Making Money on Apps

As one half of an iOS development company, I’ve been thinking about how to make money on apps for a while. The recent kerfuffle aroused by Brent Simmons and Jared Sinclair’s posts on the topic brought some of those thoughts to the surface.

To preface this discussion: I haven’t personally been successful in making money in the App Store, so you can take these thoughts with whatever-sized chunk of salt you’d like. But having watched the space since its inception in 2008, and comparing it to other types of businesses, I think there’s some clear lessons.

Let’s start with some basic economics, which is about as much as I remember from my major:

  • In a commodity market for any item, marginal revenue equals marginal cost. With software, every additional copy after the first one costs nothing for the developer to "make," so marginal cost is zero. Marginal revenue to the developer, or the price of the software, will also be zero in a competitive market.

Now before you come at me with a million exceptions and counterexamples—we’re getting there—it’s important to keep this basic principle in mind. Barring special cases, the “natural price” of an app is $0.

This is kind of a bummer. But it also quickly answers the classic question, “why won’t people pay as much for my app as a cup of coffee?” Every additional cup of coffee costs Starbucks something to make, so, intuitively, it costs money to buy a cup of coffee. It doesn't cost Facebook anything to deliver another copy of the Facebook app to your iPhone, so it makes sense that it's free. There’s a longer answer, but that’s the basic difference between $0 and not-$0.

Paul Graham put this point more elegantly in one of my favorite essays about the decline of print media (and the future of journalism):

Economically, the print media are in the business of marking up paper. We can all imagine an old-style editor getting a scoop and saying "this will sell a lot of papers!" Cross out that final S and you're describing their business model. The reason they make less money now is that people don't need as much paper.

IN OTHER WORDS: People pay for physical stuff because physical stuff seems like it should cost something. Pixels on a screen do not seem like they should cost something. This basic human intuition is very very very hard to break. Keep that in mind!

But hey. I thought this post was about “making money on apps,” not “not making money on apps.” So how do you do that? Three ways:

  1. Charge them for something that helps them make money.
  2. Charge them for an emotional experience.
  3. Don’t charge them, charge someone else for helping that someone else make money.

The first way is the foundation of the enterprise software industry. Oracle, Bloomberg, Microsoft, Salesforce, Box, etc. If you can make software that helps other people make money, you can charge them. This often necessitates a huge sales force, marketing budget, distribution strategy, contacts in enterprise, and so on, but it can be done. You can sell software to people for money. It’s just a huge pain. See Ben Thompson on Box v. Dropbox, or the aforementioned Paul Graham essay for more.

The second way—charging for an emotional experience—is the foundation of the iTunes media store, the free-to-play gaming business, and many of the solid-but-small businesses that indie developers have managed to drum up.

The iTunes media store is able to sell digital, zero-marginal-cost movies, music, and TV because customers know they’re paying for the emotional high of a great song, a favorite movie, or “Breaking Bad.” But this has never been at the core of Apple’s business because, again, people pay a lot more for stuff (iPhones) than pixels (iTunes). And it seems Netflix, Spotify, and HBOGo are gradually swallowing up the paid content business. The march towards free pixels continues.

The free-to-play business pushes users to the point where the emotional need to play on is so strong that they’re willing to make that one button-tap to send Kim Kardashian another 80 bucks. Preying on the pain of loss from prospect theory and the sunk cost fallacy are particularly effective here.

While indie developers may not think of their businesses this way, they are similarly profiting from emotional connections. Maybe the design sensibility of the app resonated with a potential customer.[1] Or maybe the developer has been such a good steward of the app that many users are willing to throw a few bucks into a virtual “tip jar” as a thank you.[2] An emotional connection gives many indie apps the differentiation they need to charge above-market prices. Which, again, is any price above $0.

But there’s a lesson indies can learn from the free-to-play apps: they’re free-to-start-playing for a reason. It’s always difficult to build an emotional connection strong enough to charge someone. It’s even harder if you put up a wall before they can try out your product.

Last week I tried out Overcast as my new podcast app. I didn’t buy the $5 in-app purchase right away. I listened to a few podcasts, tried out Smart Speed, and finally had an impulsive moment of emotional intensity that went something like “well-smart-speed-is-cool-and-I-think-Marco’s-a-good-guy-so-OH-WELL-I’ll-buy-it!” Three taps, and I was done. This is not very far from the emotional cycle that leads someone to buy extra lives in Candy Crush.

The third way to make money is to give the app away for free and charge somebody else. This is the only way to build a big social network that’s worked so far. It’s the way Twitter, Facebook, and Google make money. What I find amusing is that it’s really just an inversion of the first strategy—charging someone for something that can make them money. Advertisers can make money with access to user data, so they’re willing to pay for it.

(And if you want to go even deeper down the rabbit hole, how do the advertisers make money? Probably by selling physical stuff. It all comes back around.)

So what to do if you’re an indie developer? Pick a strategy. Most seem to be going with #2, and that’s fine. But I highly recommend you charge $0 up-front and build an emotional connection strong enough to charge more later.

I’m personally going for #3, because my dream is to build something that millions of people use and enjoy. That’s really, really hard if you charge people for something they feel should be free.

  1. Sometimes the developer's design sensibility, and not just the app itself, resonates with customers. E.g. Vesper
  2. Marco described on an episode of ATP that he made about half of his revenue on Instapaper from subscriptions to search, a feature that was not extremely valuable to users. Coincidentally, I was/am one such subscriber.