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Has Apple just screwed the business model for selling software?

By on January 10, 2011

Last week, Apple launched an app store for Macs.

This marks the beginning of the end traditional software business.

Mac AppStore

Apple has already show a new way of selling software using the three-way integration between the iPhone, the App Store and iTunes. From a business perspective, the most important aspect of this integration is not the seamless purchase path and the high conversion rates; it’s the way it has reduced distribution costs to close-to-zero.

When distribution is free

Software, like most content, is expensive to create. It requires skilled engineers, programmers and product managers to get right. However, like most content, it is inexpensive to distribute.

Actually, what I mean is that it used to be expensive to distribute’; now it’s cheap. The old model involved boxes and shiny discs and glossy packaging. The new model involves digital download. Making one more copy of a piece of software is incredibly cheap. So cheap as to be almost free.

What happened on the iPhone when distribution was free

if you put a product up on the iPhone App Store, distribution is free. The bandwidth costs are swallowed by Apple as a cross promotional tool to sell its hardware. If you give away a free app, and never make any money from it, Apple doesn’t charge you anything. If you make money from it, Apple charges you 30%.

This truth – that distribution is effectively free – has seen a rapid change of business models on the iPhone. Initially, games launched at a price point to compete with PSP and DS titles. By December 2008, the average price of an iPhone app had fallen to $1.58. Before long, the Freemium model emerged and now 34 of the top 100 grossing apps are free, with revenues generated from In App Purchases.

Expectations are changing

it was easy to charge for software when it came in a box and had associated physical costs. No, scratch that. It was essential to charge for software when the marginal cost of distribution was meaningful. To put that another way, if it cost you real money to make one more copy, which it does with a physical copy, you need to charge real money for a copy.

This is not true in the digital era. However, many business models have not evolved to reflect this. (Obviously the software-as-a-service model is an evolution in this direction.)

The Mac Appstore brings smartphone style pricing to the desktop. Smart SaaS companies will look at ways of making their software available for free via the distribution mechanism of the App Store, and using their existing upsell expertise to generate revenues. Startups who can’t afford the marketing budgets to compete with incumbent software business will launch freemium products via the appstore (like Zynga and Playfish did on Facebook; like ngMoco and Nimblebits on iPhone). Companies who only know how to sell premium priced products as software downloads are in trouble.

The Mac App Store is the deathknell for selling software in boxes. When it comes to the PC (and there is about to be a bun fight for the position as the desktop App Store), it will start driving prices down to zero.

Watch the smart phone arena closely. That’s what the desktop market will look like in 2 to 3 years.

About Nicholas Lovell

Nicholas is the founder of Gamesbrief, a blog dedicated to the business of games. It aims to be informative, authoritative and above all helpful to developers grappling with business strategy. He is the author of a growing list of books about making money in the games industry and other digital media, including How to Publish a Game and Design Rules for Free-to-Play Games, and Penguin-published title The Curve: thecurveonline.com
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  • http://www.facebook.com/cliffski Cliff Harris

    I disagree :D
    The iphone market is different because the products themselves are simpler. Simpler software can be produced by hobbyists, and the vast vast majority of people I know involved in iphone games do it as a hobby for weekend extra money.

    Because so many of them are already holding down a day job, they don’t price in their labour, and they don’t mind if their *hobby* only makes a small amount of money.
    With bigger, mroe complex and polished games, such as those on the PC desktop, the majority are full-time commercial ventures. The costs of production are vastly higher, and the viable competition from hobbyists in their spare time, prepared to work for near-free is much lower.

    I say this, as someone with a decent-selling (top 10 grossing by revenue) game on the app store, and it’s priced at £17…

  • http://www.facebook.com/cliffski Cliff Harris

    I disagree :D
    The iphone market is different because the products themselves are simpler. Simpler software can be produced by hobbyists, and the vast vast majority of people I know involved in iphone games do it as a hobby for weekend extra money.

    Because so many of them are already holding down a day job, they don’t price in their labour, and they don’t mind if their *hobby* only makes a small amount of money.
    With bigger, mroe complex and polished games, such as those on the PC desktop, the majority are full-time commercial ventures. The costs of production are vastly higher, and the viable competition from hobbyists in their spare time, prepared to work for near-free is much lower.

