Digital Goods: Apple App Store View

The App store is certainly critical to a holitistic platform strategy. Given that Apple owns the entire life cycle of the physical product (Deisgn, mfg, build, distribution, …), the App Store is the only area where external parties can participate. It is therefore in Apple’s best interest to court developers and spin the marketing machine here. As an investor.. my intuition is to ask… where is the money being made? Are these app store forecasts reliable?

Digital Goods: An Apple View (Big update on 7/28.. missed a big number… set developer rev share at 30%..  more than a little embarrassing. This changed my view on Apple’s accounting… but did not change my view on the App Store TAM. )

25 July 2011

This Blog is an update from my previous Jan 2011 blog on App Stores. Prior to reading my blog below, I encourage you to review excellent blog by Horace Dideu (App Store revenue analysis  June 2011).

I’m reading Apple’s 10-k today and also checking out an analysis by Canalys which is forecasting a 92% increase in App Store Revenue (Apple and all others) next year to $14B, and growing further to $37B by 2015. Remember back in January TechCrunch ran a store on on AppStore market growth going to $25B by 2015 (up from $6.8B in 2010), and Juniper estimated in-app purchase revenues going to $11B by 2015 (across all platforms, driven by social gaming).

Apple is certainly killing it with device sales (10-Q data below), but how does overall device growth impact iTunes and App Store?

From Oct 10-K we get that the iTunes Store (Including App Store), drove $4.1B in Sales.

From 3Q11 10K

As I stated in January.. Apple does not make it easy for us to separate out the different components of Digital Goods revenue as they are all lumped together in “Other music related products and services”. Here is what we do know:

1) Historical iTunes revenue and growth rates prior to 2008 launch of App Store

2) Public Statements on App Store revenue

3) Download rates of applications

4) Physical product unit sales

Public Statements:

In June Venture Beat reported Apple senior vice president Scott Forstall said, “Apple has paid out more than $2.5 billion to developers for apps in the App Store.”

This statement has stumped me, and would love your opinion… at a 70% developer payout, this would mean that the app store had total sales of $3,570M over the (since 2008 inception). From SEC filings we know that total music related Sales from 2008 to present is $16,220M. If 100% of “developer revenue” was accounted for in “Other music related products and services”, App Store sales would be 22% of this category (on average from 2008).

This  seems high. Does “paid out”  include revenue and fees outside of Music Related products and services category (ex iAd, in App Billing).

If we chart the Other music related and the total sales related to total iPhone units in market we get a pretty bleak picture of app store efficacy (yes, Music related should also apply to iPod ++ but this is conservative). Another alternative (Scenario 2) is to assume that not all developer revenue is within  “other music related…” category.

The App store is certainly critical to a holitistic platform strategy. Given that Apple owns the entire life cycle of the physical product (Deisgn, mfg, build, distribution, …), the App Store is the only area where external parties can participate. It is therefore in Apple’s best interest to court developers and spin the marketing machine here.

As an investor.. my intuition is to ask… where is the money being made? Are these app store forecasts reliable?

In my January blog, I analyzed app store revenue from Distimo data, consistent with approach of  LightSpeed Ventures in their excellent 2009 analysis on Apple’s $25M App Store revenue estimate. The market has tremendous information on number of app downloads.. what we don’t see is much in the way of revenue numbers for paid apps (or in-app purchases).

Using Distimo data see for December 2010 350k paid app downloads per day at average price estimates ranging from $2.43 to  $0.99 (with prices declining 15% YoY).

December Revenue Estimate (excludes in app purchases)

350k * $2.43 *30 = $24.6M

For FY 2010 given 15% price decline and 40% growth rate, Apple 2010 App Store Gross Sales (Excluding in App Purchases)

= $24.6 * 12 * ((1 + 0.15/12)^12)* ((1-0.4/12)^12) = $228M

Apple’s Net App Store Revenue = 30% of $228M = $68.4M

These number align to Scenerio 2 (App store is 15% of Other Music related category) for 3Q. A significant “error” in the assumptions in of spreadsheet above is the assumption that App Store revenue is a consistent (linear) percentage of Music Related other.. Obviously this is not true (stated from 0.0 in 3Q08). In scenario 1.. this means that App Store revenue is a much higher percentage (greater than 22%) in recent quarters.

Independent of the current revenue composition, it is clear that App Store Revenue is not on an $11B trajectory this year (approximately $1.6B  Sales for Apple FY11). App Stores are an extremely important element of Apple’s mobile platform strategy, but they are not currently a substantial revenue driver for either Apple or developers outside of gaming and a few focused applications. The Canalys estimate of $14B for 2011 seems very unrealistic. Given Apple’s FY11 trajectory of $1.6B App Store sales, I project 2011 App Store TAM to be approximately $2B. The App Store TAM is separate from the Gaming TAM (mobile), which is approximately $3B.

iPhone Sales are indeed exploding, as you can see from the Distimo data below, not all markets are created the same… and not all iPhones are going to new users. For example Asia (as a whole) appears to have rejected the concept of paid apps.  Users that are refreshing their iPhone also do not repurchase applications. Number of new post-paid subscriptions are estimated below from Jim Patterson

It is very important to note trend in Other music related products and services (aka iTunes Sales) to Total iPhones in Market. We would expect to see solid absolute, consistent growth in iTunes sales as the number of iPhones expands. The data shows a highly erratic growth trend of 20% (iTunes Sales) on iPhone Sales growth of 140%+.  In last quarter, Music Related other actually declined 5%… hardly a trend that will drive growth to $14B.. this year.. or 5 years from now.

