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What makes a smart phone App a good business?

At a recent conference Rich Miner (to whom I always listen carefully) answered this question:  “How many good companies will be created by the smart phone application market?” Rich answered:  “There will be a few, as about as many as succeeded in the PC market.”    [Rich, currently a GP with Google Ventures, has been head of Google’s Android group and its Boston site leader, an Android founder (sold it to GOOG), partner with Orange Ventures, and a Wildfire founder.]

We are excited about the smart phone as an app platform because it holds the promise of being the “new PC” (ie, smart phone capability is what a PC was 5 years ago, network connection speed is where my home DSL connection was 5 years ago) and more: the phone is inherently a multi-media device (media player, camera), and it “knows all about me” — where I am, where I travel, who I know and communicate with.

And, we’re seeing a lot of business plans centered around smart phone apps, usually starting with iPhone.  At a recent partner meeting we spent time thinking about the characteristics of a good business based on a smart phone app.

First, a few relevant facts.

• The smart phone installed base is approaching 100 million units worldwide,about where the PC market was in the late ‘90s.  By smart phone I mean BlackBerry, iPhone, and the equivalent.  I am not counting the Symbian devices at this point, as they are not yet a big part of the application market.  Today the global installed base of PCs is ~1 billion [PC data from Wikipedia].
• The smart phone installed base is much more global than the PC was in the early going, however.  Data is sketchy, but it appears that about 2/3 of the BlackBerry and iPhone units are outside the US.
• Smart phone applications are exploding:  there are more than 50 k apps for the iPhone, the leading platform, and more than 1 B downloads have occurred.  Some developers are making a nice living just selling apps off the iTunes app store.  This is reminiscent of the salad days of the PC app business in the 80s.
• But, look at the PC app business now.  Twenty-five years on, there are about a dozen apps that most people use (browser, mail/calendar/contacts, word processing, spreadsheet, slides, pdf reader/creator, IM, media player, anti-virus (if you still use Windows), Skype), plus a few dozen significant specialized apps:  over 25 years that’s less than two per year.  Most of these were created by a start-up that had a good exit. The era of entrepreneurs in the PC software business looks to be over, however; the last big exit in the PC software business was Skype in 2005 [admittedly a good one].
  

How is the smart phone app business like (or unlike) the PC app business at the same stage of development?

• Reaching customers is much easier.  Distribution was a big challenge in the early days of PC applications.  Vendors had to sell floppy disks in boxes through retailers, with all of the cost, inertia, and complexity that entails.  The internet and recently the Apple app store have made distribution of smart phone apps much easier:  submit to Apple, wait for approval (usually happens with some delay), voila! the app is on the virtual shelf, and Apple provides the commerce platform and takes a reasonable margin (30%).  BlackBerry is behind with its app store, but downloading and installing BlackBerry apps from the web has always been easy.  The proliferation of platforms (phones and operating systems) has historically be a big challenge for mobile app developers, but at this point the concentration of the smart phone market (Apple + BlackBerry have over 70%) minimizes the issue for smart phone apps.
• But, getting the customer’s attention is hard.  The Apple app store is there to sell iPhones and iPods by dazzling users with application possibilities, not to merchandize apps.  50 k apps compete for customer attention.  Search and discovery tools are modest (compare to Amazon).  The systems that determine rankings and ratings seem whimsical at times.  BlackBerry app world is much worse.
• Price points are lower by an order of magnitude.  PC apps used to sell for $10s to $100s of 1980s dollars:  I remember paying $600 for Lotus Jazz, which would be about $1,200 today. [I probably deserve a Darwin award for that.]  iPhone apps average a few dollars, not including the many that are free.  So it’s going to be very difficult to make a real business from simply selling applications.
• A lot of the customer, brand, and product turf has been staked out already. The PC and the internet are in full bloom as the smart phones emerge.  Customer relationships, brands, and business models are established.  Internet-era consumers expect to get most information for free.  It is not surprising that the top ten applications (by downloads) are mostly extensions of established brands, and the top non-game apps are mostly free.  Who has built a major new revenue stream from smart phone apps?  There is no “Visicalc” for the smart phone yet.
  

So, despite all of the energy in this market, it does not look like easy pickings for entrepreneurs and investors.

What do we think are the “bio-markers” for a good smart phone app business?  Here is a start:

• The app needs to add value to a big part of daily life, to offer a better way to do something important and habitual.
• It needs to have clear potential to win a place on the favorites bar of the mobile device (which has room for 4 or 5 icons), and get there by pushing something else off.
• It needs to have an ongoing revenue model that is credible.  Revenue from app sales alone could be a good lifestyle business, but is unlikely to create a company.
• It needs to scale nationally or globally.  Software businesses usually do scale, but a lot of the “local” apps to which mobile devices lend themselves don’t necessarily.
  

That’s a tall order, but not impossible.  We are investors in a company called Stitcher Radio that we think can do these things:  provide a new, better information radio experience via the smart phone (think Tivo for information radio), become a core part of the day for commuters, win a spot on your favorites bar, and sell ads at radio rates (5x the web) to a demo that is better than NPR or The Economist.  It works for me and a growing group of devotees.  Try it and see if you agree.