Apple iPhone Software: Developers See Green

Apple (AAPL) wants to give software developers one more reason to love the new version of its mobile operating system. Released June 17, iPhone 3.0 includes a feature that makes it easier for users to make purchases using iPhone applications and, as a result, for developers to make money from the software they create.

Electronic Arts (ERTS) founder Trip Hawkins couldn't wait for the upgrade. His latest startup, Digital Chocolate, sells games for mobile phones. With the existing version of iPhone software, the company charges a one-time fee for each of the 15 games it makes for the iPhone and iPod touch. But iPhone 3.0's in-app purchasing tool will help Digital Chocolate sell additional products, including advanced versions of games and virtual weapons and other items for use by players. "There's no question that [players] buying games for a one-time fee wouldn't be spending anywhere near this kind of money," Hawkins says. Digital Chocolate plans to have released 100 iPhone games in a year.

Bait for Programmers

Mobile game makers aren't the only developers seeing dollar signs in Apple's in-app purchasing feature. Mobile app provider Handmark, for instance, is considering offering a "Zagat to Go" application that would regularly update reviews of 40,000 restaurants, hotels and shops, on a subscription basis. Newspaper USA Today plans to start charging monthly and annual subscriptions for new apps showcasing its travel and sports content. Authors and publishers are considering selling their work in installments instead of in their entirety.

For the software makers who pocket 70% of the revenue generated by the applications they sell for Apple's devices, the appeal of in-app purchasing is obvious. Apple benefits not only from gains in the 30% of revenue it keeps, but also because the tool gives developers added reason to keep writing software for its devices. Competition in mobile software is heating up, as companies including Nokia (NOK), Research In Motion (RIMM), and Palm (PALM) ramp up their own efforts to attract developers. For many consumers, smartphones need to have not just cutting-edge hardware, but also enticing games, productivity applications, and other software-based features. In-app purchasing is one of several tools Apple is working on to attract programmers.

Potential Revenue Gains

As a result of in-app purchasing, some developers' App Store revenues could increase three to five times, says Jeremy Liew, managing director at venture capital firm Lightspeed Venture Partners. The App Store has generated about $318 million in sales since its debut a year ago, he estimates. "Apple could dramatically increase its revenues," says Liew, whose estimate assumes that before long, Apple will allow the in-app purchasing feature with free apps. For now, the in-app tool is available in paid-for apps only.

Booyah, an application due to go on sale soon, lets users chronicle and share life achievements and purchase virtual goods to decorate avatars. With in-app purchasing, "you've got a much larger platform and more opportunities to monetize better," says Matt Murphy, a partner at venture capital firm Kleiner Perkins Caufield & Byers, which is backing Booyah. With 40 million iPhones and iPod touches already in users' hands, "the opportunity that in-app purchasing allows is enormous."

Nickel-and-Diming Users?

But will iPhone users be willing to make additional purchases from an app they already had to pay for? As it is, few users are willing to pay more than 99¢ for applications, and average selling prices at the App Store have plummeted. Developers will probably keep initial prices low or even cut prices in hopes of getting users to make added purchases down the road. The onus will be on developers to create a steady stream of compelling new features. "We see this as a shift in the paradigm for iPhone apps," says Michael Bullock, a vice-president at Intermap (IMP.TO), maker of a hiking-map application. "We are going to make applications as inexpensive as possible. The revenue comes through the provision of [additional] content." Bullock speculates that 80% to 90% of Intermap's revenue will ultimately come through in-app purchases.

More ways to charge consumers also present more opportunities to make a buck on low-quality goods. "Initially, we are going to see a mixed bag—some of the developers who are doing it the right way, and others who are nickel-and-diming the consumers," says Adam Sussman, a vice-president at EA. "Consumers could get upset. You have to make sure what you deliver is of significant value."

Rivals Watch Closely

Rivals such as RIM's BlackBerry App World and the Android Market, created by a Google (GOOG)-led consortium, are expected to follow Apple into in-app purchasing within months. "If this particular rollout is successful, I don't think we'll have to look too far into the future to see the same capabilities on Android or the BlackBerry," says Matt Jones, vice-president for mobile strategy and operations at Gannett (GCI) Digital, which is considering putting out a subscription-based app that would let users delve deep into sports scores and statistics. Google and RIM wouldn't comment on possible features.

At the very least, the prospect of added sales will probably spur innovation, Murphy says. Developers may also start launching apps in genres they've bypassed previously. Electronic Arts, for instance, is prepping new kinds of mobile games that users haven't been willing to pay much for before. The company currently charges $4.99 to $9.99 for its 16 iTunes games. Says Sussman: "We had to revisit our slate of games."