The 13 Million Nerds That Apple's Counting On

Christmas came early. The iPhone makeup promised to double the cash you could learn if you made an app, put it on the App Store and convince customers to subscribe for a whole year. That's like a huge, huge, dramatic move. It increases the revenue by by twenty something percent. Uvalkamenka

was listening in the audience. He had traveled from Israel to be that it is a game changer of showing what the strategic shift is UM that Apple is going through, because it's not like it's not something that they would do UM without you know, a very good cause. You've always right, Apple probably wouldn't do this unless it needed to. After all, it's the world's most highly valued company, the creator of the Mac, the iPod. It literally changed the

world with the iPhone. But last year Apple's revenues dropped for the first time in fifteen years. Investors started to worry that everyone who wanted a small phone and already had one. Now Apple had to prove it was more than just the iPhone company. All of a sudden, the app store was at the heart of the new growth strategy. I even had a sense that all the people around me that were most of them were engineers coming from

from um all the different developer companies. I had a sense of not even grasping the extent of of the change. The change might seem small from the outside, but in fact it was the first move from Apple in a bigger effort to sweeten its relationship with some thirty million software developers. You see, Apple needs them. They make most

of the apps that people use on their phones. Well, the developers also need Apple to sell the apps and games, right, But for too long, Apple hasn't really prioritized its relationship with them. In the heady days when iPhone sales were going gangbusters, Apple assumed that of course people would make apps for the iPhone. Now, with a saturated global market for smartphones. That dynamic is shifting. Hi, I'm Brad Stone

and I'm Alex Webb. And this week on Decrypted, we'll look at what Apple is doing to pull off its next act as everyone waits for a new blockbuster device. Tim Book is trying to show that Apple can keep making money even if people are buying fewer iPhones. But if you own an iPhone right now, chances are you've downloaded many apps from the App Store already. We're going to take you inside the world of how apps get made and how people who create them make money, sometimes

even fortunes. It's the changing relationship between Apple and developers. You'll hear a lot more about today and why it's so crucial for Apple to strike a new balance. It's a complicated world, and you'll come out of this episode knowing more about Apple's business than perhaps you ever thought you would. But stick with us now. It's worth stating that last year was something of an Anna cerebelist for Apple.

They had that drop of revenue to deal with, and that turned out to be a serious blow to shareholder moral. Apple also got ensnared in some complicated and potentially expensive tax issues, a standoff with the US government over encryption, and other projects like the self driving car were all but shelved. So a lot of people feel like services. That's Apple. Software platforms like iTunes and iCloud are a bright spot right now, and the app Store is a

huge part of that. Yeah. Apple expert Gene Munster told me the app Store grew more than last year, generating eight point six billion dollars in revenue. For context, that's more than three times twitters two thousand sixteen sales, though it's still only about four percent of Apple's total. Even though it's already doing well, Apple has said it wants to see the app store start bringing in a lot

more money than it does today. Tim Cook, the CEO, said it explicitly on a cool with analysts in January. Services are becoming a larger part of our business, and we expect the revenues to be the size of a fortune company. This year, Apple realized that if it wants to grow its App store sales, it needs to incentivize its software developers, inspired them to make more better products so that customers spend more money buying them, and that's

where those changes. Apple and nounced the Developers Conference. Come in back to you've all Kaminka the entrepreneur who traveled from Israel to here. Tim Cook speaking on stage. He started joy Tunes in two thousand and eleven. It's an app that teaches you how to play the piano in a fun way, like playing video games. But it wasn't until last year that things really started to go stratospheric.

You've all on this team made some changes to their product, and they coincided with these revenue changes happening at the app store. The change in revenue sharing meant that once a customer had clocked twelve months of subscription to an app, the card of revenue that Apple would take from developers felt a fifteen percent from initially. You've our wondered if Apple was simply making superficial changes. Being a cynical person like I am, it's you also get worried. Okay, what

you know? What's uh? Is there anything any hidden interests? What does it mean that all of the apps are going to do subscription? Now? Is it going to stop? Here? Are you going to continue? So far? He's relieved to have been proven wrong, like they've been rolling out one after the other more capabilities, more data, more analytics, more abilities to change pricing in a more convenient way, like a lot of a lot of stuff. It just makes it so much, so much better. More transparency for developers.

Believe me, if you make apps for the iPhone, these are welcome changes. Until now, Apple had the power to dictate many important aspects of how apps were made. We have this highly controlled device. This is Cushal Dave. He's in charge of technology at the startups scroll dot Com. Every application and the content of what it says and how you build it and how you release it and how you test new features is sort of all you

know up to Apple's wims. What Crusha is describing here are the ways in which Apple can force developers to work in a particular way. It was an especially heavy burden for people releasing new apps. Small apps trying to get off the ground face review hurdles in this pretty opaque process and can get totally stuck at any given time. Now, obviously a lot of developers have managed to do well