    I say this, as someone with a decent-selling (top 10 grossing by revenue) game on the app store, and it’s priced at £17…

  • Rob

    interesting and this is only going to escalate with the advent of Chrome and its App Store – Software itself will reduce in price in part as a result or the reduction of the costs of delivery to market.
    It’ll be very egalitarian with good software (with good reviews) selling well and making a decent profit –
    Poor software wont – and unlike in physical retail wont be able to “buy” it’s way out of trouble in acquiring exclusive retail deals and large and prominent shelf space.
    However, i am more concerned how app stores can manipulate sales – in the same way as Apple has with “promotions” …
    Has no one else noticed that every 3 or 6 months a “wonder” app appears – cue Angry Birds – and keeps the development community believing there’s gold in them there hills….? Is there? – Or is it a promised land for only a few…

  • http://www.gamesbrief.com Nicholas Lovell

    Would it surprise you that I disagree with you? :-)
    You take the view that iPhone apps are hobbyists. Yet successful games like Smurfville and anything from ngMoco are created by large, professional organisations with bills to pay that dwarf those of a hobbyist. They are free to play.

    In the PC world (and I’m including browsers here), we have games like Seafight and Dark Orbit from Bigpoint, Dungeons & Dragons Online and Lord of the Rings Online from Turbine, Metin 2 from Gameforge (in Europe, anyway), and Champions Online from Atari (going free shortly).

    The business model of free is not about reducing the revenue from games (DDO saw revenues increase 5x in the first six months when it went free) but from a new way of allowing users to determine how much they are prepared to spend which seems, so far at least, to lead to more revenue overall.

    If you can find a way to harness your greatest fans, while giving your game away for free to widen the funnel of potential players, you will make money.
    The problem is that this plan is hard to execute.

  • http://www.gamesbrief.com Nicholas Lovell

    I agree that every so often a wonder app appears. I am however congenitally disinclined to believe in conspiracy theories when it is just more likely, particularly in entertainment media, that every so often a Black Swan-style breakout hit emerges that captures the popular imagination.

  • http://twitter.com/fbindie Facebook Indie Games

    Small developers have been selling software for download on the “open web” for a long time. There’s anecdotal evidence that for many this is a better use of developer’s time than becoming a slave to the Apple app store.

    The App Store isn’t really about reducing the cost of distribution. This has been at practically zero for most software for years now. It’s about reducing the cost of reaching customers, and making it easier for customers to buy and install the software once they’ve found it. That is what Apple will take their cut for.

    Witness also that the downward pressure on price is far stronger on the iPhone than the iPad. My take — people think a small device should have simple software with mass appeal and a lower price. iPad apps can be pricier. I bet Mac apps can be pricier again.

    The real question I have is: “where is Microsoft in all this?” See my blog…

  • http://www.gamesbrief.com Nicholas Lovell

    I agree that the App Store has been more about reducing the cost of reaching customers. However by reducing the cost of implementing a billing and distribution service to “zero upfront”, and just taking a 30% cut of revenues, Apple has changed the market.

    I also note that for a free app aiming to get millions of users of whom a small percentage pay, the difference between “zero” and “practically zero” can be quite high. When Apple swallows all the costs it is definitely zero from the developer’s perspective.
    In the end, I believe that smart businesses will find better, more cost-effective and more profitable ways of making money by offering the initial content for free. If you don’t have a strategy to compete with this, I think you will struggle.
    You make a good point about the iPad, though I fear it is too early to form a definitive opinion.

  • http://twitter.com/Neurogames Simon Reed

    Even though the distribution on the App Store is practically free, the bigger issue is the cost of or difficulty in getting noticed and staying noticed. As the stores develop it seems that the companies with the biggest marketing budgets will take advantage of this and effectively buy themselves up the charts to gain the exposure that gains traction and further downloads (it’s already happening). Unless the App store changes it’s structure there will continue to be big winners in the paid downloads sections as it accounts for between 1/3 and 1/2 of a stores free exposure and all evidence shows that this exposure is one of the most effective ways to sell more Apps along with a variety of other reasons such as people associating initial price with quality and disliking hidden charges or being up sold too.

    That said I do agree that the biggest winners will be/are those working the freemium model in areas that offer potential repeat purchases within their products, as offering an option to spend lots of money to the small percentage of non price sensitive users out there requires in App purchases and offering good quality Apps for free is likely to hook these people in.

    All in all as each store gets bigger and more profitable, unless apple sort out their recommendation and suggestion methods the indie developers will struggle when competing against the big money companies who have the resources to plough in 100k+ for a big launch and allocate the same to post release advertising and paid downloads (through CPA’s).

  • http://www.gamesbrief.com Nicholas Lovell

    Simon,
    I think this is true for the big hits. But the joy of in-app purchases is that you don’t need a massive audience; you need a committed audience who will spend money with you and tell their friends. This is a much more achievable target for Indies than trying to get, say, 2 million paid downloads.

  • Atchik

    Very sharp view. The smartphone industry is leading the way to the whole IT and PC industry.
    Another interesting post here on Apple’s integrated business model : http://issard.wordpress.com/2010/02/01/apple-integrated-model/

  • Roman Kl

    Thank you for sharing with useful, good info. It must to know that QC quality control services will protect software products from unexpected expenses.