Admittedly I have not wrapped up this analysis cleanly.. this is a blog not a treatise. I’d love your feedback on other numbers and perspectives.

Other related articles

http://tech.fortune.cnn.com/2010/06/23/app-store-1-of-apples-gross-profit/

Distimo is an excellent source for raw app store information ( http://monitor.distimo.com/ )

Mobile Apps will Die

As Google evolves Android into an open mobile platform, the “app” revenue model will evolve as well. Just as with Apple’s Mac experience, it will be difficult for Apple to attract continued investment. Given the tremendous talent at Nokia, MSFT, Google, RIM.. I’m sure they see the analogy to the 1994 example I have provided above. An “open” mobile browser with enhanced features would destroy the Apple ecosystem. App developers would choose “open” first (IF they could monetize their investments).

16 February 2011

Yeah.. thought the headline would make you read this one. This was the theme of yesterday’s  WSJ article covering a NYC Mobile Monday Confab. I agree with these young CEOs, as I’m sure would James Gosling, Grady Booch, Marc Andreesen, Alan Kay (and the Xerox PARC team). Most of the readership of this blog are business/payments folks, and probably don’t recognize the names or the technical dynamics at play. Objective of this blog is to give a business perspective on a “death of apps” dynamic as these business execs are the ones who actually fund (and take the risk) on these technical approaches.

Let me start off with 2 stories

Story 1 – 1994

A long, long time ago (1994)…  Netscape launched and gave ability to view basic HTML. The experience was rather dry, with even “drop down” boxes a major accomplishment. There was very little transacting, and the internet looked like one big marketing brochure. Early stage corporate use was limited to “employee directory” kind of functions, and interactive employee applications were built on … wait for it… POWERBUILDER, VisualBasic, or … for the more advanced companies… Smalltalk (an excellent language and my personal favorite). IBMs OS2 Warp was easily winning the enterprise war against Microsoft’s 3.1, a release which required a TCP/IP add on (Win95 came the next year in 1995). 

Enterprises had a desktop mess, applications had to be installed with all of their supporting libraries, on multiple machine types, with multiple operating system versions, hardware versions, most of which conflicted. Fortunately internet browsers began to develop more and more functionality, with scripting and embedded virtual machines of their own. “Light” applications began to migrate to the browser with a significant advantage in cost to deploy and a slight disadvantage in functionality. As browsers and standards further evolved, more applications changed their architecture, attracting more top tier developers. Fat client apps became an ugly legacy (for all but Microsoft’s Office applications).

Lessons learned: multiple proprietary architectures won in “functionality” but lost in cost to develop, cost to deploy and cost to service. Greater investment in a “sub standard” approach enabled faster growth, focus and subsequent adoption. Open architectures allowed multiple parties to create profitable businesses, and further invest.

Story 2 – Fat Mobile Applications

I had a tremendous global team at Citi, quite frankly some of the best and brightest people I have ever worked with at any company. As head of channels for Citi Global Consumer, mobile (outside of the US) was in my domain. Banks are highly driven to reduce cost to serve and acquire. Mobile was (and is) a channel with much experimentation. At Citi I took a look at 6 key mobile initiatives within the last 3 years to look for patterns of success/learnings that could be leveraged. We had developed “fat client” mobile applications in US, Germany, Japan, Mexico, AU as well as SMS based applications in PH, SG, IN, Indonesia, … In every case fat client mobile applications failed.  Why? Technology, user experience, cost to deploy, MNO “support”, …  The testing matrix of handset types, OS types, screen size, OS versions, …. was just not manageable.

Perhaps the biggest learning of all.. is how mobile is viewed by the customer. As my head of mobile in HK (Brian Hui) told me “what is so urgent that the customer can’t wait to get back to their PC”? Customers want speed and simplicity in their mobile interactions. For services like “what is my balance”? Fat clients are not needed. Even today, bank mobile applications are largely a competitive “me too”, as deployment costs to support 3 platforms (RIM, iPhone and Android) are much lower than prior “universal” support attempts. Although the statistics are not widely published, more than 3x customers access their bank through a mobile browser than through their bank’s mobile application (not everyone has an iPhone.. imagine that).

Proprietary Closed Systems must go first in NEW markets… then evolve or fail

As I mentioned in my previous blog, history has shown that closed networks form prior to open networks (in almost every circumstance). Closed networks are uniquely capable of managing end-end quality of service and pricing. This enables the single “network owner” to manage risk and investment. How can any company make investment in a network that does not exist, it cannot control, at a price consumers will not pay, with a group that can not make decisions or execute? Answer: Companies cannot, it is the domain of academics, governments, NGOs and Philanthropic organizations.

