All About Apps: Part 2. Web Stores as a Business Model

This is Part 2 in the series “All About Apps”.

App stores must not be viewed as simply distribution outlets for apps but as a new business model. That model centers on building an attractive business platform and leveraging its network effects to reshape the competitive landscape to the advantage of leading app store operators.

Mobile apps are downloaded mainly from app stores, e.g., three out of four iPhone apps from Apple App Store and more than half of Android apps from Android Market (VisionMobile, 2011). These stores generated approximately 7 billion downloads for $4.1 billion in revenue in 2009 and are projected to reach 50 billion downloads for $17.5 billion in revenue by 2012 (Chetan Sharma Consulting, 2010). There are 103 app stores, according to the Wireless Industry Partnetship (WIP, 2010). Only a few stores (among them, Apple App Store, Google Android Market, Androlib and GetJar) have reached the level of one billion plus downloads. For developers, app stores offer the widest market reach, far ahead of other distribution channels (e.g., own websites). However, each store has its own developer sign-up, app submission process, app certification and approval criteria, revenue model options, and payment settlement terms. Developers may find the costs of distributing apps via multiple stores, even for the same development platform, add up quickly and are thus hesistant to go beyond a few stores.

App stores are run by either:

• mobile device producers (aka original equipmentmanufacturers [OEMs], e.g., Dell Mobile Application Store, BlackBerry App World, Nokia Ovi and Samsung Apps),
• mobile operating system developers (e.g., Apple App Store, Android Market and Windows Marketplace for Mobile),
• mobile network operators (MNOs, aka phone carriers, e.g., Orange App Shop and Verizon Apps) or
• independent intermediaries (e.g., Amazon Appstore, Getjar and Appitalism).

By design, some stores carry only native apps for a particular operating system (e.g., Android Market, Apple App Store, BlackBerry App World and Nokia Ovi Store) while others offer apps for multiple platforms (e.g., Getjar, Mobango and Hallmark).

App stores embody a new business model that capitalizes on the trends toward technology and media convergence, leverages a different economic driver and reshapes industry landscape to the advantage of leading app store operators.

Technology and media convergence. Traditionally, industry boundary was clear cut and key market players easily identified. In the hardware sector, the phone industry was led by global OEMs (e.g., Nokia, Samsung, LG, RIM, Sony Ericsson and Motorola). Their focus was on the hardware; they typically treated software (operating system and applications) as a supporting elements necessary for the hardware to function rather than a key market differentiator. In introducing the iPhone and its associated App Store, Apple sees the business quite differently: traditional industry boundary no longer matters when several technologies are converging on a single piece of hardware. The iPhone is not just a mobile phone; it is also a media player, a game device, a web browser and a networked computer (though with only limited computing capabilities).

From scale economies to network effect. Apple views its operation system iOS not as a piece of software on which its iPhone hardware runs but as a platform serving a multi-sided market. In the old mobile phone business, the market was viewed as single-sided – the OEMs served only one side of the market (phone users); third-party developers and their applications were very few in number and limited to providing some basic functionalities for the hardware as specified by the OEMs. One OEM saw other OEMs as its competitors. Their business model typically relied on supply-side economies of scale – pricing aggressively to boost sales; higher sale volume would lead to larger production scale, lower unit costs and in turn even lower prices to boost sales further. By contrast, the iOS platform, with the App Store being its business element, mediates interactions and transactions between several groups of market partipants who were, except the phone users, traditionally not key players in the mobile phone business. Each group is attracted to the platform by the vast opportunities to monetize on the products and services they can offer to participants on the other side or sides of the market, e.g., independent developers by the large base of iPhone users who may download their apps, and iPhone users by the large and growing number of apps and media sources that enrich their user experience. The value of a platform to any group of market participants depends on the number of participants on the other side or sides of the market. This is known as the (cross-side) network effect. It tends to propel a market leader already ahead of its competitors further ahead. There is little benefits for market participants to join a trailing platform when many participants on the other side(s) already join the leading platform. Few developers are interested in building apps for HP Touchpad, which runs on HP WebOS, when most users prefer Apple iPad; in absence of any other compelling incentive, few users would be interested in buying the Touchpad when most apps are being built for the iOS (and Android) instead.

