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/ )

Digital Goods: Where to Invest?

What is driving the explosive growth in digital goods? Social gaming. The nice thing about running a credit card network is that you can see who is making money. No doubt a factor in last week’s $190M Visa acquisition of Playspan.

 17 Feb 2011

Digital goods are everything that can be sold and shipped online (music, movies, articles, ring tones). John Doerr (legendary KPCB Partner) certainly turned heads in Nov 2010 when he said Zynga is “our best company ever”.  What is driving the explosive growth in digital goods? Social gaming. The nice thing about running a credit card network is that you can see who is making money. No doubt a factor in last week’s $190M Visa acquisition of Playspan.

A key benchmark in the category of “digital goods” is Apple. Within Apple’s annual 10k digital goods revenue is accounted for within the  “Other Music Related Products and Services” category.  This category also includes app stores. For FY10 Apple saw a 93% increase in iPhone sales, but there was only a 23% uptick in “digital goods” (growth in line with previous 2 years). This makes intuitive sense given that Apple customers did not need to repurchase their iTunes library from iPod 1 to iPhone 4. But Digital Goods has certainly NOT been a key source of  growth for Apple. 

Lets take a look at Zynga. As I stated in previous blog,

…three years old with an estimated market value above $5 billion with more than 320 million registered users and estimated revenues above $500 million… From my perspective, Zynga’s secret sauce has been its ability to get 1-2% of their customer base to pay for game credits (see Gawker article). Although they have recently agreed to a 5 year deal with Facebook, this patent (if granted) will provide them leverage in future negotiations and extending their services outside of the Facebook platform.

For more info see TechCrunch / Steven Carpenter Zynga analysis (excellent)

The fortunes of Zynga have been tightly tied to the success of Facebook. Facebook’s new payment policy (mandating use of Facebook credits) will enable them to capture 30% of revenue. Zynga’s margins are obviously impacted in this move.. I’m sure many people immediately see the analogies here with today’s WSJ article (Apple Risks App-lash…) on Apple’s 30% digital goods tariff.  

As an investor, where do you place your social gaming bets?

A foundational digital goods investment question is your view on how social gaming can exist. Can social gaming survive in a model disconnected from Facebook and Apple? If you believe so, then possibly place bets in the Google model. Over the past 6 months, Google  has made five acquisitions in the field: SocialDeck, a mobile social gaming company; Angstro, a social networking search application; Like.com, a social fashion store; Jambool, a social gaming virtual currency; and Slide, a social game maker, and a $100M+ stealth investment in gaming giant Zynga.  Beyond Google, other views exist for social gaming in a mobile context  (MNO driven model).

Now that you have chosen the model (I’m tired of using the word ecosystem), where will your bet play? I see 5 categories:

  • Games (Zynga, EA, …)
  • Analytics/Incentives/Advertising
  • Distribution
  • Gaming Infrastructure. Example Payment, Hosting, Mobility, Support, …
  • Confluence. game-community, game-retail, game-mobile, game-mobile operator, … Example.. earn farm $$ by visiting a retail store and checking in..

Is social gaming a sustainable category? My personal preference is to place bets in common infrastructure until the next Zynga flourishes. Something I learned from Larry Ellison “when there is an arms race, don’t fight.. sell the guns”

Feedback appreciated..

Digital Goods Payment

There is a birth of new payment types brought on by digital goods. Companies like Zynga, Boku, PlaySpan, Bango, Zuora, SocialGold are being assessed at multiples exceeding 100x revenue. Social gaming is the focus of many of these companies, with estimated transaction volume of around $2.2B and expected market growth of 50-80% CAGR.

8 Nov 2010

There is a wealth of new payment types (and currencies) brought on by digital goods. Companies like Zynga, Boku, PlaySpan, Bango, Zuora, SocialGold (see list here) are being assessed at multiples exceeding 100x revenue. Social gaming is the focus of many of these companies, with estimated transaction volume of around $2.2B and expected market growth of 50-80% CAGR.

Quite exciting. Is it a “fad” and will these notional currencies be able with withstand the light of regulatory review?

Apple and Google after Boku?

So if Apple buys Boku will Android still support Boku payments (http://www.boku.com/android/)? I do think Boku is in play.. but the real acquirer may look more like the Mercury NewCo than google.. MNO synergies are the core of the Boku business model. Unfortunate that the Mercury NewCo still has no CEO.

2 Nov 2010

TechCrunch: Apple’s next strategic move

Yesterday: AT&T inks deal w/ Boku

http://news.cnet.com/8301-13577_3-10265243-36.html

What is Boku’s core asset? Technology? MNO billing relationships?

Hope that Apple and Google look long and hard at the MNO contracts as the “secret sauce” that has driven Boku’s growth. Boku’s MNO friendly approach and neutrality allows any customer to buy digital goods and charge it to their carrier bill.  Neither Google, nor Apple would seem to have a strategic fit here. Why would carriers allow Google/Apple to bill to goods to their customers? Or perhaps I should ask at what cost will carriers allow this to happen?

All of this is even more relevent as ATT/Verizon/TMobile/Discover,.. etc. build their own payments business.

Boku is a great business, but it operates on a precipice much the way PayPal did in its early days.  Carrier billing can certainly be  a much more cost effective infrastructure for mobile digital goods purchases. But what drives this efficiency? Isn’t it the carriers and their relationship to mobile customers?

On the “buy side” digital goods stores use Boku because of its independence. So if Apple buys Boku will Android still support Boku payments (http://www.boku.com/android/)? I do think Boku is in play.. but the real acquirer may look more like the Mercury NewCo than google.. as the MNO synergies are the core of the Boku business model. Unfortunate that the Mercury NewCo still has no CEO.