App Stores as Commodities

Analysts all know that Android smartphone hardware is being commoditised and the implication is that value is moving up into the cloud. The idea is that hardware OEMs will no longer be able to earn profits, and the only profits in the ecosystem will be gained by players who own cloud services. Thus Google will profit as will Xiaomi, which supposedly has a good cloud business in China.

I disagree. Whereas I agree that hardware is being commoditised, I do not assume that the beneficiary will necessarily be the owners of cloud services. Instead, the profits will simply be made in any layer in the value chain which provides a service/product which has not been commoditised (i.e. products/services for which customers are willing to pay a premium). This layer is not necessarily cloud services or even services in general. It could even be hardware components.

What is important to realise is that all cloud services are not created equal. There are cloud services which provide little added-value and are hence easily commoditised. On the other hand, there are cloud services which provide immense value which can not be replicated by competitors, and which earn disproportionate profits. Hence there will be unprofitable and commodity cloud services, just as there are profitable and differentiated ones.

One of these commoditised services (there are actually quite a few) is the Android App Stores. We know, for example, that there are more than 10 of these in China (1, 2) with huge numbers of downloads and revenue. Obviously, from a technical point of view, creating a good App Store is not difficult. Here, I’d like to point out that Japan has its fair share of App Stores as well.

  1. AU Smartpass App Store: This is the app store for the second largest carrier in Japan. For 3 USD per month, users can download as many apps they want from the AU Smartpass App Store. Included in this monthly fee, subscribers can also get a free anti-malware service, a “find my phone”-like service, data backups, 50GB of cloud storage, etc. The application for this store is prominently placed on the top screen of the Android devices that AU sells, just next to the Google Play App icon.
  2. Softbank App Pass: This is the app store for the third largest carrier in Japan. The price is similar to the AU store at about 3 USD per month.
  3. Rakuten App Store: This was just released on August 19th. Reportedly, it has about 390 applications and will offer 10% discount on the price of apps in the form of loyalty points. Developers will also be paid 75% of the regular price, as opposed to 70% for Google Play. Essentially, Rakuten will run this app store on only 15% margins as opposed to 30% margins for Google Play. The interesting thing here is that in addition to being the largest e-commerce company in Japan, Rakuten also owns an MVNO and will preinstall this App Store application on all the devices that they sell.

What is clear to me is that App Stores are a commodity business. Although Google Play currently has, and will probably continue to have the largest selection of apps in the world, this does not mean much if the most popular apps are being sold on alternative app stores at significant discounts or as an all-you-can-eat package. Customers will purchase most apps from the cheaper app store, and only download apps that they cannot find there from the Google App Store. Unless the Google App Store matches the prices of the other App Stores, Google will lose business.

It will not be difficult for other countries to replicate this business. You don’t necessarily have to match the vast number of apps in the Google Play store; you just have to get the more popular titles (for your country) on board, and promise a higher revenue share for the developers, while discounting for the customers.

State of Non-Game Revenue on Google Play

Back in February, App Annie released a report on Google Play and App Store revenue in Germany. The central theme was that Google Play revenue had surpassed App Store revenue in Germany, which actually isn’t very surprising given the large number of Android users in Germany (StatCounter suggests that in other developed countries, Android market share is generally lower). What is startling is the chart showing how small non-game revenue is on Google Play.

Google Plays Rapid Rise in Germany EN pdf 10 17ページ

Clearly, if your app is not a game and you want to make money from it directly (either from an up-front payment or an in-app payment), then it doesn’t make that much sense to develop for Android, and the situation hasn’t improved much.

I have also discussed non-game revenue in some previous posts.

  1. Non-game Apps Growth in the Google Play Store
  2. Non-Game Apps: iOS App Store vs. Android Google Play

App Annie Shows iOS App Store Widening Revenue Lead Over Google Play

As I have been mentioning on this blog for quite a while now, despite the impressive growth rates that Google Play is showing in revenue growth, data suggests that the gap in absolute revenue between it and the iOS App Store is actually widening.

App Annie has been my source for data. However, since about a year ago, they have made it quite hard to directly observe the gap. Now, in a recent report, App Annie has provided the chart that clearly shows this trend.