on the App Store despite all the rules. Adrian Deyong is a successful independent game developer, so Apple speaks to him. But that's an exception to most people. Apple is a black box. Basically, once you submit an app to the App Store, Apple controls everything. A group of people in the so called editorial team decide which apps get promoted on the front page of the store. It can make the difference between losing money and making a fortune. Just

look at Adrian's experience. His new game Hidden Folks, launched on the App Store last month Imagine Where's Waldo, but black and white and interactive and animated. He and his business partner have been working in it for almost two and a half years, but after you got featured on the app Store, after four days of having Hidden Folks on the store, we broke even on it. But members of the editorial team don't really talk to developers, so nobody knows for sure how they decide what to feature

and when. Adrian considers himself fortunate because Apple does communicate with him, which is very rare, but he's not allowed to talk directly to the editorial team. He communicates with someone else. The actual editorial team is very much a black box. I talked to Apple developer relations people who have been assigned to me from the moment my first game got on the App Store and was doing really well.

That was the first time they called me, and you know, said from now on, you can just email email me if you have questions. Adrian agrees Apple is becoming more open with developers, even if they're just small steps for now. One example, a few weeks ago, he came to San Francisco for the Game Developers Conference. It's a big industry event with thirty attendees, and for the first time, Apple held a drinks mixer for about forty select iOS engineers.

That may sound like a tiny detail, but it's actually a major change. Outside w w d C, Apple has made few significant efforts to meet the people who make iPhone apps, let alone talk to them and buy them beers. It's crazy, really, I feel extremely privileged. Um these kinds of mixers can change my life quite dramatically, Like it can make the difference between selling a thousand copies and selling a hundred thousand copies, and that's a very dramatic change.

It's partly about ensuring there's an ongoing dialogue with the developer community. It's also about Apple's effort to get more returning revenue from customers. People see games as a service these days, so you start. The release is only the beginning, and that's when you start ending more content. That's when you start ending more features, because that's also the point where a lot of your fans will get to know your game. That's also why Apple decided to change how

much revenue it gives to developers. In the past, only a handful of app categories dealing with content like Netflix, Spotify or drop Box could charge a subscription fee. When the business community looks at smartphone makers, they often talk about the stickiness of devices. In other words, what feature does a phone have which makes it harder to switch to a competitor to take a phone running Google's Android system?

For example, With global smartphone sales slowing, the manufacturers are fighting for market share, and Apple overtook Samsung in the final quarter of helps. Of course, by the recall of Samsung's flagship smartphone. Apple has also been masterful at the stickiness game. Your music, photos and film library build stickiness, the movement tracking, and the health app same thing. Even the Apple Watch itself could be seen as a ploy

to make it harder to dig your iPhone. So for years, the app store was seen as a big differentiator for Apple. The great apps available for the iOS operating system meant that customers would up for an iPhone rather than an Android, but there were question marks over just how sticky the apps were, as in, how many of these apps do you return to every day or even every week. The way the app Store was set up encouraged most developers to build products which customers would pay for once enjoy

for a brief spell, than maybe never use again. Newn Glen Salveas Pedro is a venture capitalist at Delta Partners Group and Strive Capital who invests in startups. Do you still need to have actually engagement? You still need to make sure as a developer that you're getting people enough utility that they will come back to the app on a daily basis or weekly basis, whatever makes sense for

the app right. Opening subscriptions up to everyone and reducing Apple's cut gave more developers an incentive to build sticky apps, but this move didn't come out of nowhere. In December, Tim Cook, the Apple CEO, put a new executive in charge of the App Store. His name is Phil Schiller, the head of Worldwide Marketing. He was already in charge of developer relations. He's one of the masterminds behind Apple's

glitzie product launches. Behind the scenes, Apple engineers have been fighting since at least twenty thirteen too improve the data they give developers. Again, that might sound small, but it gives developers a chance to understand how people are using their app, and it's hard to make improvements without these kinds of metrics. Phil Schiller moved a hundred engineers from Apple's faltering i ads advertising business to work on new

tools for the App Store. Within a few months, app developers were seeing wait times for approving new apps or updates were getting shorter. Right, if you can believe it, it was normal for Apple to take a week or ten days to review submissions that drafted less than two days a few months after Phil Schiller took over. The biggest thing that we've seen from Apple which has had a real positive influence on that is how they've sped out with the review times. That's James Vaughan, CEO of

Endemic Creations. He talked to me from Bristol in the UK. His mobile game is called Plague Inc. Players develop a disease with the intention of destroying the world entire population, and it has been in the app stores top ten since launching five years ago. That's been really significant in just get we can get our content out there quicker. We don't have to wait if there's something we need to fix or we want to get out an additional update. We don't have to worry about waiting a week two

weeks anymore. And I mean that's that's been hugely positive as well. That success has given him a front row seat for how developers are using another of the tools introduced under Phil Schiller, paid search. Developers can now pay for their app to appear in the search results for certain keywords. Now that's not necessarily good news if you're

already successful. I mean, what we we tend to see quite a bit is the game fALS starting out our look around the games that already being search for quite a lot, and we'll see thereous games putting in plaguing as their search ads to try and get some of that search traffic. Not quite sure how I feel about that soup or how successful it is, but it's it's certainly been something most interesting to see there. Here's the

