble or one of their other games that’s free. They rely on making money on in-app purchases. You play Scramble, they allow/urge you to buy credits to play more games in a time period, or to unlock things.

When you do, Apple gets its cut. In-app sales make sense for certain types of mobile apps, like games or content service offerings, and Apple will continue to derive revenue from the in-app purchases. Free apps are the growing leader in the number of downloads, and alternative models for developers to derive revenue could cut into things if they gain traction.

Me: And what are the alternative models?

Relay: Advertising. In the aforementioned Zynga game, you might never buy a thing, but Zynga will still profit from you, and Apple might not. Developers can still make money through advertising, referrals, incentives, etc. Things that Apple doesn't necessarily get a cut of.

Me: You used the word “might?”

Relay: Yes. You are currently allowed to use any ad network you want, and Apple has an ad network called iAd, but it is one of many options out there, and often developers integrate multiple ad networks. Using a mediation platform to coordinate ad fulfillment across networks is common. Google (NASDAQ: GOOG) offers that as an integrated piece of their AdMob service. It's very convenient.

Me: Do developers make a lot of money using just the advertising model?

Relay: It's improving and there are stories of apps that can make significantly more with an ad-supported, free app rather than a pay app. But honestly, at this point traditional ad banner models don't work as well in the mobile space. People just are less willing to click on banners, and many clicks are by accident (this has probably happenned to many a reader out there,) thus the conversion rate is much lower than on desktop or tablets.

Me: So people using the iPad will convert well?

Relay: Yes, better than the average cell phone, but it's still a small percentage of the overall mobile user base, though in terms of sheer numbers, tablet users are growing.

Me: According to NeoWin.net “Tim Cook has revealed that Apple paid out $8 billion to developers, up $1 billion in just one month. The $8 billion payout will net Apple around $3.5 billion in revenue, a substantial figure from a service that is just 5 years old.” 

Relay: It’s quite a cash cow. Those numbers can definitely encourage developers.

Me: What challenges do they face going forward?

Relay: Well, we just spoke of the advertising model that Apple is missing out in part, unless people choose to use iAd. There may be other models looming that could undercut some of that revenue  unless Apple can start offering more options for developers to monetize, thereby keeping its cut of the action. The growth of Android market share means Apple has to offer other value over the competition to entice developers to continue innovating and launching in the App Store. To stay in this game, they will need to expand the services developer's can use to capture more of the growing market.

Me: What about all the free apps?

Relay: When the app store opened, most apps were not free: somewhere in the 75% range. Today that number is sinking, it might be 25% as developers go to the in-app or advertising model to drive revenue. People seem to be much less willing to pay outright for apps than they used to, and again, competition amongst developers is a big part of that. Of course, without revenue for us, there’s less revenue for Apple. Like I said, Apple needs to help developers find new ways to monetize.

Me: It seems like the public only hears about a few apps out there. Angry Birds, etc.

Relay: A mere 25 of the top US developers accounted for half of app revenue. With such a consolidation of the power, it seems inevitable that there will be increasing pressure on how much of a cut Apple gets.

Me: In other words, they won’t want to give Apple their 30%, say 20%.

Relay: Exactly.

Me: If you were Tim Cook, how would you address this?

Relay:  Make sure to keep the App Store front-end fresh with new, highlighted applications ensuring that new blood will come in and the success stories continue. You need more than a few ultra-success stories. At some point those will get stale. By fostering this, Apple isn’t beholden to a few large developers. As they say: diversify.

Me: How is your company making money? Your app is free, and I didn’t see any in-app purchase options.

Relay: Right now we aren’t making a dime off it. We're experimenting with a few options but our goal was to provide a valuable service to our users and not charge for "Relay Stuff." The mobile experience tends to be more intimate and people are less willing to jump out of an app to follow a traditional display ad, and we are focused on building our user base first. We're evaluating partnerships that allow us to offer our users valuable discounts, credits, or other offers as a result of their use of Relay. I expect this type of approach we'll be seeing more of in the mobile space. It takes a little more to get right as the tools aren't quite there yet so there's no single solution.

Me: Last question. If you had Tim Cook’s ear, what would you advise him to do in a way that would benefit both developers and Apple?

Relay: Build or buy tools to help developers monetize, including ad mediation. Do something more with Passbook: create a Passbook Partner service for retailers or service providers that is easy for developers to integrate into their apps for referral or pass-through sales to customers. These are a couple that would ultimately be a win-win-win as Apple will continue to get a cut in the emerging "free" models and have a voice in how those evolve; Developers would have a more complete set of monetization options directly from Apple; Users would continue to see app innovation and services that encourage engagement and usage.

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Again, thanks to the guys at Network Anomaly, makers of Relay Stuff, for the time they took to help us all understand the app store a little more thoroughly. If you have a thought or comment or question that will help us all gain a better understanding of Apple and app stores -- especially if you're an app developer! -- please enter it below.


margiecfl owns shares of Apple and Google. The Motley Fool recommends Apple and Google. The Motley Fool owns shares of Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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