Peer over the shoulder of that person fiddling with an iPhone. Chances are they're doing something other than making a phone call. They may be playing a game like Tetris or trading stocks through TD Ameritrade (AMTD). They may even be conducting serious business, with a mobile version of Salesforce.com's customer-management software. The possibilities grow by the day: Since Apple (AAPL) began letting outsiders offer software for the iPhone six months ago, more than 10,000 apps have been created.
This is more than just fun and games for Apple. The company has grabbed an early lead in turning the mobile phone into a high-powered computing device capable of running all kinds of applications. The average iPhone owner has downloaded at least 15 applications in the past six months. The average person carrying a phone from Nokia (NOK), Motorola (MOT), or others hasn't downloaded a single one, says Nielsen Mobile analyst Nic Covey. "It's remarkable what Apple has accomplished in so short a time," he says.
There's no guarantee Apple can maintain its lead. CEO Steve Jobs' decision to step down for six months will be a distraction. Plus, the bulk of the 10,000 applications available from its online App Store are free or cost just 99 cents. So most developers aren't making the kind of money needed to build substantial companies. "On average, the App Store model is not working out for developers," says Roger McNamee, a financier with Elevation Partners who is backing mobile-phone rival Palm (PALM). In addition, Nokia, Research In Motion (PALM), and Microsoft (MSFT) all plan to unveil competing application stores.
Still, Apple is making progress in expanding the kinds of software available for the iPhone. Besides Salesforce.com, Oracle (ORCL) is developing corporate software for the device. A growing number of startups are charging higher prices for software, including applications for photo editing, project management, and exercise routines. San Francisco's Beejive Inc. gets $16.99 for a program that lets instant-messaging addicts stay in touch with friends on a variety of messaging services at the same time. Research firm Evans Data says 20% of wireless developers now create software for Apple, up from 8% six months ago. "That's the biggest leap we've ever seen," says Vice-President John F. Andrews.
DEVELOPERS NEED TO PROFIT, TOO
Apple may have a shot at staking out a position in mobile phones similar to the one Microsoft established in personal computers. In the 1980s and '90s, the software giant fostered a strong community of independent developers who built products for the Windows operating system, which in turn fueled demand for PCs that ran Windows. No one expects Apple to achieve Microsoft's level of dominance, but expectations are high for a company that holds less than 2% of the mobile-phone market today. "Apple could be at 20% in five years," says analyst Ken Dulaney of researcher Gartner Group (IT). "Every developer I talk to wants to work with them." (Apple will likely see iPhone sales decline in the short term because of the economic downturn.
Citigroup (C) analyst Richard Gardner said on Jan. 13 that sales in the fourth quarter could be below 4 million units, down from 6.9 million in the third quarter.)
Apple's challenge in software will be to create a way for developers to make a healthy profit at the same time it does. The company has software tools that make it possible to create an application in weeks rather than several months. It also keeps just 30% of the sales price for applications instead of the 50% many wireless carriers charge. (If the application is free, Apple takes nothing.) And because the App Store is part of the iTunes online store, where 100 million people already buy music, a popular application can quickly attract millions of downloads—creating sizeable audiences that are attracting advertiser attention.
Developers are finding ways to make money while charging little or nothing for their software. Startup Tapulous has given away more than 5.5 million copies of its eponymous game, which tests music fans' ability to tap their iPhone to the beat of their favorite songs. The popularity of the free offering has drawn advertisers and persuaded CEO Bart Decrem to start charging $4.99 for a version with more features. Decrem says the combined sales and advertising revenue allowed the 10-person startup to turn a profit in December, six months ahead of schedule.
Broker TD Ameritrade offers its stock-trading application for free and makes money from trading commissions. It didn't have to pay anything for the software, either. A five-person outfit in Argentina called iStockTrader developed the program in exchange for a cut of any trades.
Apple's rivals point out that these are early days. While mobile-phone giant Nokia is developing its own app store, it can also help developers get their applications pre-installed on mobile phones so consumers don't have to download them. That can end up being more profitable for the developer than being in Apple's App Store. "We want to make money for ourselves and our partners by maintaining the value so the price doesn't gravitate to zero," says Tero Ojanperä, executive vice-president of Nokia Services.
Still, Andrew Fisher, CEO of music-software maker Shazam, sees developers gravitating toward Apple because of the company's momentum. It's a twist on the PC market, where the best applications appeared first, and sometimes only, on PCs with Windows. This time, the one benefiting is Apple. "That's the position Apple has established," says Fisher. "[The more software they offer], the more justifications there are for people to buy iPhones."