trade off for Apple. It wants more developers to make more apps, get more downloads, and eventually make more money, but it also means more competition for the apps that are already successful in the App Store, so faster a view, times, improved outreach to developers, different revenue models. But in some ways those were all just tips of the iceberg. There's

also an eight pound gorilla in the room. It's called Google. Yes, indeed, Google owns the Android operating system used by most smartphones not made by Apple, and Google has its own version of the App Store called the play Store, So if you have a phone made by Samsung or LG that's probably where you would download new apps. The thing is Google has great analytics. Google's main business comes from ads that appear next to its search results, and that's a

very data intensive process. So it already has a ton of expertise in this area because they've been doing Google analytics for for a lot of years. They're very very agile around measurements on advertising, etcetera. The investor we had from before. For several months now, Apple has been rolling out tools which help developers understand how people are using and spending money in their apps and let them react accordingly.

You've all again they added and analytics specifically for subscription um His ability to see conversions from from child to see subscription events when people are canceling, when people are subscribing. Um So a lot of reporting, a lot of analytics for that, which is which is amazing, Like, you didn't have visibility for this before, so this is a tool for you to learn on what people like and dislike

in in the product. Again, these are all positive developments, but Apple has been playing catch up and we haven't even mentioned the pressure Tim cook has been under firm as investors. We already said glow will smartphone sales slowed last year, but Apple gets almost two thirds of its revenue from selling iPhones, so it has to prove that it's not a one trick pony. Here's the key. Revenue from the app Store has a higher profit margin than from an iPhone, iPad or Mac. That's because it's software,

so there's no manufacturing cost. The irony is that while Apple is by some distance the most highly valued company in the world, with a market cap exceeding seven hundred billion, it's by other measures valued less optimistically than Google or Amazon. And here's why. Google and Amazon have customers who return on a daily or weekly basis to use their services. So Google's market valuation is thirty times it's earnings and Amazon is a staggering a hundred and seventy three times

it's earnings. That means for every dollar per share in profit that Amazon records, investors give its stock one hundred and seventy three dollars in value. Apple meanwhile, there's value to just sixteen times earnings, which is why Tim Cook talks up the prospects of Apple services business here is on the January one earnings call with analysts. Our services offerings are now driving over one hundred and fifty million paid customer subscriptions. This includes our own services and third

party content that we offer on our stores. We feel great about this momentum, and our goal is to double the size of our services business in the next four years. Apple is basically admitted that they don't quite know yet how they're going to reach that goal, but they've made the first steps. The app store is seeing robust growth. Counterintuitively, James Vaughan's game Plague, Inc. Has seen its position in the grossing charts how much total revenue it makes decline

in recent years. Now that potentially sounds like it's a big problem, but actually it's not it's not in the flight is our revenues state broadly constant that the only reason why we're going down the grossing chart is because the absolute is just making more and more money every All the private A pie is just getting bigger and bigger. So all this data that Apple is starting to supply to developers is helping them build products which can be

carefully tuned towards customer demand. I think the notion that you can just create an app and it will do very well is sort of slowly disappearing UM, which is good. So the very very early stage UM apps that we see UH sort of the what I call the two men and a dog type type teams. UM. The ones

that do exist are much more thought through. A final word from Uvalcamina, the developer we heard from at the very start, to means this change means that Apple is serious about building bigger businesses that depend on the App store ecosystem, and I think it's going to be I think it's it's a very big win. It's a very big bet on their part. So Alex, in conclusion, is the app store really the next big leg on the

Apple revenue store? Has no doubt. Many investors hope the way that Tim Cook talks about it, their revenue from services, which also includes things like iTunes and the I Cloud, will be above fifty billion dollars by now. Apple does about a hundred and fifty billion dollars in iPhone sales, so it's certainly got a very good chance of being a size of revenue contributor. But for the foreseeable future, Apple is going to remain the iPhone company. Yeah, I

think these changes are promising. I mean, what we what we've seen with a lot of successful apps is subscription models work Pandora, Spotify, Netflix, That app store commission was steep, and you could tell that companies like Netflix would go out of their way to avoid signing people up via

the app store. So with these changes, and with Phil Schiller now in charge of the app Store, it feels like Apple starting to make some changes that are receptive to the demands of these companies and how they want to interact with customers. And that's it for this week's episode of Decrypted. Thanks for listening. Do tell us what you thought of the show. You can write to us at Decrypted at Bloomberg dot net or find me on Twitter, I'm at a t B web and I'm at brad Stone.

Don't forget to subscribe to us on iTunes or wherever you get your podcast and leave us a rating and review. It really helps new listeners find our show. This episode was produced by Peter Gadkari Archie Ito, Liz Smith, and Magnus Hendrickson. Big shout out to Robin and Yellow, who edited the article I wrote alongside this podcast. You can read it at Bloomberg dot com Forward slash Tech. Alec McCabe is head of podcasts. We'll see you next week.