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Missing the dazzling profit potential of free apps

Published Nov 19th, 2012 11:55AM EST
Mobile App Market Analysis

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Many tech journalists have recently rendered grim judgments on the mobile app market. One such jeremiad was recently published by The Atlantic. The column ponders “How Much Longer Can Tech’s Free Party Last?” and whether “somewhere in the distant future the promise of monetization” is “dangling.” Sounds scary, right?

The article concludes with dark drama: “But it’s also possible that as some of the app economy’s monetization windows start to close as venture firms turn sober on online and mobile advertising, engineers and entrepreneurs starting a company will have to charge users more (or charge users earlier) for their program.”

What is odd about this negativity is that the app market has just demonstrated decisively how profitable and well-functioning it is. This is particularly true of the free app market — the very niche many thought would damage the overall app market by undercutting demand for paid apps.

This past year has proven that free apps are more profitable than paid apps. The “monetization window” of app companies is nowhere near closing; on the contrary, the latest statistics are persuading an increasing number of venture capital firms to jump right in.

The iPad app king of this autumn is Supercell, with “Clash of Clans” at No.1 and “Hay Day” at No.3  in the U.S. chart of highest grossing apps. “Clash of Clans” is also the No.1 iPhone revenue generator. Both games are free to download.

“Clash of Clans” is estimated to be grossing between 160,000 – 200,000 euros each day right now. Helsinki industry sources peg the game’s initial development cost at below 140,000 euros. Supercell uses teams of five people to develop its games and the production cycle is a couple of months. What makes the creation of mobile apps so cheap is a simple trick: producers can first put out an initial version featuring 30-60 levels or 30 hours of simulation gameplay. If the app sinks, the production can be closed down. If it soars, new levels and expansion packs can be churned out at short intervals.

Yes, “Halo 4” grossed more than $200 million on its launch day. But its development and marketing budget is close to $100 million. “Clash of Clans” is earning its entire production budget every 18 hours, and it’s keeping up this staggering rate 100 days after its debut. It is safe to say that “Halo 4” is not going to be grossing even 3% of its production budget on a daily basis in February.

From a cash flow perspective, the savvy mobile app companies are golden. Product development takes just 4 months; only small portion of the game has to be produced before the  launch; lack of physical distribution allows them to cut out distributors; initial marketing costs can be held below $30,000 if the game is truly viral. It is hard to understand why people are still talking about free app market “dangling somewhere in the distant future, the promise of monetization” when true pros of the industry are churning out 100x return on production costs within four months of a launch.

Another point moaners miss is that longevity of popular apps gives them entirely different long-term ROI than console games, songs or movies. There are six apps in the iPhone paid app download top-40 chart that were published more than 1,000 days ago. Three years after their debuts, they are each still grossing more than their development budget every month.

What about the criticism that mobile app market is so over-saturated that creating hits is nothing but a lottery and vendors cannot build long-term success with any predictability? First of all, the number of available apps is an illusion. There are thousands of flashlight apps out there. And thousands of currency converters. Most are nowhere near to being competitive. The size of the truly competitive app market is counted in the tens of thousands – not hundreds of thousands.

Supercell started publishing games in June 2012 and its first two titles have both already become top-five hits in app revenue generation in more than 50 countries. How many video game vendors or movie producers have a hit rate like that? Getting two major successes in four months in two different genres clearly implies that the producer has found a successful strategy it can clone effectively.

Rovio has launched four games in 2012 that have become No.1 downloads on the iPhone and iPad in more than 100 countries. Rovio figured out in 2010 that if it signs up a massive number of marketing partners, it can build monumental brand recognition that effectively insulates it from the competition.

The plan worked. In the fall of 2011, American television audiences were bombarded with lavish ad campaigns that featured Angry Birds characters. Microsoft (MSFT), Apple (AAPL), Google (GOOG), Twentieth Century Fox, Barnes & Noble (BKS), Toys R Us… they all placed Rovio’s characters into major primetime ad blitzes. As a result, Rovio is now able to churn out new mobile games every 2-3 months, each one certain to hit No.1 in a hundred countries. It’s a solid business strategy that has been implemented over a three-year period.

Yet another strategy is employed by Fingersoft. Its blockbuster game “Hill Climb Racing” first became a hit as an Android app. After the developer had racked up tens of millions of downloads on Android devices, the resulting buzz ensured that when the game hit Apple’s iPhone, it went to the top of the free download chart in less than a week.

It is no coincidence that all three mobile app vendors I have discussed are Finnish. That is my final point: A center of excellence in mobile app development has suddenly coalesced in Finland during the past year.

Rovio has racked up four No.1 games in the U.S. download and revenue charts in 2012. Supercell has the No.1 grossing iPhone and iPad app in America right now, as well as the N0.3 iPad game. Fingersoft just clinched the N0.1 slot in the free iPhone download chart. You would not have this Finnish cluster of leading game developers popping up if the mobile app market was chaotic and random.

This is proof of the app market working efficiently and rewarding companies with real mobile content savvy. In a truly efficient market, industry power centers can suddenly materialize anywhere there is a sufficient mass of mobile know-how and sophisticated labor — Ontario, Stockholm, Taipei, Helsinki. In an inefficient market, the most successful players congregate where access to distribution happens to be, not where the real talent is — Hollywood being one notorious example.

The profitability of the mobile app market is no longer a puzzle. It’s real. Perhaps the problem many American observers have with the app market lies in the fact that the best-known American app developer, Zynga, has crashed and burned so spectacularly. The real revenue generation innovation is taking place somewhere else.[bgr-post-bug]

After launching mobile game company SpringToys tragically early in 2000, Tero Kuittinen spent eight years doing equity research at firms including Alliance Capital and Opstock. He is currently an analyst and VP of North American sales at mobile diagnostics and expense management Alekstra, and has contributed to, Forbes and Business 2.0 Magazine in addition to BGR.

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