How do you measure the value of an app? The standard method is to add the total amount users spent buying an app plus the total amount users spent on in-app purchases, to get the app’s gross revenue. Some platforms publish lists of top grossing apps:
The problem is that gross only measures the direct flow of money from an app’s users. In this post, we’ll see how apps create and monetize value in the larger economy.
Visualizing economic value
We can visualize how economic value is created and exchanged by drawing a diagram like this:
The diagram above represents the economic value created and exchanged when a lego man buys a sandwich from a 7-Eleven. We call it an economic value diagram.
Economic value diagrams have the following properties:
- Green arrows represent money being exchanged
- Blue arrows represent non-monetary value being exchanged
- Solid arrows represent ongoing costs
- D-a-s-h-e-d arrows represent one-time value exchanges
- The thickness of arrows represents the amount of value being exchanged
In the diagram above, 7-Eleven pays a one-time cost to create a sandwich, then Lego Guy pays $4.35 for it and gets nourishment value. Pretty cool, right?
Here’s a quiz to see if you understand economic value diagrams:
In the diagram above, circle the part where 7-Eleven creates value.
Here’s the answer:
The thin green arrow represents the cost that 7-Eleven paid to make the sandwich, which is probably less than $2. The thick blue arrow represents the amount of nourishment value that Lego Guy got out of the sandwich, which has to be worth more than $4.35 to Lego Guy, since he’d rather have the sandwich than have his $4.35.
The reason we circled the sandwich – the way we know value is being created – is that the arrow leaving the sandwich is thicker than the arrow entering the sandwich. The difference in arrow thicknesses represents the magnitude of the value being created.
Now that we can visualize economic value, let’s see how apps create and monetize it.
How apps create and monetize value
Selling themselves as goods
Let’s start with the classic value-creation model: apps as economic goods, a.k.a. “paid apps”.
In the age of shrink-wrapped software, all apps were goods – tangible products sold in cardboard boxes on store shelves.
The original Angry Birds app was a lot like a good. Users would buy it in an app store for $0.99, play through all the levels, and then lose interest.
By definition, a good requires a one-time cost from a producer. On the other hand, a consumer might get either a one-time benefit or an ongoing benefit from a good.
In the 7-Eleven diagram, the dashed blue arrow shows that 7-Eleven’s sandwiches provide a one-time nourishment benefit to consumers.
In the diagram below, the solid blue arrow shows that Lowes’ hammers provide ongoing hammering benefits to consumers.
Similarly, the Sleep Cycle Alarm Clock app provides an ongoing waking-up benefit after a one-time $0.99 purchase.
Selling subscriptions and in-app purchases
The app industry has seen a big trend toward freemium apps - apps that are free to download and try, but then charge for subscriptions or in-app purchases. Some recent stats:
- In-app purchases generate 76% of revenue on iOS apps.
- The vast majority of the highest-grossing iOS apps are free.
The Wall Street Journal creates value by writing original news content. It monetizes that value through a classic freemium model.
Supporting a larger business
What about apps that aren’t paid or freemium, but simply free?
You can be sure that “free” apps still create and monetize value, but you can’t just look at the direct exchange of value between user and app. You have to consider the bigger picture.
Domino’s creates value, billions of dollars of it per year, by making pizzas. They also created some additional value by developing the Domino’s apps. These apps are “free”, but they help the larger Domino’s business.
The Domino’s app economic value diagram is interesting to analyze:
- If the “convenience” arrow is thicker than the “development” arrow, then the app has created economic value
- If the app causes the “pizza order” arrow to increase its thickness, then the app has both created and monetized economic value
- If the thickness of the “pizza order” arrow increases more than the total thickness of the “development” arrow, then the app has monetized enough of its economic value to recoup its development costs
Increasing brand awareness
The Domino’s app is free to use, but it still asks for your credit card info when you want to order a pizza. What about free apps that never mention spending money?
The Coca Cola Christmas Snow Globes app seems like a fun game that has nothing to do with drinking Coke.
The app creates value by letting users send fun Christmas cards. But how does it monetize that value?
The Coca Cola Company is betting that users of its app will raise their awareness of the Coca Cola brand at least enough to recoup the development cost. In other words, it’s betting that the “brand awareness” arrow will be thicker than the “development” arrow.
Selling users’ attention
Coca Cola’s app keeps users’ brand awareness for itself. But what about companies that monetize their apps through ads? Let’s diagram one of the most complicated examples: YouTube.
To make YouTube work, Google pays lots of ongoing video-hosting costs. It also paid a relatively tiny one-time cost to develop its YouTube for iOS app.
As users watch YouTube videos, they pay some attention to YouTube’s ads. When users pay attention to ads, advertisers receive economic value in the form of brand awareness. And advertisers pay Google a lot of money for that brand awareness, as you can see by the thickness of the “placement” arrow.
Functional Web economics
Last week, we argued that app stores’ concept of “installation” is obsolete. Similarly, we suspect that the concepts of “buying an app” is becoming obsolete.
Economic value diagrams show us that many apps create ongoing value for users. It makes sense to monetize these apps as services rather than goods, so we expect purchases of paid apps to continue declining while freemium in-app purchases continue rising.
Economic value diagrams also show us that economic value exchanges between users and app developers can transcend the boundaries of apps. For example, the Domino’s app has zero gross revenue in the app store, but it’s probably added millions of dollars to Domino’s’ yearly revenue by helping users buy more pizza. So even gross revenue is a narrow measure of monetized app value.
The Functional Web model predicts that URLs will remain constant as function identifiers, while everything else – including monetization models – will become infinitely flexible. We predict that apponomics will become uniformly freemium – just like websites and retail stores are all freemium.