The principle challenge in evolving a closed business platform is financial. The margins associated with maintaining “control” of a platform are substantial… they are very hard for any company to give up (ie Microsoft, Apple, IBM). Just take a look at today’s WSJ regarding Apple’s subscription service plans. Apple wants to take a 30% cut of everything ever sold to its platform… for eternity. Can you imagine Microsoft asking to take a 30% cut of every fee on any item viewed or played on a Windows PC? How do you think Amazon or the music industry feel about this? Every iPhone App developer? It must feel like a Faustian bargain at best.

Apple’s big advantage today is app revenue, as it provides:

  • Terms and Control
  • In App Billing
  • In App Advertising
  • Consumer Payment Management

Yet I digress…. what about fat apps? This is why I like Google’s model, and why it will be so hard to compete against them. As Google evolves Android into an open mobile platform, the “app” revenue model will evolve as well. Just as with Apple’s Mac experience, it will be difficult for Apple to attract continued investment.  Given the tremendous talent at Nokia, MSFT, Google, RIM.. I’m sure they see the analogy to the 1994 example I have provided above. An “open” mobile browser with enhanced features would destroy the Apple ecosystem. App developers would choose “open” first (IF they could monetize their investments). Every handset manufacture and MNO has incentive to develop and invest in a “kill the app” mobile browser standard to compete with Apple and change the competitive dynamic.

One exception I see is in mobile “secure” applications. In this the GSMA and NFC Forum are absolutely brilliant… they have defined a common standard.. unfortunately the business model to monetize it has not yet developed. They had the right technical team design it.. can they get the right business leaders to make is successful? (see related blog)

Excellent TechCrunch Article on HTML 5  Feb 5, 2011

App Stores $25B Market?

$7B in App Store Rev? Given that Apple’s total is certainly under $1B I see it quite a bit under this. If there were some movers within the space I would expect to see Apple become more aggressive in investing and acquiring either directly or though their iFund investment vehicle (in partnership w/ KPCB). What is my guess? In-App and social gaming is the revenue driver of the segment and it represents $500M-$700M of gross sales

18 January 2011

Read the report in TechCrunch this AM on AppStore market growth going to $25B by 2015 (up from $6.8B in 2010), as well as their excellent article on the App Store Boom from last week. Other analysis:

 As an investor.. my intuition is to ask… Are these forecasts reliable? Where is the revenue? 

Perhaps LightSpeed Ventures can provide an update to their excellent 2009 analysis on Apple’s $25M App Store revenue estimate. The market has tremendous information on number of app downloads.. what we don’t see is much in the way of revenue numbers for paid apps (or in-app purchases).

Starting with the first study’s estimated 2010 app store revenue of $6.8B (Juniper also aligns on this estimate). The easiest place to start analysis is Apple’s numbers(as Nokia’s are even more obscure, and Android’s marketplace is fragmented). We can either calculate revenue as Lightspeed did (# paid apps x average price) or from Apples financials. Using Distimo data see for December 2010 350k paid app downloads per day at average price estimates ranging from $2.43 to  $0.99 (with prices declining 15% YoY).

December  Gross App Store Sales Estimate (excludes in app purchases)

350k * $2.43 *30 = $24.6M

For FY 2010 given 15% price decline and 40% growth rate, Apple 2010 App Store Gross Sales (Excluding in App Purchases)

Gross Sales = $24.6 * 12 * ((1 + 0.15/12)^12)* ((1-0.4/12)^12) = $228M

Apple’s Net App Store Revenue = 30% of $228M = $68.4M

Is there a way to validate these numbers using Apple’s 2010 10-k? A: Not really.  As you know, App Store revenue is accounted for as “other related music products and services” which totaled $4.1B for FY10 (23%, $912 YoY growth), where this same category grew 21% in prior year (FY08 v FY09) and 34% (FY07 v FY08). This segment includes iTunes revenue (note App store launched in July 2008). On its face, it would certainly seem that App Store revenue has not significantly added any substantial growth for this “other” segment”, and the LightSpeed Venture 2009 analysis of $25M is aligned.

The question remains: to what extent does in app purchase drive app store economics (Apple + Nokia + Google +…)? This is where the Juniper Study comes in to play. The Juniper information is tightly correlated (directionally) with market G2 from both issuers and the card networks. The lightning growth is in social gaming segment of digital goods. I still have a hard time with a $7B number given that Apple’s total for the segment is certainly under $1B (10k). If there were some movers within the space I would expect to see Apple become more aggressive in investing and acquiring either directly or though their iFund investment vehicle (in partnership w/ KPCB). What is my guess? In-App and social gaming is the revenue driver of the segment and it represents $500M-$700M of gross sales. Adding Nokia and Android, this market is at most $2B Gross Sales.

Investment take

  • Go strong into social gaming
  • Ensure in-app purchases are part of all plans
  • Treat market analysis skeptically
  • Watch for rollups and Apple investments.. this is where the money is.

Admittedly I have not wrapped up this analysis cleanly.. this is a blog not a treatise. I’d love your feedback on other numbers and perspectives.

Apple’s 1Q earnings call is today at 5pm… let’s see if we get any more insight.