Choosing The Right Business Model For Your App

Opinion

Today nobody questions that the apps economy is going to be big. Very big. At least four different researchers predict the apps industry will bring in $30-40 billion dollars a year in just three to five years. Just to put this into perspective, the entire music industry is estimated to generate $25 billion a year. But which specific business model will capture this massive revenue?

There are today four major ways to make money with an app:

1) Paid. You simply sell your app. Depending on your distribution/billing partners, you’ll keep between 98 percent (e.g. sell from own website using credit cards paying 2 percent to your credit card billing partner) and 25 percent (e.g. using carrier distribution where carrier takes 75 percent revenue share). App stores like Apple’s will charge you a moderate 30 percent fee.

2) Ad supported. You distribute your application for free, but it contains ads. You partner with an ad network like AdMob, InMobi or BuzzCity, insert a small piece of their code into your app and wait for a paycheck, as ad networks will rotate ads in your app and pay you 60-70 percent of the money they collect from advertisers.

3) Virtual goods. Sometimes called “freemium,” but the concept is the same. You distribute a free copy of the application, but there are some paid “premium” services that you offer in addition to the basic free service. These may be anything from calling credits in the case of Skype to virtual items in games to “ego services” in social networks.

4) Subscriptions. Just as the name suggests, users subscribe to a service and pay a regular fee to continue accessing the service.

There are of course more business models out there (cross selling, data collection, and many others) as well as combinations of two and more models, but the above four are the major generic models. To give you a rough idea on how app revenue splits today, last year about 80 percent of all revenue came from paid apps, 12 percent from ad supported apps and 5 percent from virtual goods. In three years though, this will change, with paid apps making up only 50 percent of the revenue, ads growing to 30 percent and virtual goods, subscriptions and other models filling the rest.

Now, how do you decide which model will work best for you?

At GetJar we see thousands of apps and we’ve learned what does/doesn’t work for them. Analyzing best practices allowed to me come up with a pretty simple model, which I called the “US” model. By the way, this has nothing to do with the US centric view of the world; the abbreviation merely stands for Utility vs. Stickiness. Measuring only these two parameters for your app can tell you which model is the right one for you.

First, the Utility: This means how much entertainment or productivity value one engagement with the app brings the user. If you are playing the Tiny Wings game (my latest favorite), a game session gives you a lot of entertainment. On the other hand, if you post a status update (like “I’m in the bus now”) to some social network, this has relatively low Utility for you.

Second, the Stickiness: Games, despite high Utility, would generally have low stickiness. Most will be played a few times, some for a whole week. Only one out of a thousand will be as sticky as Angry Birds, which can keep you busy for weeks or even months. On the other hand, Facebook, Mail and many other apps will engage you for life.

Below is a usual 2×2 for Utility vs. Stickiness:

Now, if you’re in the 1st quadrant (high utility, low stickiness), the business model of choice is Paid. On the one hand, the user is willing to pay for the app, because it has high Utility (the user will generally not pay for an app with a low Utility). On the other hand, you cannot use other models because of the low stickiness. For example, if you were to insert ads into a game that the user plays only 5 times, then displaying 10 ads (two ads per game session) will earn you 1 cent (assuming an industry average $1 CPM).

If, the opposite, you’re in the 3rd quadrant (low utility, high stickiness), your obvious choice is Ads. On the one hand, the user will not pay for a low Utility app, so you simply won’t sell many copies. On the other hand, high stickiness allows you to generate a lot of ad impressions and earn a decent amount from advertising. For example, a weather application launched 200-300 times throughout a phone’s lifetime can earn you $0.40-$0.60 per download (again, assuming 2 banners per launch and $1 CPM), which is comparable to paid app earnings.

If you’re lucky to be in the 2nd quadrant (high utility, high stickiness), you’ve hit the jackpot, because applying virtual goods or subscriptions will skyrocket your user value to $20-100 (an average of only $1-2 for 1st or 3rd quadrants). High utility means the consumer is willing to pay. High stickiness means you can charge on an ongoing basis, with recurring payments (either for virtual goods or for subscription) putting a high multiple on the sale. It would be a total mistake here to sell the service once, or limit only to ad revenue. This is one reason why social game companies are so successful.

And lastly, if you find your app in the 4th quadrant (low Utility, low Stickiness), drop it and do something else. You are not going to make money.

Despite the fact that choosing an appropriate business model is relatively simple when you know your Utility/Stickiness, there are many “modifiers” to the generic model selection process.

One is what I call “marketability”:

The graph above basically shows that for the same marketing spend you will achieve much bigger scale if your app is free (ad supported and virtual goods being perceived as “free” by the user). For every marketing dollar, you are likely to distribute 10-50 times more copies of a free app than sell paid ones. You can determine your exact marketability multiplier by experimenting with marketing different versions of your app across different channels. For instance, you can try marketing a “demo” or ad supported version and compare the results to marketing a full paid app. It is very important to take “marketability” into account, as it can change the economics for you. For example, if you earn only $0.50 per download from ads, but $0.70 per paid download of the same app, doesn’t always mean you should go for paid. You may find out that spending $2,000 on marketing allows you to distribute 10,000 free copies of an ad supported version and earn $3,000 in profit (10,000 copies times $0.50 ad revenue per unit minus $2,000 on marketing), while the same $2,000 spent marketing a paid app will only earn you $100 (30 times less!) in profit, as the campaign will generate only 3,000 paid downloads.

Another important modifier is what I call “billing conversion”:

The idea here is that billing friction and the effective payout change your paid app conversion and can shift your revenue optimizing strategy toward or away from the paid model. Apple has the world’s easiest way to pay for apps (simply type a password), so of 100 initiated purchases almost all are completed. Some alternate billing platforms such as Billing Revolution and Urban Airship can provide fairly good purchasing experiences, too. On the other hand, purchases going through cumbersome (e.g. Checkout) billing systems will make a lot of purchase attempts fail (users simply dropping the process when getting confused or realizing it takes too long). A failed purchase—which is even worse than no purchase at all (the user will remember the negative experience for a long time!)—means you might be better off financially choosing a business model that does not include payment, such as Advertising. In a very similar way, high transaction taxes (while Apple and other app stores are charging a moderate 30 percent tax on transactions, some carriers can go as high as 80 percent) decrease a sale’s value to you and make non-transaction based models more attractive. I cannot resist the temptation here to mention that GetJar does not tax developers at all, they keep all the money they make!

All in all, the purpose of this article is to put you into the right thinking mode about your app’s business model. Looking at just revenue share or even per download earnings itself, without taking into account other variables, is meaningless. All in all, you are maximizing your overall revenue. Your total revenue is a function of your scale and individual user value. Scale and user value in turn are functions of utility, stickiness, marketability, billing conversion and many other factors. Only when you align all of it can you win big time. Good luck!

Ilja Laurs is the founder and CEO of GetJar, the world's largest open mobile application store. Follow @iljalaurs

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8 responses to “Choosing The Right Business Model For Your App”

  1. Shaun says:

    Wow great read!!! Could you give an example of an app that is high value and high utility, that is using the subscription rev model?

  2. Patricia Quinche says:

    Excellent article! Thanks :-)