So I finally got an iPhone (yeah, I know, I know…).

I considered writing a post about the pros/cons of it, but there are just too many of those and frankly, we all already know what they are (I still can’t type well on that thing).  By far the coolest thing about it is the App Store.  While the app discovery interface is incredibly bad, the sheer number of cool apps is amazing (as you already know).

The thing that has me scratching my head this morning is how to make money in the app store.

It used to be that consumer software was purchased and installed.  The software company created new versions from time to time, hopefully enticing you to purchase the latest and greatest.  Support was either really cheaply provided or was charged for.  In essence, the software company had little to no ongoing costs associated with previously shipped versions (occasional bug fixes were it).  Ongoing revenue was from upgrades and new user acquisition.  The company I work for (Intuit) is still partially there.

Then there were subscription models. Ongoing service for ongoing fees. Simple enough and very effective.  My previous company (Homestead) did this all day long.

The apps in Apple’s app store (and I imagine every other mobile device’s app market) are a different financial model altogether. Case and point: my current #1 time waster, Words with Friends.

First, the model starts simply enough: it’s free with ads, and you pay $2.99 to get rid of the ads. OK, while the price is high relative to what most apps cost, this is a model proven to work. Check.

Then, it gets a bit strange. This is not a standalone application but includes a service that connects you to friends so you can play socially. That means we are getting ongoing services (and the company is incurring ongoing costs) with out any ongoing payment.  Would the market accept an ongoing subscription to play Words with Friends?  I don’t know, but it’s not prevalent in the culture of the app store currently to charge a subscription fee for a game.

Then, it gets really interesting. Again, this is a social game where the company is paying for servers for the game communication. That means that while their revenue grows linearly with the number of users who play, their costs grow linearly with the number of connections in the graph (the number of games played).  Net results: their costs grow exponentially (roughly) as their revenue grows linearly.

The assumption has to be that the company makes enough money in the linear revenue to offset the exponential growth of the cost.  I hope that’s true because I love the game.

But put it all together:

• You have a game that some users buy for $3 not monthly, not annually, but once. Ever.
• You have ongoing costs associated with maintaining servers.
• You have costs that grow faster than revenue.

In the short run, it works.  But in the long run, what’s going to happen?  At some point, revenue from the game will start to decline but costs will continue (fewer new users buy it, but existing users still play it).  And at some point, it will become unprofitable for the company to maintain the servers for this game. Maybe they’ll shut it down, or more likely, try to move to a subscription model ($3/year?).

Clearly, other models work (e.g., Zynga), but I think this one in particular needs work to survive in the long run.