This that chart;

App Annie Index 2014 Retrospective EN pdf 5 39ページ

We can clearly see that Google Play’s revenue growth rate has been quite impressive, but that is only because it was quite small in 2013. In absolute terms, the gap is clearly widening. Hence the current trajectory suggests that Google Play will not catch up with iOS in revenue.

Breaking down the revenue, we can see why.

  1. As App Annie has previously shown and as they show again in their most recent report, revenue growth of both the iOS App Store and Google Play comes almost entirely from three countries; Japan, South Korea and the United States. Revenue growth from developing countries, the countries where Android is typically very strong, is still almost negligible.
  2. In both Japan and the US, iPhone is increasing market share. Therefore it follows that iOS App Store revenue in these markets should be outpacing Google Play. With the iPhone 6 and 6 plus, it looks like this is starting to be the case in South Korea as well. Therefore, iOS App Store revenue in winning in the countries that matter.
  3. Android is continuing to gain market share in the developing countries and download numbers in these nations clearly show tremendous growth. This however has very little effect on absolute revenue because in these markets, customers simply do not pay much for apps.

What else would I like to know

Now that it is clear that Google Play revenue will not catch up with iOS App Store in the foreseeable future, the next topic related to the app ecosystem that I find interesting is the status of non-game apps.

App Annie has noted in their Q3 2014 report that “Games drive nearly all Google Play Revenue Growth”. This is deeply disturbing. It suggests that the non-game categories in Google Play are barely growing at all.

When we revel in how technology has improved out lives, we are seldom talking about games. We are talking about apps that help us and our children learn things, apps that improve our productivity and apps that help us communicate. If these apps are not growing, then it suggests that tech is not improving or lives, but is in fact an opium that enslaves us to spend money wasting our time.

It would be terrible if this were the case.

Short Note on App Store vs. Google Play Revenue

As Benedict Evans wrote in his weekly newsletter, Apple reported its revenue from the app store in 2014.

Apple reported that app store revenue net of its 30% commission was $10bn in 2014. This is actually the same as the figure it gave at WWDC in the summer for the previous 12 months – I suspect there’s some rounding going on. Apple’s commissions on this would be about 2% of CY 2014 revenue.

Apple announcement link

Although we will not know exactly what the rounding error was, given the very strong growth of the app store in the past, it is quite difficult to believe that sales have suddenly flattened out. So to get a better picture, I decided to provide an update to my series of articles on the iOS App Store vs. Google Play (most recent one is here).

In that article, I lamented that App Annie was not giving out the actual growth of neither the App Store nor Google Play and as such, it was impossible to see whether the revenue gap was closing in absolute terms.

Since then, App Annie has reported its Portable Gaming Spotlight, 2Q14 report in conjunction with IDC. This report gives us a direct answer.

Screen Shot 2015 01 13 22 12 07

As you can clearly see, iOS App Store absolute revenue growth is larger than Google Play absolute growth. Although Google Play is doing remarkably well on a YoY percentage basis (>+100%) compared to iOS App Store (+70%), it is not closing the gap at all.

Also you have to keep in mind that Google Play revenue is increasingly games. In fact, App Annie notes in their Q3 2014 report that, “Games drive nearly all Google Play Revenue Growth”. This is presumably not the case with iOS which suggest that the gap between the App Store in Google Play revenue is wider and also growing if we include non-game apps.

Actually, my view is that the difference in non-game app category is more interesting than the total difference. It’s likely that by now, iOS has about 6-times more non-game revenue than Android. This means that apps like Byword, RunKeeper and others which are either paid-apps or in-app payment apps are struggling on Android.

Overhyping the Revenue Potential of the Emerging Countries

A beautiful infographic on the state of App Stores by App Annie.

Unfortunately, I can’t agree with the title “Mobilizing the Next 5 Billion”. If anything, this infographic tells us how dominant the “app store superpowers”, Japan, South Korea and the United States are. These superpowers are not only dominant in current revenue, but also have revenue growth that is equal to the emerging countries. This means that the emerging countries are not catching up; instead the lead of the superpowers is widening.

The infographic tells us that the superpowers will remain dominant in revenue for the foreseeable future. The next 5 billion is unlikely to contribute significantly to total revenue from app stores for quite a while.

