Store set to be apple of master’s eye

In 2007 Steve Jobs launched the iPhone with a fanfare of fiery rhetoric.

The iPhone, Apple’s chief executive claimed, was three “revolutionary” devices in one. Combining a touch-controlled iPod media player, a phone and an “internet communicator”, the iPhone was “a leapfrog product that is way smarter than any mobile device has ever been”.

In contrast, when Mr Jobs introduced the App store a little less than 18 months ago, his vocabulary was considerably more muted.

The digital distribution channel, he said, was a “pretty cool” way for programmers to get their applications into the hands of millions of iPhone users.

Yet, more than 2bn downloads later, the app phenomenon that has fuelled and fed off the iPhone’s success not only appears more significant than that blockbuster product, it might prove to be the most important thing Apple has ever created.

Apps for the iPhone and an array of imitators are generating billions of dollars in annual sales even as most of the technology industry slumps. They have proved the key to Apple’s disrupting of a fourth industry after computers, music, and phones: the world of video games. And they have created a gold rush mentality in Silicon Valley and elsewhere as coders try to strike it rich with a new gimmick or must-have feature.

The vast number of iPhone apps, now more than 100,000, is helping to drive sales of the iPhone, with users installing an average of 10 new apps a month. Sales of 50m iPhones and iPod touches, in turn, are encouraging more companies to churn out apps.

But this self-reinforcing cycle does not require the same symbiotic exclusivity as previous software partnerships, such as Microsoft’s system for Windows developers. Like many a revolution, the new app economy is heading beyond the control of its fathers.

Already, the app eruption has superseded all the sober predictions of Apple executives and outside champions like Kleiner Perkins Caufield & Byers, the venture capital firm that created the first investment fund aimed solely at backing iPhone app developers.

“We had no idea there would be 2bn downloads by October,” says Kleiner Perkins partner Matt Murphy, manager of the then $100m fund. “Most people within Apple, if you had told them it would be a fifth of that by now, they would have been pretty happy.”

In retrospect, of course, the App store seems an obvious winner. Instead of picking the work of a handful of developers to ship in Apple products, the company offered developers a direct connection to consumers via the invaluable real estate of the iPhone home screen.

As a result, tapping on a small square icon on an iPhone home screen now brings up a vast range of programmes, which are fun or useful (or sometimes even both). Most of these programmes are free, and others cost just a dollar or two.

Developers set the price while Apple handles the distribution and takes a 30 per cent cut of the initial sale and, since June, of any subsequent purchases made within an application. If a player wants to, say, buy a virtual suit of armour while playing an online game such as Eliminate, he will pay for it and Apple will take 30 per cent of the payment.

“From Apple’s perspective, the gold mine was that they found a source of differentiation, independent of the hardware and basics software design, that they could never have anticipated,” says Professor David Yoffie of Harvard Business School.

Apple’s competitors – including Nokia, which still sells more smartphones than any other company, BlackBerry maker Research in Motion, king of the corporate market, and the multitude of vendors that use Google’s year-old Android operating system – all support app stores now, although they lag well behind Apple in the number of programmes on offer.

There is a certain irony in Apple benefiting so much from what was essentially a missed business opportunity a decade ago. After sitting out the digital music explosion begun in 1999 by Napster and pirates everywhere, Apple decided it was better to be late at the party than not show up at all and introduced the iPod MP3 player in 2001.

Many thought the iPod was the best portable music player on the market and it sold well, helped by free jukebox software called iTunes. But the real breakthrough came two years later, when Apple introduced the iTunes Music Store, offering the first wide selection of digitised major-label songs for just 99 cents a song.

Best of all, from Apple’s perspective, was that the store kept iPod users coming back again and again. The iTunes store was a service, consumers became accustomed to using it frequently, and it kept on selling almost free intangible goods cheaply.

These were all traits which prefigured the App store.

There were other important benefits as well. Although Mr Jobs initially resisted the idea, iTunes served as a Trojan horse by allowing Apple a way inside Windows computers.

And Mr Jobs’ experience negotiating outside the tech industry with the record labels was unbeatable practice for a parlay with AT&T and other wireless network carriers. He needed them to offer discounts to iPhone buyers in exchange for annual carrier contracts, even deeper discounts than they offered on other handset models, in order to offset the high cost of producing the iPhone.

Apple wanted, and would get, the deepest discounts in history, turning a $600 piece of equipment into a far more affordable $200 purchase. Mr Jobs could extract those terms because he promised temporary exclusivity for what he believed to be a winning product – and because wireless providers were starting to earn most of their money on data deals, not voice, and iPhone users were certain to be data hogs.

Even more important was Mr Jobs’ willingness to demand that AT&T and other network carriers give up control over what sorts of programmes could operate over their airwaves.

He argued that the iPhone was a computer, not a phone, and that consumers expected to be able to do many things with computers.

History had shown that this kind of freedom was what drove the more profitable “ecosystems” of computers – where sales of hardware were dependent on a wide variety of useable software.

Less than a year after the iPhone went on sale in 2007, the fast-growing social networking site Facebook began allowing users to add free applications built by third parties to their site. Those applications, including a Scrabble knock-off and other easy games, soon became major attractions.

Apple decided to do the same thing. Like Robin Hood stealing from the rich and giving to the poor, Mr Jobs took the handset control that he had just won from the carriers and gave it to a teeming mass of independent programmers.

Because the iPhone could do so many things that a Nokia or BlackBerry couldn’t, apps had instant appeal. The new audience, and the fact that it was so easy to reach it, drew in tens of thousands of registered programmers.

But just as not every singer makes it as a rock star, not every apps developer was going to have a monster hit. As more piled in and the odds against writing a hit grew larger, disillusion set in.

This article is the first in a three part series. On Tuesday: is the apps revolution eating its children?

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