Apple 2.0

Covering the business that Steve Jobs built

Trouble in the (99-cent) App Store

December 10, 2008: 7:57 AM ET

Ocarina 99 centsWith 10,000 applications and 300 million downloads in less than four months, Apple's iPhone may be the most successful software platform since the IBM personal computer.

But that doesn't mean all is well in the App Store.

In fact, the business model that nurtured its success now threatens to choke off the programming talent that sustained it.

The problem is succinctly encapsulated in a bar graph and an open letter to Steve Jobs.

The bar graph was posted Nov. 30 by Edible Apple, a few days before the App Store hit the 10,000 mark. It shows the distribution of prices -- from $0 to $49.99 -- for the bulk of available applications (it leaves off the 30 or so apps that cost more than $50).

App pricing distribution

Note the preponderance of free and $0.99 apps.

Which leads us to that "Dear Steve" letter. It was written by Craig Hockenberry, a veteran programmer who jumped into iPhone development on Day 1. His company, Iconfactory, has produced several products and two iPhone hits: Frenzic and Twitterrific.

"It hasn't been easy," he writes, "but we've learned what it takes to make a kick ass product for the iPhone.

"The problem now is funding those products."

The sticking point, as Hockenberry sees it, is that spike by Edible Apple's graph: the proliferation of 99-cent applications -- what he dubs "ringtone apps" -- as developers reduce their prices to the lowest possible level in order to get favorable placement in iTunes.

"We have a lot of great ideas for iPhone applications," Hockenberry writes. "Unfortunately, we're not working on the cooler (and more complex) ideas. Instead, we're working on 99¢ titles that have a limited lifespan and broad appeal. Market conditions make ringtone apps most appealing."

What's causing this "rush to the 99¢ price point," according to Hockenberry, is the way the App Store displays its products, which results in most iPhone owners buying them sight unseen:

"I see customers complaining about how 'expensive' a $4.99 app is and that it should cost less. (Do they do the same thing when they walk into Starbucks?) The only justification I can find for these attitudes is that you only have a screenshot to evaluate the quality of a product. A buck is easy to waste on an app that looks great in iTunes but works poorly once you install it.

"Our products are a joy to use: as you well know, customers are willing to pay a premium for a quality products. This quality comes at a cost—which we're willing to incur. The issue is then getting people to see that our $2.99 product really is worth three times the price of a 99¢ piece of crapware."

TwitterrificTo illustrate his dilemma, Hockenberry spells out -- in revealing detail -- what it costs him to develop an app:

"Before commencing any new iPhone development, we look at the numbers and evaluate the risk of recouping our investment on a new project. Both developers and designers cost somewhere between $150-200 per hour. For a three man month project, let's say that's about $80K in development costs. To break even, we have to sell over 115K units. Not impossible with a good concept and few of weeks of prominent placement in iTunes.

"But what happens when we start talking about bigger projects: something that takes 6 or even 9 man months? That's either $150K or $225K in development costs with a break even at 215K or 322K units. Unless you have a white hot title, selling 10-15K units a day for a few weeks isn't going to happen. There's too much risk.

"Raising your price to help cover these costs makes it hard to get to the top of the charts. (You're competing against a lot of other titles in the lower price tier.) You also have to come to terms with the fact that you're only going to be featured for a short time, so you have to make the bulk of your revenue during this period.

"This is why we're going for simple and cheap instead of complex and expensive. Not our preferred choice, but the one that's fiscally responsible."

What should Apple (AAPL) do about the ringtone problem? Hockenberry doesn't offer Jobs a solution. ("You and your team are perfectly capable of dealing with it on your own terms," he says.) But he warns that pricing issues are choking off innovation and could prevent development of an app that could do for the iPhone what the spreadsheet did for the Apple II or desktop publishing did for the Mac.

"It would be great if the killer app for the iPhone cost 99¢," Hockenberry concludes. "But given the numbers above I can't see it being very likely."

To read Hockenberry's letter in full, click here.

For another take on the issue, see How to prevent the App Store from becoming the Crap Store by John Casasanta and Phill Ryu. They're the creators of the Classics book reader, which, after a price reduction from $2.99 price to 99¢, climbed the charts to No. 4 on iTunes.

Below the fold: A pie chart from Edible Apple showing the distribution of iPhone apps  by category. Note the preponderance of games and entertainments and the paucity of, say, social networking apps.

iPhone app categories pie chart

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About This Author
Philip Elmer-Dewitt
Philip Elmer-DeWitt
Editor, Apple 2.0, Fortune

Philip Elmer-DeWitt has been following Apple since 1982, first for Time Magazine, and now on the Web for Fortune.com.

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