Altered competitive landscape. Apple’s rival, Google, has been quick to recognize the new business model centering on leveraging the network effects. It leads the Open Handset Alliance, a consortium of many hardware, software and telecommunication companies, in developing Android as an operating system for mobile devices. It seeks to capitalize on Android not simply as an operating system for mobile devices but as a platform to capture the lion’s share of a multi-sided market emerging from the convergence of several technologies and media. Unlike Apple, it does not offer mobile devices but its partners in the Open Handset Alliance (e.g., Samsung, LG, Sony Ericsson and Toshiba) do. The graphic below depicts Android as a platform serving a five-sided market.

1. On the one side are app developers and media publishers who seek to monetize their apps and media content through downloads, subscription and/or advertising revenues. They are attracted to Android by the potentially large number of devices running on this operating system.
2. On another side are the OEMs who see the bennefit of having a common (thus popular) operating system that (a) lets them quickly enter the smartphone business without having to develop an operatingn system of their own and (b) can quickly attract many app developers.
3. On the third side are mobile device users who are drawn by the large number of available apps giving the hardware a fuller set of functionalities and offering them rich sources of media content.
4. On the fourth side are network operators (or phone carriers, e.g., Verizon and ATT) who see a huge pool of subscribers for their service and data plans. They also see the growing libraries of media content being made available for mobile devices as a new source of demand growth for higher-price, unlimited data plans. They are eager to sign up subscribers by offering subsidized prices for mobile devices so as to lower the initial cost of hardware acquisition.
5. On the fifth side are marketers. They view this huge pool of mobile device users, who are individually identifiable and geographically located, as an attractive target for their ads and services.

For Apple’s iOS, the picture is quite similar. The main difference lies in the second side of this five-sided platform – mobile device producers. All devices running iOS are Apple’s products. Still the network effects work the same way. All the other sides are atttracted to iOS by the large and fast expanding population of iOS devices (iPhone and iPad) in use.

In this emerging multi-sided market, the rising stars are the few players that can attract the most apps for their platforms and in turn enrich user experience and generate greater value to other market participants. Success in this regard enables these platform operators to gain market shares without resorting to price competition. Apple (with its iOS) and Google (with its Android) are two such rising stars. Apple has been charging premium prices on its iPhone and iPads. Meanwhile, Google focuses on making money from advertising and location-based services, leaving  it up to the OEMs to flood the market with affordable Android smartphones and mobile devices; the more ubiquitous these devices become, the more money Google is going to make from its advertising business. On the decline are some former leading OEMs (e.g., Motorola and Sony Erickson) who have stayed too long with the old-style strategy of exploiting supply-side economies of scale to drive down unit costs and prices. Unfortunately for them, the consumers buying smartphones and tablets in recent years are much more willing to pay for design novelty, rich media consumption experience and business productivity tools than for stripped-down devices at a low price. Other OEMs may have rested on the large size of their customer base and thus not been active in attracting app developers. Their platforms (e.g., Blackberry by RIM and Symbianby Nokia) trail far behind Android and iOS in app count.

Putting Web 2.0 and Social Media in Context

Note: A presentation on this topic is available on SlideRocket — “Web 2.0 and Social Media in Context”

The selection of “You” in 2006 and Facebook co-founder Mark Zuckerberg in 2010 as TIME’s Person of the Year provides two time markers in the “Web 2.0” or “social media” era (my earlier post: “TIME’s Person of the Year, 2006 and 2010“). Earlier on, the topic of discussion was all about Web 2.0; more recently, it is mostly about social media. Do not ask for a definition of these terms – Web 2.0 or social media (an attempt to define the latter term can be found in an earlier post: “Social Media: More ‘Social’ than ‘Media’“. Neither term is easy to define. Few business professionals have time to spare on such a definition. Ask someone for examples of the tools (i.e., applications and services) closely associated with either Web 2.0 or social media and you would get very much the same answers: blogs, RSS, tweets, online social networks, and so forth. If the two terms refer to the same phenomenon, then why do we need both? But if they do not, then how do they differ?

