Apple makes changes to the App Store

Apple announced two major changes to the App Store for its various software platforms (iPhone, iPad and OSX). The first would be to allow search based advertising. The second would be to reform subscription pricing. These are large changes as I will explain below.

Search-based Advertising

A little appreciated fact is that apps themselves have generated advertisements. Indeed, one of the primary ways apps are ad-supported is that they sell ads for other apps. Moreover, ads for apps are a significant component of mobile ads placed on Facebook. In both cases, it is easy to see why. If you are using an app, chances are you are the sort of person who might use another app.

Interestingly, Apple itself has always had power in this market. The App Store landing pages are a key way apps are promoted. But they are promoted at Apple’s own discretion. To be sure, Apple are trying to help sell apps but it is also the case that Apple do not always know which apps would do that. There are other places on the web that also provide such curation but my guess is that Apple noticed that ads for apps were themselves powerful motivators of app downloads and purchases. Moreover, they could easily have correlated ad-driven downloads with ratings to see if they were generating leads that consumers valued. It is highly likely that they were.

Given this, Apple has decided to tap into that business. One way to view it is that Apple are trying to earn revenue on paid search. But whatever they might get there would be a drop in the bucket relative to the entire eco-system (a “Trump Steak” level of impact even under the best scenarios). Instead, I suspect Apple are doing this because they believe that by allowing app developers to signal their own value by bidding on keywords, consumers will end up finding apps that are better for them. It is a way of ensuring that quality rises above what is considerable noise. For instance, so newly developed apps can obtain priority if they so choose.

For each search, Apple are only selling a single slot. So unlike Google or Bing paid-search ads, there is no list and hence no need to design an auction that will efficiently manage that list. Instead, Apple can use a second-price auction which is likely to be optimal in this scenario. That said, it may well be that Apple — following Google’s long history — may want to ‘quality-rate’ the bidders for ads and so it would not be a pure monetary affair. Interestingly, I am not aware that Apple has employed a market design expert to do this and, as we economists know, if you don’t get an expert on this, it is very easy to fall into traps that can be somewhat disastrous.

Subscription Pricing Changes

Apple usually takes a 30:70 split on app store purchases and in-app purchases. In some cases (like Netflix), these are subscriptions but Apple have also allowed developers to sell subscriptions off site without any revenue sharing. That’s less convenient for users but it may be significant for developers.

But Apple have another problem and that is the quality of apps produced and ensuring that apps are updated so that they are of continued value to users. The absence of upgrade pricing options has muted developer incentives in that regard.

Its new approach is to allow subscription pricing to be widespread (for instance, for games and productivity software and not just media). But also Apple will move to a 15:85 split for subscriptions that last more than one year. In other words, if you, as a developer, do things to retain a user, you get a bigger share. The logic is simple: Apple helps find the user initially but it is the job of the developer to keep them on.

This is a significant change in the business model that can really change the incentives for developers. That said, there is one issue that I am not clear about. Doesn’t this also incentivise developers to have a very low subscription price for the first year and rack it up in subsequent years? To be sure, that may be costly and it also may be the point. But I wonder if it could be distortionary.

Interestingly, Google responded immediately to the announcement with its own change. In contrast to Apple, Google will have an 15:85 split immediately. It seems that they are doing so in the hope they can rollout the changes quickly — it is hard to keep track of who has subscribed for a year. But the question otherwise is why?

For starters, app developers tend to offer apps on both platforms. So the Google approach will not necessarily gain it more developers. In other words, this is not straight out price competition but instead just a straight out give-a-way. It won’t pressure Apple to follow at all.

Second, if you were an app developer on Google why wouldn’t you call everything a subscription? If you sell an app you have a 30:70 split but if you call it a subscription you get more. This seems like a big potential distortion. Given both of these things one wonders if Google thought this through at all.