Understanding the Valuation of Apps

Whether you prefer iOS, Android, Blackberry, Windows Phone, or heck – even Symbian, if there’s one thing we can all agree on about smartphones, it’s that we love our apps. Games, utilities, productivity apps, social networking apps – you name it. We just can’t get enough of ‘em. Apps have transformed the way we work, communicate, and spend our free time. It’s hard to imagine life before they came along, and even harder to believe they’ve only been around for a few years.

“What’s that? We’re supposed to spend our hard-earned money to download some silly apps? In this economy?”

 What exactly is it about apps that makes people so instinctively close-fisted? How can the same person who shells out $4 every morning on a Starbucks coffee-to-go agonize over the decision to buy a 99-cent app that will last them forever? Why does this distortion occur in our minds, causing us to view app purchases as a waste of money, even though the benefit gained from many apps is glaringly obvious? And what can we learn from this as developers to help us determine pricing for our own apps?

I don’t claim to have all the answers to these questions, but I hope to shed some light on some of the main factors that motivate people to purchase apps (or not to purchase them). This is not a post about pricing strategies. It’s aimed to help developers learn about the various perspectives on the value of apps in this highly complex and ever-growing market.

I’ll break my view on the valuation of apps down into 4 main categories:

• Cost of production
• Value of ownership
• Market competition
• Alternative acquirement methods

Cost of production

When we consider purchasing certain products, on some level, whether conscious or not, we try to guesstimate the cost of production. This is a very logical thought process, which basically says that the sales price should cover the cost of production and leave the seller with a fair profit. I’ll avoid getting into the long debate over what constitutes a “fair profit”, but the general idea holds.

A good example of this is gasoline. When you go to the gas station, you know that what you’re going to pay is directly affected by the cost of the materials used to produce it, namely crude oil. When oil prices go up, gas prices immediately follow.

Now let’s look at apps. The cost of developing a single iPhone app is quite high, generally ranging from several thousand dollars all the way up to hundreds of thousands of dollars, depending on its complexity and maintenance costs. At the time of this writing, the average sales price of an iPhone app is $2.13. So on average, a publisher needs to sell many thousands of units of a given app just to break even. But honestly, how many of us have ever taken the time to think about this as app consumers? It must be something else that’s driving consumer valuation.

“I don’t care how much it costs you to build the app. I care how much it costs ME to buy it.”

 Value of ownership

Value of ownership, as opposed to cost of production, focuses on the consumer side. It’s a subjective measurement of how much benefit the consumer gets out of the product. It could derive from any number of factors, such as personal taste, short-lasting vs. long-lasting value, return on investment, how fun or entertaining it is to use, its contribution to social stature, and of course its benefits vs. competing products.

Going back to the Starbucks example from the introduction, there are a few obvious benefits of purchasing your coffee there: it saves time and effort; it’s widely considered delicious (I personally beg to differ); it’s available everywhere and consistent in quality; and you have the option to use the space provided at their stores, so you can work on that screenplay you’ve been meaning to finish. It’s true that the cost of materials for a home-made cup of coffee is negligible in comparison, and the long-lasting value of Starbucks coffee amounts to an aftertaste and extended wakefulness. Yet many people apparently value the other factors I mentioned enough to make up for the difference in costs, and that is how they justify paying $3-$6 for a cup of coffee.

Valuing apps is a bit more complicated. Apps are still largely considered a luxury product, therefore they are perceived more as “want” items than “need” items, regardless of their actual usefulness. That being said, some apps offer more obvious value than others. For example, 1Password for iPhone is a very useful productivity app with a clear value proposition: it enables you to manage all of your passwords in one place in an efficient, secure manner. It’s not hard to justify the $9.99 expense to yourself if you take into account all the time it will save you, and the risk you will avoid by owning it. The long lasting value of this is tangible. On the other hand, a game app like Cut the Rope isn’t a “need” product per se, so it might be harder for one to justify spending money on (personally, it’s one of my all-time favorite games, and at $0.99 I got a high ROI out of it).

And of course, in the world of apps there are many alternatives for almost every product. Which brings us to…

Market competition

In highly competitive markets, consumer is king, and so is the case for the app market. With over half a million apps available on Apple’s App Store and a similar number in the Android Market, it’s clear that the intense competition is affecting consumer valuation of apps, in a downward direction.

Looking at just one niche of productivity apps – password management – we find a plethora of apps available to purchase, and some are even free. 1Password, Lastpass, Roboform, and KyPass are just a few of the better-known ones. The prices of these apps range from free to $10, while some require a subscription fee. Each product has a unique set of features, and it’s up to the consumer to decide which product best suits their individual needs. The bar is set high, and each player in the market needs to consistently release new features and improvements just to stay relevant.

What if there were just one password management app available for the iPhone? It could be priced at $20, or even $50, and some people would still buy it (that’s not to say that the publisher would necessarily price it that high; they would still aim to maximize total revenue).

But since in reality there are many alternative apps, the competition for consumers’ hearts (and wallets) is fierce. That’s why app developers are always searching for the next killer app or feature. Market competition is clearly a key factor in app valuation.

“I pay so little for apps because I can.”

Alternative acquirement methods

Imagine going to the Apple Store with your heart set on a shiny new MacBook Air. Kind of expensive, isn’t it? Oh well, there’s always hope of winning the lottery. Now imagine being able to go into an Apple Store in an parallel universe, where you can just pick one up off the shelf and walk out of the store – no questions asked, no consequences.

We already have something like this for apps, in our own universe. It’s called Installous.

Installous enables users to install cracked iOS apps on jailbroken devices. This essentially facilitates stealing, but it sure doesn’t feel that way for most users.

Internet piracy has been discussed ad nauseam, so I’ll give my two cents and move on. As opposed to physical products, many people have no moral issues with illegally downloading digital products. I would assume, however, that the average Installous or Torrent user wouldn’t shoplift from their local convenience store. How come? The reason is often attributed to the fact that digital goods aren’t conceived as being “real products”, since they are duplicable and the cost of duplication to the publisher is zero. But at least part of me thinks that the real reason is because the risk in stealing physical goods is much higher. In other words, if people could get away with taking whatever they want from the convenience store without paying, free of any repercussions (besides knowing that it’s illegal), many probably would.

Figures show that most smartphone users are law-abiding citizens who pay for their apps, or at least stick to downloading only free ones. The reason? Probably because building up a collection of apps, as opposed to music or movies/TV shows, is actually affordable.

Ultimately, it isn’t worth spending too much time trying to understand those who download apps illegally – if they’re using Installous to save $0.99 on Whatsapp or Words With Friends, then you’ll never get them to pay for your app. Don’t waste your time trying.

Another factor worth noting, that doesn’t fall into any of the categories above, is that there is no return policy for apps in Apple’s App Store – all sales are final. This uncertainty likely causes users to be more hesitant to make a buying decision.

Final thoughts

After exploring the various valuation perspectives on apps, we can conclude that the most powerful ones are value of ownership, which is often quite difficult to estimate, and market competition, which is easy to estimate, but changes constantly. Hey, no one said it would be easy. Understanding the consumer’s perspective is vital for any developer, not only for the product itself, but also for its pricing. Focus on these two factors, and if your business case for developing an app doesn’t satisfy both perspectives as well as your own financial goals, you may want to rethink it.

Now it’s your turn: what do you think about consumer valuation of apps? How do you use it to market your products more effectively? I would love to hear about it and any other input you have in the comments!