The Forces Behind

The terms Web 2.0 and social media essentially refer to the same phenomenon: the technological, social and economic transformations associated with a new era in the evolution of the Web. Initially, these transformations caught the attention of software developers, system architects and other information technology (IT) professionals. The term Web 2.0, used widely earlier on, tried to capture the transformation of the Web and eventually the society. These transformations are quite fundamental and lie mostly underneath the surface or behind the scene. They, hence the term Web 2.0, attracted little attention beyond IT professionals and some business strategists.

Transformed by Apps

At the heart of Web 2.0 transformations is the new system architecture centering on the lightweight programming model. This model is intended on delivering interoperability for easy deployment of applications over the network, independent of operating systems and hardware devices. Lightweight applications, often taking the form of Web services, are built as reusable, self-contained, function-specific software components that can be easily selected, extended and combined into new applications known as mashups. An example is HousingMaps, which meshes Google Maps data with home listings from Craig’s List to offer users the convenience of searching for rental and for-sale properties and getting their map locations on the same website. Such applications are highly modular and hence allow complementary services and functionalities to be added easily.

Modular application architecture introduces new sets of design possibilities and thereby creates opportunities for entry by new developers, including individuals with limited technological and financial resources. It means products do not create much value on their own as stand-alone elements. Rather, they depend on complementary products and services from other producers or providers to be useful. Think of Apple and the tens of thousands of iPhone and iPad apps available on AppStore plus all the entertainment on iTunes. The value of the iPad and iPhone lie as much in these apps and content as in the hardware (“There’s an app for that”). These devices plus iTunes and AppStore function as a platform that brings together several groups from different sides of the market – app developers, content publishers and users – and facilitate their transactions. For competitors, they need not only match Apple hardware quality and features but also build a comparable ecosystem of app developers and content publishers. Look at Facebook. It was trailing behind MySpace until it decided in May 2007 to let independent software developers to build apps for Facebook (and earn a share of advertising revenues). As more such apps become available, users can do more things (e.g., sharing shopping info with friends) and hence spend more time on Facebook, making it an attractive platform for advertisers. Meanwhile, MySpace and other online social networks did not respond to Facebook in the timely fashion; when they did, they did so in a half-heartedly manner through Google’s app development platform OpenSocial. By then many app developers had joined the Facebook platform and would be reluctant to spare their limited resources on another platform. Like Apple, Facebook offers much more value as a platform, bringing together multiple sides of a market, than a standalone product or service.

Propelled by Network Effect

To any side of a market (group of market participants), the value of a platform depends of its ability to attract participants on the other side or sides. To users, the value of Apple iPhone and iPad or that of Facebook social network depends on their ability to attract more app developers and content publishers or advertisers, respectively; to developers and publishers/advertisers, that value depends on the number of users buying Apple devices or signing up for Facebook. This is known as the network effect, which creates a virtuous cycle that can drastically reshape market landscape (an earlier post: “What do Amazon, Apple, eBay,Facebook and Saleforce have in common?“).

The presence of network effect is not uniquely Web 2.0, but its magnitude is. Modular application architecture has lowers the entry barriers for complementary service providers so drastically that a visionary platform operator like Apple or Facebook can mobilize enormous pools of developer resources and quickly scale up its offerings to offer so compelling value to users. Three years after its launch, Facebook development platform has attracted 2.5 million developers offering more than 75,000 apps; 20 millions apps are installed by Facebook users every day. As more apps become available, users can do more things (e.g., sharing shopping info with friends) on Facebook, they spend more time there instead of searching on Google or going somewhere else. As users spend more time on Facebook, advertisers become attracted. As more advertisers spend their ad dollars on Facebook, more app developers become interested; as more apps become available, users spend more time on Facebook… The virtuous circle spirals upward. Facebook user population has reached 500 millions, ten folds what it was in Oct 2007.

The Public Face

While some transformational effects of the new Web era (e.g., modular application architecture) lie beneath the surface, others (e.g., the proliferation of online social networks – OSNs) are much more visible. The term “social media” captures the essence of the latter transformations .

