If you hold shares in Apple and you're keen to help the company boost iPhone sales — not that it needs your help — try this: Next time you're at an office happy hour, whip out your phone, open the App Store, and buy a title called Ocarina (it'll set you back a buck). Now hand the phone over to an iPhone skeptic and watch him figure it out.
Ocarina starts up with four mysterious blue circles on the screen, and in the lower right-hand corner, a flashing yellow arrow with the instruction, blow into the mic. Your pal does that — and when his breath hits the phone, the device emits an ethereal, high-pitched tone, perhaps what a flute would sound like in the universe of Stanley Kubrick's 2001. The purpose of the blue circles now dawns on your friend. As he blows into the mic, he slips his fingers over these circles, at first tentatively and then with aplomb. The sounds shift in response to his digits, the phone producing strange, otherworldly music — but music nonetheless.
At this point, you can be fairly sure you've converted him. Even if he's not a musician, he may well dump his BlackBerry tomorrow and head over to the Apple Store. Ocarina has this effect on people. Show it to a group of techno-jaded VCs and watch them turn to jelly. They'll see dancing dollar signs leaping off the screen. After all, what other phone can transform into a flute, just like that? And if it can turn into a flute, what other amazing things might it do?
That question animates app mania. In an otherwise grim economic time, mobile applications like Ocarina — downloaded more than 700,000 times in its first four months on sale — have sparked a frenzy among entrepreneurs, investors, marketers, artists, and even hobbyist programmers hoping to hit the smartphone jackpot. Startups now flock to the iPhone as the biggest new market in town, the one place where customers are willing to pry open their wallets (at least a little) and actually pay for software. Venture capitalists see Apple's device as a vista of possibilities. If apps are the next big platform — and the most wide-eyed analysts argue that apps will be as big as the PC, as big as the Web — then the mobile equivalents of Microsoft, Google, and Amazon are waiting to be discovered. To the world's major brands, meanwhile, iPhone apps represent a direct connection to the customer, an advertising model that puts your logo in people's pockets, right in their lives.
At the moment, all this excitement is centered on Apple, whose iPhone and iPod Touch App Store now carries more than 25,000 programs, with 5,000 new apps being added every month. But Apple's rivals are also catching app fever. Time was, people bought phones for inherent traits — stylish facade, Internet prowess, fancy camera. Nowadays, we're just as interested in the downloadable little amulets that bless the devices with special powers. No one wants to market handsets that can't access this bounty. Last October, Google opened the Android Market, and it has already attracted more than 1,500 titles. Microsoft, Nokia, Palm, and Research in Motion, BlackBerry's maker, have already opened app stores this year or plan to do so.
App frenzy bears much in common with the early Web boom. Some app developers sound as optimistic as circa-1999 HTML monkeys who landed on the shores of San Francisco ready to claim their stake in the then-new economy. People in the industry talk casually about which businesses the humble app will transform or destroy next: video-game consoles, newspapers, satellite radio, gas stations, perhaps shopping? Naturally, some of this is overblown. Just as in the Web 1.0 boom, success can be elusive; for every Ocarina, there are 100 apps you'll never hear about. Yet the big talk also makes sense. "I really believe that the iPhone is an inflection point," says Ge Wang, cofounder of Smule, Ocarina's creator. Remember, the PC really did change everything. And what's the iPhone but a mobile PC that's always connected to the Internet — so why wouldn't we expect it to change everything, too?
Apple didn't invent the idea of allowing third-party programs on its phones. Indeed, for several months after the iPhone's release, the company seemed reluctant to let users install any software on the device. Other phones, meanwhile, have long been able to run outside code. There were about 80,000 apps available for the BlackBerry before anyone had ever heard of the App Store. But that's a bit like pointing out that the iPod wasn't the first MP3 player to hit the market. Steve Jobs may not have been first, but when he finally let other people's programs sully his phone, he modeled his success on the iPod and iTunes. Which is to say: He made it easy, and he put Apple in charge.
Other phones required developers to distribute their mobile software over the Web; customers had to find a site selling an app, fish for their credit card, and sometimes even dock their phone to their PC in order to install it. Apple did away with all those hassles. Every iPhone app would be sold through a store that sat right on the phone. Customers loved this model, and it was also a dream for developers, who now had access to a vast new market. But the plan worked out best for Apple. The company approves every app that enters the store, and it keeps 30 cents on every dollar customers spend. Déjà vu all over again: Just as Jobs has done in the music business, he's given customers and producers everything they wanted — yet he has somehow managed to keep all the power for Apple.
Customers don't seem to mind. They're downloading apps at an amazing rate (800 million in the store's first eight months). What they're attracted to is a whole new style of software. The apps to be found on mobile phones are more personal than any you can build on a PC — after all, they're portable, available to you wherever you travel — but paradoxically, they're also more social, connecting you to other people and to the world around you. Ocarina's killer feature, for instance, allows you to listen in real time to other people who are playing with the app. The music flows over the Internet, from their lips to your ears — "a brain-frying experience," as David Pogue declared in The New York Times. Or consider ShopSavvy, one of the most popular Android apps. Go to your favorite brick-and-mortar store, pick something off the shelf, and snap a photo of its bar code. Within seconds, ShopSavvy looks up the best prices for that item both online and offline. This could remake entire industries. You'll never pay full price again.