Infographic GMIC 11182014 2

Will Google Reduce Commission on Google Play Revenue?

Although unconfirmed, I think this report is potentially very interesting;

Google is also reportedly playing hardball with device manufacturers who previously got a cut of Google Play revenue from phones and tablets they sold. Some partners have seen their commission reduced from 25 percent to 15 percent, with one partner’s cut being eliminated entirely, apparently because “Google wasn’t generating enough money from Google Play.”

It suggests two things;

  1. Google Play is not generating enough revenue.
  2. Google is playing hardball with OEMs.

None of these is a surprise.

In this blog, I have constantly mentioned that Google Play revenue is actually having a hard time, despite favorable comments from both Google itself and App Annie. It is also very well known that Google is playing hardball with OEMs.

What I do find interesting is how this might adversely affect high-end Android OEMs but not affect the low-end. As I have mentioned in my past posts, Google Play revenue is highly skewed towards Japan, South Korea and the US. These are the same countries which mainly purchase high-end Android phones from Samsung, HTC and LG (and some local manufacturers in the case of Japan). This commission reduction is going to hurt these OEMs and these OEMs only.

If this report is true, this will only affect high-end manufacturers. None of the new cheap Android entrants like Micromax will be significantly affected, because owners of these devices don’t buy much from Google Play to begin with.

Google seems to be trying really hard to make Android unattractive to high-end smartphone manufacturers, while making it look better for low-end OEMs. I am baffled as to why they might want to do that.

What Are Smartphones Used For?

Given that the majority of time spent on smartphones is in apps, it is appropriate to look at what apps are being downloaded in order to understand what people are actually doing.

Below is a list of top downloads in various countries, taken from App Annie’s statistics (iPhone and Google Play: The list is too long to put on this blog post, so please go App Annie to see all the entries).

You can immediately see that the lists for iOS App Store and Google Play are very different;

  1. Google Play is dominated by messaging and communication applications. Specifically, Facebook, Facebook messenger, WhatsApp, Skype and Instagram.
  2. On the other hand, iPhone users seem to be downloading a lot of other stuff. The top ranking apps are not dominated messaging and communication apps. There are a lot of games and some music apps.

AppAnnie Top Downloads

Now what does this mean? I suspect that this is telling us that Android users as a whole are using their smartphones for the essential tasks and the essential tasks only. By essential tasks, I mean communication. That is after all, what phones are for and what feature phones also did quite well with SMS.

Messaging and communication apps dominate Google Play but it is also certain that iPhone users download these apps too. Hence the dominance of this category on Google Play simply suggests that Android users don’t download much else on average. On the other hand, iPhone users download a lot more so the essential communications apps are lower in the rankings.

For example, App Annie has recently reported that Google Play worldwide quarterly downloads exceeded iOS App Store downloads by around 60 percent. However, Google Play downloads are most likely dominated by the essential messaging and communication apps, with little space left for others. If you are an independent app developer, the Google Play opportunity is probably much much lower than the total downloads number suggests.

iOS App Store Revenue Growth is Outpacing Google Play Revenue Growth

App Annie has just released their report for Q2 2014. In their accompanying blog, they emphasize large growth in Google Play’s downloads in Brazil, Thailand and India. However, in contrast to the most recent report where they noted marked growth in Google Play revenue, this time they do not mention revenue at all in the blog.

This suggests that Google Play revenue was not too good. Here, I will try to reverse engineer the data that App Annie disclosed. I will try to figure out how Google Play revenue grew in relation to iOS App Store revenue growth.

What App Annie’s report reveals

Regarding revenue growth, App Annie’s report (the one that you can download for free here) only provides us with the following information;

iOS retained a strong lead in app store revenue over Google Play. In Q2 2014, the iOS App Store provided around 80% more revenue than Google Play. Mobile powerhouses China and Japan were the primary drivers of iOS revenue for Q2 2014. Up-and-coming countries Taiwan, Kuwait, and Turkey also contributed significantly to iOS revenue, each growing more than 30% quarter-over-quarter.