Empowered by UGC

One highly visible transformation of the Web is the meteoric rise of user-generated content (UGC). Behind that rise is the modular application architecture, which “shifts computing to the edge of network, and empowers individual users with relative low technological sophistication in using the web to manifest their creativity, engage in social interaction, contribute their expertise, share content, collectively build new tools, disseminate information and propaganda, and assimilate collective bargaining power” (Parameswaran and Whinston, 2007). That shift, in the form of UGC, has transformed the Web from a ‘publishing’ to a ‘participatory’ medium. In the publishing Web era, institutions (e.g., corporate establishments, website operators, marketers and publishers) provided virtually all the content on the web. Users were primarily passive consumers of such content. In the participatory web era, users can now be active creators, not just passive consumers, of content on a scale never seen before, e.g., creating Facebook profiles, building Second Life avatars, recording podcasts, and blogging about political candidates, social causes or consumption experience. They have wrested power from the few (e.g., newspaper editors, broadcasters, marketers and advertisers). In the process, they have not only changed the world but also the way the world changes. “For seizing the reins of the global media, for founding and framing the new digital democracy, for working for nothing and beating the pros at their own game”, Internet users (“You” included) were selected as TIME’s 2006 Person of the Year.

What drives the participatory Web is not simply user participation per se, but an implicit “architecture of participation”. More than just facilitating user participation, it enables user interactions and collaborations such that services improve and content get richer as more users participate (O’Reilly, 2005). As more users collaborate on a Wikipedia entry, for instance, errors and intentionally bias can be detected and corrected more rapidly. Passive participation can contribute as well. Most users, for instance, bookmark web pages and tag content on social bookmarking sites such as Delicious and Furl for personal use rather for the collective benefits. Social bookmarking still can benefit other users by functioning as a recommendation system even without explicitly providing recommendations; tagging data can be automatically aggregated into useful information, e.g., folksonomy in form of a tag cloud.

Propelled by Social Interactions

UGC is not just about content. It is also about connectivity and collaboration on a massive scale. It depends on some media (means of mass communication, e.g., blogs, wikis and tweets) to deliver, aggregate, collaborate and/or improve on the content (e.g., entertainment, viewpoints, information, ratings, bookmarks, etc.). The more users it reaches or brings in, the more powerful or useful it gets. Blog posts by themselves are “isolated” content pieces. Commenting and hyperlinking can turn these isolated posts into running conversations and passionate debates or even start a social movement. Wiki entries are not content pieces by individuals but a product of the collective intelligence and collaborative efforts of crowds. User profiles on online social networks help people find and connect with each other. Web 2.0-era media are therefore social media.

Connectivity and collaboration constitute the “social” part of social media. This social dimension distinguishes UGC (contributed by the mass) from the commercially developed content (controlled by the few) in the Web 1.0 era. It shifts the balance to power from the center (e.g., advertisers and website operators) to the edge (e.g., consumers and web users). Connectivity offers content a mechanism for wider reach, or in other words, the “multiplier” effect that makes UGC so powerful. Collaboration ensures content its richness. Content constitutes the “media” part of social media. It provides the “substance”; in its void, there is nothing to converse about, nothing to share with each other, and nothing to collaborate on. Content transforms (plain) connectivity into (rich) interactions.

Social interactions follow primarily a many-to-many pattern among interconnected users, in place of a one-to-many broadcasting pattern that was well orchestrated by institutions (e.g., companies) in the past. They entail various levels of user engagement, ranging from passive usage (e.g., tagging content or joining groups) and limited engagement (e.g., rating and voting on content or commenting on blog posts) to active contributions (e.g., writing blogs or uploading photos and videos) and deep involvement (e.g., networking with others or running online communities). Depending on the level of engagement, social interactions can support sharing, facilitate conversations, engage users and help build community. They deliver a level of “stickiness” that has been elusive to website operators, advertisers and content publishers with faith in the “content is king” mantra. Commercially developed content, lacking social interactions and hence user engagement, often fails to attract visitors and keep them coming back (an earlier post: “Is [Commercially Developed] Content King?“). Social interactions, on the other hand, engage users, nurture relationships and build brand loyalty. The resulting “customer lock-in” (or stickiness) helps the firm fortify its customer base or even expand it with “word of mouth” and viral messages, and thus allow the firm to successfully leverage the network effect.

Some Takeaways

The terms Web 2.0 and social media essentially refer to the same set of tools and transformational changes taking place in the new Web era. Web 2.0 focuses on the forces behind the scene (i.e., modular application architecture and network effect) that are of interest to system architect, application developers and IT professionals. Social media, on the other hand, represent the public face of the new Web (e.g., UGC and social interactions) that captivates marketers, advertisers and PR professionals.

