App Store Search Ads

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A very interesting rumor from Bloomberg:

Apple Inc. has constructed a secret team to explore changes to the App Store, including a new strategy for charging developers to have their apps more prominently displayed, according to people familiar with the plans. Among the ideas being pursued, Apple is considering paid search, a Google-like model in which companies would pay to have their app shown at the top of search results based on what a customer is seeking. For instance, a game developer could pay to have its program shown when somebody looks for “football game,” “word puzzle” or “blackjack.”

Paid search, which Google turned into a multibillion-dollar business, would give Apple a new way to make money from the App Store. The growing marketing budgets of app developers such as “Clash of Clans” maker Supercell Oy have proven to be lucrative sources of revenue for Internet companies, including Facebook Inc. and Twitter Inc.

The reactions to this news were fascinating; the Apple universe was flabbergasted — Apple blog The Loop was representative in stating “this seems like a very un-Apple thing to do”, and John Gruber said it “sounds like a terrible idea” — while the rest of Silicon Valley was, well, flabbergasted as well: flabbergasted it took so long. Bill Gurley said on Twitter he was “super-surprised this didn’t happen years ago” and added it “sound[ed] right” to him that Apple “gifted” Facebook a $4 billion/year revenue stream; Chamath Palihapitiya claimed paid search was “a simple way to add $200 billion of market cap if FB market cap is proxy for value of app installs.”

Personally, I think both sides need to take a deep breath.

First off, while this is just a rumor, it’s actually not surprising at all if you think back to Apple’s last earnings call. For that call — the first to forecast lower year-over-year growth for the iPhone — CEO Tim Cook and especially CFO Luca Maestri spent a substantial amount of time trying to sell the narrative that Apple was a services company. They even made a special presentation for the occasion which I criticized at the time for trying to have it both ways: in the presentation Apple tried to say it was a $31.2 billion services company, but it got to that number by including the 70% of app purchases it pays out to developers; the reason this is problematic is that one of the reasons services are so attractive to Wall Street are their high gross margins (and 30% is not a high gross margin). To be sure the $19.9 billion Apple does generate from services — the majority of which is their 30% share from the App Store — is impressive, but that presentation was a real flag.

So here’s the question: if Apple was willing to create a questionable financial measure to sell the services narrative, should we be at all surprised the company is (allegedly) creating actual new revenue-generating services products as well? And indeed, paid search ads for apps is the obvious place to start: as the linked VCs and lots of other commentators have noted, the app install market is massive, and search results are a powerful place to put ads.

Moreover, it’s a place that is especially suitable for Apple: what makes search ads so effective is that the user has already signaled exactly what they are looking for with their search term. This relieves Apple of the need to gather and leverage an extensive amount of user data to help advertisers further refine their targeting, which the company has declared it won’t do. True, such data would make the search ads even more effective, but one of the benefits of a monopoly (on iOS App Store search results) is that you can get by with a subpar product.

This point, though, emphasizes why comparing Apple’s revenue opportunity to Facebook is way off-base; Facebook has three big advantages for app makers over Apple:

  • First, the problem facing the vast majority of app install advertisers is not discovery but rather awareness. To that end Facebook and its News Feed ads are a much better advertising unit (in the same vein as TV)
  • Secondly, while this applies to all app install advertisers, free-to-play games — which make up the biggest part of the market — are focused on reaching potential customers who are likely to become digital whales based on the app makers’ deep understanding of their existing user base; for this Facebook with its unmatched targeting capability cannot be beat; indeed, Apple is not even in the game
  • Third, iOS search ads only apply to…iOS! Android has the most app downloads and, if you include Chinese app stores, the most revenue (the most relevant measure for this discussion, given that Facebook is banned in China, would be iOS ex-China versus Google Play, but I wasn’t able to nail those numbers down; they are almost certainly close though, although the App Store has a healthy lead in U.S. revenue). Even if Apple’s rumored ad program were competitive with Facebook (which it’s not), it certainly couldn’t replace all of it.

This Android point actually confirms the first two: Google rolled out Search Ads in Google Play last July, and Facebook has only gone from strength-to-strength. Indeed, contra Gurley, app install ads are a great example of why I wrote Peak Google and The Facebook Epoch; Apple can certainly use search ads to add some incremental high-margin revenue (yay services!) without too much effort, but it won’t change the trajectory of either Apple or Facebook.

As for the concerns of Apple bloggers that such a scheme will reinforce the tendency of the App Store to ensure the rich get richer, well, I’m sorry to say but there is no evidence that Apple cares. The company has done nothing to help developers with more traditional business models (i.e. not pay-to-play games) monetize; indeed, in a telling twist the team working on this search ad product is the former iAd team, which Steve Jobs himself said existed so that apps could be as cheap as possible. The Occam’s Razor conclusion is that Apple is actually serious about their services business or, perhaps more accurately, hopeful they can offer an alternative narrative to Wall Street alongside what might be a very tough earnings report.

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