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.

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 #1think not of a standalone productbut 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 #2Value 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 #3Value 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”.

What do Amazon, Apple, eBay, Facebook and SalesForce have in common?

View this presentation — Increasing Returns — a Key Principle of the Information Economy — on Prezi.com

The most obvious answer to the above question — “What do Amazon, Apple, eBay, Facebook and SaleForce have in common?” — is that these companies all conduct their business exclusively, or extensively, over the Internet. That answer is technically correct but it misses a key element for understanding the information economy. The true success of these companies lies in their ability to leverage increasing returns to their competitive advantage.

Take Amazon as an example. Amazon’s decision to let other retailers, from large retail chains (e.g., Macy and Target) to mom-and-pop resellers to sell their merchandise on its Website, often in direct competition with its own retail offerings, had many skeptics at first; but no more. By transforming itself from simply a retailer into a retail platform (more on the platform concept in a later post), it is able to expand its lead as “Earth’s Largest Selection” (not just Earth’s Largest Retailer originally). With so many resellers offering a vast range of merchandise on its Website, Amazon has fortified its position as a one-stop retail destination for millions of online shoppers; if shoppers can find everything at Amazon, why would they waste time going to many other places. Thus, the more retailers Amazon can attract to its Website, the more attractive it becomes to online shoppers; as more people shop at Amazon, the more attractive its Website becomes to other retailers. The network effect is at work.

Consider Apple. Its iPhone and iPod Touch are marvelously designed. By themselves, they offer little value to their users. But the thousands and thousands of applications, available via Apple AppStore, let users add a wide range of selected functionality to these products. The more apps are available, the more attractive the iPhone and iTouch become; the more people owning them, the stronger is the incentive for developers to build applications for the iPhone and iTouch. Billions of downloads from the AppStore tell the story. Once again, the network effect is at work.

How about eBay? There are other consumer auction sites out there; but none comes close to eBay. Why goes anywhere else. As more sellers list their merchandise on eBay, more buyers find eBay an attractive place to buy; and as more buyers look for merchandise on eBay, more sellers become interested. Should I keep on saying the network effect is at work?

Look at Facebook. It was trailing far behind MySpace until it decided in May 2007 to let independent software developers to build applications for Facebook (and earn a share of advertising revenues). As more such applications 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. Look at where Facebook is now, relatively to MySpace.

Also look at SalesForce.com. It is a pioneer of Web-based CRM software applications. Competing with software giants such as Oracle and SAP, which can spend massive amounts of money on software development, is certainly not easy. So, SalesForce creates AppExchange that lets independent developers, and users as well, to develop and market complementary applications…. [You can fill in the rest of the story].

There are more than just the network effect being at work. Amazon could have expanded its offering from books into other lines of merchandise on its own; but that would be very costly, slow and perhaps ineffective (after all, each line of merchandise requires unique “domain” expertise that takes years to build). By mobilizing other retailers to sell through its website, Amazon can accomplish the “Earths’ Largest Selection” mission very expeditiously. Furthermore, a major hurdle for online retailers is “order fulfillment” — once a customer places an online order, the merchandise has to be picked, packed, shipped and, if needed, traced. Amazon has spent around a billion dollar to build such a system. That system cannot be economically justified without the massive volume of sales to utilize it; yet, the massive volume cannot be generated without having such a system in place. Here is a chicken-and-egg problem — which one, sales volume or fulfillment system, should Amazon have first? By mobilizing resellers to Amazon site, the company can quickly build up the sales volume to justify the investments in building its fulfillment system. Scalability has been at work thanks to this. Likewise, it would be cost prohibitive and take foreever for Apple, Facebook and Salesforce to develop the massive volume of applications on their own. By mobilizing independent application developers, they can scale up very economically and expeditiously.

In the video clip above, the presenter suggests that the future lies with companies like Apple and Facebook (but not Google). That means these companies will be able to maintain their market leadership (while Google cannot, at least not so effectively). My question for you is: can they? That depends on their ability to lock-in their customers/users. In the case of Amazon, it would be very costly and time-consuming for someone else to develop an order fulfillment system of that scale and even more to replicate Amazon’s website operation capabilities (search, merchandise rating and recommendation functionality, payment processing, etc.). So, it should be difficult for resellers on Amazon to migrate elsewhere. But how about Apple, Facebook and Salesforce? As for Google, where can it finds and exploits the network effects?