There’s an App for That

Note: I wrote this blog  post almost a year ago on a different platform (which is no longer conveniently accessible). The lessons are just as valid now as they were back then. So, I like to repost it here.

I wonder if you watched Steve Jobs unveiled the iPad yesterday. I did for the most part. But I am not “blogging” about the iPad here. Instead, I simply want to use the iPad (or for that matter, the iPhone and iPod Touch) as a vehicle to discuss about complementarities, the value webs (or networks) and value co-creation, and their ramifications on business strategy.

It is worth noting that Steve Jobs did not simply showcase the hardware (iPad) but also the possible content (e.g., photos, the NY Times and ebooks), entertainment (e.g., music via iTunes) and applications (e.g., games and other applications via Apple Apps Store) available for the iPad. This is increasingly the case for many information- and technology-based products and services. Such a product creates not much value by itself but much much more when being made available with other complementary products. What can you do with the iPad without the content, entertainment and applications offered by other publishers, media sources and software developers?

Lesson #1: think not of a standalone product, but rather of a bundle of offerings or even a platform (iPad plus iTunes and Apps Store).

When complementary products and services are offered together, they enhance one another’s appeals; the value of the whole system or bundle is greater than the sum of its parts. Complementarities therefore indicates a condition of increasing returns in which the adoption of one element has a higher payoff when one or more complementary elements are simultaneously adopted. The more consumers find the apps on the Apps Store appealing, the more interested they would be in having an iPad, iPhone or iPod Touch. In fact, “there’s an app for that” has become the selling point for these Apple products.

Contrast Apple iPod with Microsoft Zune. The latter product has received high marks for quality hardware in many product reviews. Its sale volume has been meager however, despite the financial clout of Microsoft. There are simply not that many apps for Zune and the Zune Marketplace, unlike Apple iTunes Apps Store, attracts far few more visitors and buyers. For prospective iPod, iPhone and iPad challengers, it is the apps as much as the hardware that will determine their success.

This new reality necessitates a shift in strategic thinking from the value chain to the value web. In a traditional value chain, a firm competes by occupying those links where it can add more value at a lower cost. Strategy becomes equated with strategically positioning the firm along that chain of value-adding activities. Value creation focuses on transforming objects. The value thus created lies in the resulting products themselves. However, as complimentarities among products and services become the source of value, the value chain concept proves less useful in uncovering value and analyzing value creation. A firm succeeds only by finding complementary technologies, products and market participants it can network together to co-create value.

Lesson #2: Value co-creation focuses on mediation (i.e., facilitating interactions and collaborations) among the networked participants.

The value thus co-created lies not only in the product itself but also in complimentarities among the products and services. The value of Google Maps lies not as much in the database of geographical mapping information as in Google’s ability to attract a large and growing number of map-based applications. Likewise, the value of the iPad is not as much in the device itself but in Apple’s ability to attract a large number of publishers, media companies and software developers to make their content, entertainment and applications available to iPad users.

The shift from value creation along a value chain to value co-creation through network relationships also coincides with a shift from production of goods (in the physical world) to the provision of service (more prevalent in the digital world). The latter necessitates a shift from the goods-dominant (G-D) logic of value to the service-dominant (S-D) logic. In the G-D logic, producers and consumers have distinct roles; the primary focus of the firm is on the production of goods to be sold to customers. In the S-D logic, their roles converge; the focus turns to interactions between the two sides, not simply to facilitate transactions but also to offer an experience unique to individual customers.

Lesson #3: Value is ultimately derived with participation of the beneficiaries (often the customers) through use, and is thereby essentially ‘value-in-use’ as opposed to ‘value-in-exchange’.

Think of YouTube, Flicker and Facebook, just to name a few. Without user active participation, they cannot even exist. The locus of value creation then moves from the ‘producer’ and market exchange to a collaborative process of co-creation between parties.

The next time, if some one says “there’s an app for that”, I hope you would also think of serious strategic marketing stuffs like multi-sided markets and platforms, complementarities, value co-creation and S-D logic.

On a lighter note, there are times (such as now — December in snowy Michigan, and thinking of sunny Florida Keys) when “there is no app for that”.