iPhone Apps: To Pay or Not to Pay?

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It's probably been a while since you bought new software. That's because so many tech firms — buoyed by ads placed in Web-based applications like the Google Docs word processor and the thousands of apps on Facebook — can now afford to give their programs away for free. But don't expect the same deal when you're shopping for add-ons to bling out your iPhone. On July 11, Apple will launch its hotly anticipated iPhone App Store — and it'll be anything but a bargain.

Sure, customers will get to gorge on hundreds of new games and utilities for their iPhones. But they'll have to pay for many of the goodies they find there. Popcap Games, for one, plans to charge $9.99 for its popular puzzle game Bejeweled. Meanwhile, some makers do plan to offer their apps for free: newcomer Buzzd, for example, will give away its GPS-enabled program, which tells you what movies, performances and other events are taking place within walking distance of your location. Rather than charging consumers, Buzzd will make money off small ads that will flash onscreen.

So why can't all iPhone apps be free? Well, quite simply, because people are still willing to pay for them. Apple currently generates most of its revenue from up-front sales — whether it's for MacBooks, iTunes or iPhones. And the pay approach for mobile games, ringtones and videos has long been used by other tech purveyors like Verizon and Research In Motion, and even third-party app stores like Handango. "It is a historical business model," notes Kevin Burden of ABI Research. Buyers are willing to pony up, though, because of the cachet of the Apple brand.

Charging up front for applications also gives Apple an edge with developers. "Part of getting developers to focus on your platform is making sure they will make money off it," says Burden. While this arrangement forces consumers to shell out for programs they may use only once, the economics of the iPhone App Store is much more attractive for developers. Normally, wireless carriers control the pricing and selection of the apps available for their handsets, paying developers no more than 40% of the proceeds. Apple, on the other hand, will give app makers 70% of all sales. (Shoppers can avoid unnecessarily contributing to the pot by checking buyer ratings on apps before purchase.)

Few companies have figured out how to turn a profit by relying solely on mobile ads for revenue. Mobile marketing brought in less than $500 million in the U.S. in 2007; compare that to online advertising, which made $21 billion. For many developers, it's just not worth the risk. "It's unclear that the revenue from ads would make up for the premium revenue we would forgo by not selling the game," says Andrew Stein, Popcap's director of business development for mobile games. What's more, "users aren't used to ads popping up on their mobile phone," says ABI's Burden. "There is no telling how quickly the backlash might kick in."

We may find out soon, as free, ad-supported applications gain momentum. The first handsets running Google's Android operating system will go on sale from T-Mobile late this year. Google won't talk specifics about pricing, but some developers expect the widgets that run on them to be free. "Google's strong point is creating inventory to run ads across. I'll bet on the fact that they are going to be free," says Buzzd co-founder Nihal Mehta. According to a Google spokeswoman, "We have nothing to announce at this time," but she says the company aims to satisfy both its customers and the developers who create Android apps. (The new Symbian mobile applications that will run on Nokia handsets are also coming down the pike, and the increased competition is expected to help bring app prices closer to zero as well.)

If Apple ever does decide to let all iPhone apps be free, it would be a radical departure from its typical way of doing business. To switch to an ad-supported model, it would have to partner with a company that already has a huge inventory of interactive ads. Google would be the most obvious choice, but the search giant is already poised to be Apple's top rival in the mobile arena once its Android handsets go on sale this fall. Such an alliance might be a little too close for comfort.