An accompanying press release actually has more details;

In Q2 2014, the iOS App Store provided around 80 percent more revenue than Google Play, down from 85% the previous quarter. Mobile powerhouses China and Japan were the primary drivers of iOS revenue for Q2 2014. Taiwan, Kuwait, and Turkey also contributed significantly to iOS revenue, each growing more than 30 percent quarter-over-quarter.

So in Q1 2014

  [iOS App Store revenue] / [Google Play revenue] = 1.85 (approximate)

and in Q2 2014

  [iOS App Store revenue] / [Google Play revenue] = 1.80 (approximate)

This alone isn’t enough to get a good picture. We need to know how iOS App Store or Google Play grew in revenue from Q1 to Q2. Since I couldn’t find this data, we assumed it to be in the range of 2% to 20% and analyzed the results for each assumption.

Absolute iOS App Store revenue growth exceeds Google Play if growth > 4%

If we assume that iOS App Store grew 10% from 1Q to 2Q and combine the App Store / Google Play ratios, we can derive the following table;

スクリーンショット 2014 07 17 20 48 26

Here we see that Google Play would grow 13% while iOS App Store would only grow 10%. However, since iOS App Store is much bigger, iOS App Store actually grows more in absolute terms compared to Google Play (18.5 vs. 13.1). This means that iOS App Store is widening its lead.

The above table assumes 10% growth for iOS App Store, but we don’t have any information to tell us if this is true or not. App Annie does not tell us what the growth was. Therefore, we tested various scenarios for iOS App Store growth, resulting in the following graph.

スクリーンショット 2014 07 17 20 45 57

Here we see that for any iOS App Store growth above 4%, iOS App Store growth in absolute terms will be larger than Google Play absolute growth.

App Annie previously provided us a chart for iOS App Store and Google Play game growth. Since the game category constitutes 75% of total iOS App Store revenue, this chart should give us an idea of what the growth of the total iOS App Store revenue should be like. From this graph, it is reasonable to estimate 10-20% quarterly growth for 2Q14.

Looking at our various scenarios, this indicates that iOS App Store absolute growth was 40-60% higher than Google Play. This means that the revenue gap between iOS App Store is widening quite rapidly.

Since the App Annie narrative for Google Play growth has consistently been that Google is catching up with the iOS App Store, it is understandable that App Annie is shying away from highlighting these numbers.

Chinese Android Larger Than Google’s Android

Chinese Android, that is the Android that is based on Android Open-Source (AOSP) and is independent of Google’s services and restrictions, seems to be already significantly larger than Google’s Android (the one that relies on Google services, and comes with Google’s restrictions).

At least that seems to be the case if we look at app download statistics.

According to Analysys International, App downloads in China were 23.4 billion for 2014Q1 alone. In comparison, Google Play downloads were probably in the 15 billion range for 2014Q2 (Estimated from 1 & 2). That’s quite a big difference.

Revenue-wise, I don’t have any data. However, given that Google Play revenue is dependent on mature developed nations (Japan, US, South Korea), it is very possible that revenue is growing much faster in China. Furthermore, iOS App Store revenue has been pretty high in China, suggesting that the Chinese have a rather high propensity to spend money on Apps. I would not be surprised if Chinese Android app revenue is similar to or has already surpassed Google Play app revenue.

Of course this discussion hinges on the “23.4 billion for 2014Q1 alone” report being true. Hopefully, we will get verification soon.

Obviously, the implications of this are huge for the Android ecosystem.

The Law of Conservation of Attractive Profits And Personal Computing

In a previous post, I wrote about my concerns on how the law of conservation of attractive profits might apply to the next stage of mobile computing, especially in emerging nations.

Here, I would like to describe how the law of conservation of attractive profits helps us to understand the history of personal computing. This is particularly instructive because it strongly suggests that this law will continue to be applicable in the future.

The law of conservation of attractive profits

I quoted a brief description of the law of conservation of attractive profits from Clayton Christensen’s book “Seeing What’s Next” in my previous post.

What it tells us is;

  1. When commoditization occurs at a certain stage in the value chain, an adjacent stage will gain the opportunity to earn attractive profits.
  2. Attractive profits emerge at the stage which solves the most difficult problems in the industry, typically with an integrated approach.
  3. This integration may happen at the product component level, customer interaction level or supplier interface level.

