On Pricing and the App Store

As we wrap up our 2009 Buyers’ Guide and look back on three months spent reviewing hundreds of applications, I’ve been pondering the ways in which Apple has changed the game in the mobile applications market.

As some of our readers will know, I’m a very long-time PDA user, going back to the days when Palm was owned by U.S. Robotics. The device was actually called the “Pilot 1000” and had a whopping 128 KB of RAM—yes, that’s “KB” as in “KILObytes.” I bought my first Pilot 1000 for what it could actually do by itself, and only later discovered the fact that I could add more applications onto the device. Well, the result of that was that I quickly needed to upgrade to the 512KB model Pilot 5000, as I was pretty much hooked on the idea of third-party applications that expanded what my little pocket-sized friend could do.

Over the years, as the world of PDAs expanded and other vendors such as Microsoft entered the market, an entire ecosystem built around third-party PDA apps sprung up, with thousands of third-party developers focused on PDA applications, and numerous sites like Palmgear.com and Handango specializing in nothing more than providing store-fronts for these types of apps.

Thus, I watched with some interest last spring as Apple announced their concept of an iTunes App Store. On the one hand, the idea of buying a PDA application online was nothing particularly novel. However, as with most things that Apple does, the approach was just different enough to be intriguing. The business model was quite simple: developers would only be able to sell their applications through the iTunes App Store, and Apple would take a 30% cut of revenues. In return, however, Apple would handle all of the order processing and digital store front, collecting the money and simply handing the developers a check every so often.

Other than the prohibition on selling applications through any other channel, this wasn’t really that different from what Handango and other sites like it had been doing for several years. However, a funny thing happened on the way to the App Store: the average price of applications dropped dramatically.

If you search Handango and other sites like it, you will discover that it’s not at all uncommon to find relatively simple applications like alarm clocks selling for $10 or more for other devices, and $30-$40 applications for Palm and Windows Mobile devices are not at all uncommon. These are prices that we would now consider absolutely absurd for similar iPhone applications.

This discrepancy becomes interesting when you consider that people were and still are buying these applications for other platforms. Further, there’s no evidence that Apple has forced any kind of low pricing model on its developers—to the contrary, there was buzz early on that Apple was trying to persuade developers to charge more. The only pricing restrictions on the App Store are minimum $0.99 and maximum $999.99 price tags, and a requirement that prices be set to easily-rounded increments, meaning simply that you won’t see apps being sold for $7.39, for instance.

When you really sit down and think about it, the really interesting part is that it is the iTunes App Store business model combined with market forces that has led to this. Nobody told developers that they had to set their prices low—most of them just did so naturally, possibly expecting that they would make their money on volume of sales rather than higher profit margins. That appears to be the case; people selling $5 apps are carting away $250,000 in a month or two. Not bad.

The iTunes Store has always held a relatively unique position among online vendors in the way in which it is seamlessly integrated into an application that every iPod and iPhone user already has. You don’t have to search Google and wade through dozens of possibly irrelevant hits when looking for something. Further, developers do not have to rely on their customers knowing about third-party applications or sites that they can get them at. With the iTunes App Store, everything is right there in front of the user with generally no more than a few clicks of the mouse.

The result is that volume sales are easily achievable, since every developer is instantly on a mostly level playing field and has access to an established customer base of millions. For most developers, it’s the digital equivalent of being able to set up a shop selling home-made jewellery in the middle of Macy’s.

The other important factor that I think has contributed to driving prices down is the lack of any kind of shareware-style trial mode for software. While the App Store easily allows for free applications, these are simply given away. There is no way for a developer to provide a limited free application and later allow the customer to unlock additional functionality. In fact, selling features outside of the App Store is expressly prohibited by Apple. Some developers have worked around this by providing limited “Free” versions of their applications, and then paid “Pro” versions, but it seems that most developers have simply kept their prices low in the hopes that for a couple of bucks, most users will give the application a chance, sight unseen.