Developers, meanwhile, are drawn to the app market's many heartwarming success stories. As the Dow plummeted last winter, the tech press went gaga over Ethan Nicholas, a programmer at Sun Microsystems, whose family had contemplated selling their house in order to pay a raft of unexpected medical bills. Nicholas's Hail Mary pass was to build iShoot, an iPhone tank game. For weeks, he woke up early and stayed up late, cradling his baby boy in one hand while coding the game with the other. The game, which Nicholas sells for $2.99, proved an addictive hit, and he has estimated that he'll be a millionaire before the year is out.
Nicholas's story illustrates a central truth about the App Store: It is radically egalitarian, with programs from big companies sitting next to those from one-man shops, all of them with an equal shot. But that's also the store's consuming problem. The iPhone's screen measures just 3.5 inches diagonally; as a retail experience, it's more cramped than a Black Friday sale at Wal-Mart. Of the tens of thousands of apps on sale, most are never seen by the customer. The apps that do best are those that catch a few early downloads and make it into one of the store's best-seller lists, which are determined by download volume over a short period of time (the exact algorithm is a secret). "If you get to the top 100 list, you see your sales go up by an average of 250%," says Greg Yardley, the cofounder of a company called Pinch Media, which makes a tracking script that developers can add to their apps in order to measure success. "When you get on the top 10, it's an order of magnitude more downloads."
So the App Store is a hit machine. The economics are not unlike those of the movie business or the online viral-video market: lopsided and impossible to predict. A few lucky apps burn up the charts for a couple of weeks, selling tens or hundreds of thousands of copies, and then fade away. The vast majority, meanwhile, see a tiny number of sales.
Customers are not only prone to fads, but they're cheap. A few companies have had success selling apps at $10 or more. EA Mobile sold versions of its best-selling SimCity and Spore games for $9.99 each, and both titles made it to the No. 1 slot in the store. Kai Yu, the founder of Beejive, a company that makes an instant-messaging client for iPhones, sells his app for $15.99 — among the higher-priced ones in the store. "We're a software company," Yu says. "We think we're offering a good value, and we still have very good reviews." But even developers of the best-reviewed products say they feel pressure to lower prices. As Yardley notes, when an app's price falls to 99 cents, the lowest nonfree price allowed in the App Store, downloads can double. This is due, in part, to the fickleness of iPhone customers. A lot of people buy apps knowing they won't use them very often, Yardley has found. On average, people will use one about 10 to 12 times, and then never again. If people consider apps disposable, why pay a lot of money?
All these factors — fierce competition, high churn, the lure of low prices — make business in the App Store a treacherous experience. Perhaps as a consequence, some of the most active developers aren't in it for sales from downloads. Instead, they're looking for an audience. AdMob, one of several companies hoping to make mobile phones the next great advertising medium, is currently serving ads in more than 700 iPhone apps. "In general, people are projecting that the interactive-ad market will be flat to slightly down this year," says Omar Hamoui, AdMob's CEO. "On mobile, it's still growing." Moreover, customers don't seem to mind banner ads in their mobile apps. About 1% to 2% of people even click on the ads — about 10 times the rate people click on Web ads.
That kind of enthusiasm has pushed marketers to create their own branded apps. Target, Coca-Cola, Nike, Kraft Foods, and even Pedigree can be found in the iPhone store. The dog-food company's app lets you upload a picture of your best friend and record his bark — and then, shake your phone to listen to Rover wherever you go. "You can't get that connection with any other media format," says Tina Unterlaender, acting management supervisor for AKQA Mobile, a San Francisco agency that creates apps-as-ads for major brands. "The app knows who you are, where you are, what time of day it is — you can give the consumers everything they need when they need it, and you can't do that anywhere else." The upshot is increased loyalty and sales. "Our business is stronger since Nike+," says Trevor Edwards, the Nike executive who championed the Apple-powered service. "Nike+ has become part of customers' lives as runners."
Of course, the main brand succeeding in the App Store now is Apple — so far the one unquestionable winner on this new platform. The company rules the business with an iron fist. Over the past few months, developers have complained about the length of time it takes for Apple to review programs before they show up in the store. Worse, without much explanation, Apple has arbitrarily rejected several apps, including a utility that lets people stream podcasts, a game that allows you to hoist Barack Obama on a trampoline, and a program that features characters from South Park. It's here that Apple's rivals see an opening. Google's Android project, in particular, has sought to attract developers by touting the store's "openness." "We believe it's important to reduce barriers that make it difficult for developers to get apps to users," says Eric Chu, Google's mobile-platform program manager.
But at some point, it's going to become too late for rivals to catch up with Apple. The App Store, just like Microsoft's PC hegemony, succeeds on network effects: Every time you buy an app, you're tying yourself ever more tightly to Apple's mobile platform. This only makes the platform more attractive to developers — which, of course, keeps us buying more apps. It's a vicious cycle. Unless you're Steve Jobs, in which case, it's genius.
A version of this article appeared in the May 2009 issue of Fast Company magazine.