Hence to identify which stage will earn attractive profits, we have to understand what the most difficult problem in the industry is. This is not necessarily a technical problem, but can be any stage in the value chain.

Obviously, different countries, different regions may have different problems in their value chains. In particular, the average spending power is very variable between regions and this will necessitate different approaches to the market. Hence different stages will earn the attractive profits, depending on region.

Application to personal computing history

  1. From the late 1970s to early 1980, Apple and IBM were the powers in personal computing. They took components and assembled them into their respective proprietary personal computer platforms. During this age, the attractive profits were in designing the platform and assembling the computer.
  2. As technology improved however, this shifted. Compaq reverse-engineered the IBM-PC, creating a clean room implementation in the 1980s. This effectively commoditized the platform design of the IBM-PC. Assembling a PC suddenly became very easy to do. When this happened, the power in the industry shifted to adjacent stages, namely Microsoft (in software) and Intel (in CPUs).
  3. In the 2000s, the Internet came and created another layer in the value chain. At the same time, innovation in PCs started to falter partially due to the fact that PCs had become “good enough” for office productivity. The absolute processing power that Intel provided through its new CPUs no longer became important because the old ones or the cheaper ones from AMD were “good enough”. Similarly, the new operating systems that Microsoft released no longer became essential because the old ones had “good enough” features. This created an opportunity for the attractive profits to shift towards Internet service companies (which were in their infancy and not yet “good enough”), and bore behemoths like Google.
  4. Apple then came along in 2007, bringing a totally revolutionary product, the iPhone. This caused the whole evolution cycle to go back to the beginning and once again, the company that assembled the final product commanded the most attractive profits (Apple). The most difficult problem in computing was designing and creating smartphones that were small and light, yet powerful. They also had to contend with the dilemma of very limited battery capacity and full-day battery-life expectations. This was the responsibility of the hardware manufacturers.
    Hence similarly in the Android ecosystem, the most profitable company became Samsung, also the company that assembled the device.
  5. As technology progresses and solves the most pressing problems in smartphones, the profits move away from the hardware assemblers to adjacent stages. Hence the predicament that Samsung now finds itself in. At this point however, it is not yet clear which adjacent stages will reap the profits. In particular, it should stress that is no by no means obvious whether Google services will become this stage or not.

Which layer could reap future smartphone profits?

I won’t try to reach a conclusion here, but simply point out a few things that I think are important.

Things to consider;

  1. A huge problem in the smartphone industry is how to expand customers and how to expand usage in various countries and various market segments. It is increasingly apparent that a one-size-fits-all approach is not going to work.
  2. The problems in the industry will significantly differ according to which market segment we are looking at. For example, high-end smartphone users may have issues with sharing links, customizing the user interface, pure Google-ness, continuity with other devices, notifications, maps, etc. On the other hand, low-end users will have issues with ease-of-use and prices. Similarly, price is much more of an issue for users in emerging countries (regardless of tech literacy) than developed countries.
  3. Whereas hardware and low-level software affect the experience of every user, the service layer is more specialized. For example, not everyone uses a complex social networking service like Facebook and may be content with SMS. Similarly, people who often visit unfamiliar places will make constant use of maps, but there are also many people who simply go to-and-fro from the same few locations most of the time. The same thing can be said for Google Now. People don’t need to be constantly reminded of things that they do every day of the week.
  4. Google actually doesn’t control a lot of the services that are suited to people in emerging nations. For example, their most visited property on mobile devices is YouTube. However, YouTube takes up hideous amounts of bandwidth which will be a problem in these countries. Facebook and WhatsApp either don’t have this issue or have worked hard to fix this.
  5. Because emerging countries do not have too many people on credit cards, billing for software and services is a large issue. Carrier billing is seen as a solution for this. Carriers will be able to extract the attractive profits proportionally to the importance of carrier billing in that country.
  6. The layer that can customize the solutions to match the different markets is in a good position to gain the attractive profits. For hardware, this would be the local vendors who can now easily create custom hardware with the help of the Shenzen ecosystem in China. For the software and services, carriers traditionally have been the gateway.