Rick Gibson on why Appleâ??s U-turn on freemium, in-app purchasing has revitalised the iPhone business

â??To the App Storeâ??s rescue: In-app purchasingâ?

There’s no question that the iPhone has had a huge positive impact on mobile gaming since launch in 2007.

The iPhone gaming market is growing healthily and has attracted crowds of independents looking to go ‘direct’ (through Apple). But as this market has matured, major potholes have killed many plucky start-ups. This potted history will evaluate whether the pitfalls outweigh the benefits.

Few games markets are more broken than Java mobile gaming. Most indie developers work for hire with no royalty, keeping them small and cash-strapped.

Poor audience profiling means developers have little idea who they are developing for, resulting in copious games for boys when the average Java gamer is a woman in her mid-twenties.

The cost of porting to thousands of handsets outweighs initial development costs for publishers, driving down quality.

Hundreds of competitors on operator decks drove decreasing numbers of viable large publishers to pay ‘marketing fees’ for placement. Where Japanese operators triggered massive innovation by taking 30 per cent of a transaction, Western operators take 40 to 50 per cent, constricting the market.

Consumers are overcharged for downloads, and buy Java games in brief spurts, shortening most games’ viable shelf lives. Below five per cent of Western mobile subscribers actually buy games, a figure gradually falling.

Enter iPhone. Apple solved many of these problems by creating a desirable device with a great UI and a smooth buying experience. Low handset variation has largely extinguished porting. Development is easier and faster.

The App Store made games more prominent, and Apple sensibly shares 70 per cent with developers. They take no payments from publishers for placement, so the chart’s higher reaches feature many more original independent IPs.

Most significantly, Apple entirely bypasses operators and ensures internet is bundled for free. iPhone’s predominantly male users love buying premium games apps made by boys for boys, and well over three times as many buy iPhone games versus Java.

The contrast between these two is stark. While Java declines, iPhone has reinvigorated a market that had got stuck at around $1bn in the West, and will take the lion’s share in future, despite having a relatively tiny installed base (only 5m in the UK). With so many old handsets still in use, Java gaming will linger on for several years but it won’t be pretty.

iPhone had a bright childhood, abounding with breathless reports of bedroom programmers making millions. In its first year, a number of early movers made substantial revenues from quick little games. By mid-2009, the App Store passed 10,000 games and Apple’s tiny editorial and approval teams creaked under piles of new applications.

Average unit sales, prices and returns for new IP were falling fast. Despite experienced work-for-hire studios like Distinctive reporting that any iPhone game costing over $40,000 would not break even, an arms race has been fought by studios raising production values over $1m to counter rising competition.

Little studios reliant on premium app sales started to go out of business, while bigger studios started marketing heavily to keep their branded apps in the charts. The market now consists of a thin layer of big publishers and top-tier iPhone studios but few studios at scale below them. Older studios could port existing games to iPhone for low cost and still do well, but original IP struggles to be shine in a market with over 35,000 games.

Early mover Ngmoco watched this change in the market with concern. Lots of low quality games at low prices felt like Java all over again. To make a business at the scale demanded by investors, it calculated they needed a game in the top five all year round.

The premium app market looked unsustainable before Apple’s U-turn to enable freemium, in-app purchasing. Ngmoco went free in July 2009, acquiring several freemium studios and making its premium games free. These are monetised by selling virtual goods, advertising and offers, optimised by data mining. It radically changed production methodology to build only the minimum required to live-test player retention levels and refine their game designs.

Ngmoco has even found way around Apple’s ban on third party premium currencies by selling services and not items. Ngmoco estimates it makes four times more money from freemium than premium, and is thought to be grossing well over a million dollars each month.

While iPad steals media attention, Apple and Facebook have signalled mobile gaming’s future through recent announcements. Apple’s forthcoming Game Center is a social network platform that provides a viral marketing channel for studios to exploit players’ social ties.

In parallel, Facebook has sneaked in reference to location-based services in its latest API, which means that mobile app developers, like Foursquare, may be able to map a Facebook Friend list to its mobile players’ locations.

Anyone who has read our previous blogs will not be surprised to hear us saying that free or social network gaming are exciting opportunities, but iPhone’s transition to these more sustainable, higher value commercial models could trigger huge innovation.

Social gaming on iPhone will be held back until either the ban on third party premium currencies is fully reversed, or Apple introduces its own currency, much like Facebook’s controversial Credits.

Whatever happens, iPhone gaming has discovered a new kind of highly lucrative and socially relevant mobile game.

Rick Gibson is a director at Games Investor Consulting, providing research, strategy consulting and corporate finance services to the games, media and finance industries.

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