(this piece also appeared on Silicon Alley Insider)

As a number obsessed techie and ex-management consultant, market sizing and research were a big part of my launch preparations for Exit Strategy NYC. Since launch, I’ve received many questions from people struggling to estimate the market for their iPhone app ideas.

I’ve put together this document as a guide for entrepreneurs considering developing an app. Below, I’ve compiled some up-to-date numbers about Apple devices. I’ve also laid out a framework for estimating what kind of sales can be expected from a paid app.

The Basic Facts

• 45 million iPhone and iPod Touch devices [Apple Earnings Announcement]
• 54% of iPhone and iPod Touch users are in the US as of June 2009 [Admob Mobile Metrics Report]
• The iPhone comprises 68% of worldwide iPhone OS devices and the iPod Touch makes up the other 32% [Admob Mobile Metrics Report]
• Only 75% of users actually download apps [Pinch Media]
  • The most frequently downloaded free apps reach approximately 30% of devices [comScore]
  • The most frequently downloaded paid apps reach approximately 3% of devices [My calculations - explained later]

Right off the bat, there’s a few back of the envelope calculations to make: 54% of the 45M devices are in the US which means ~ 25M devices. The US has about 300M people.  That means about 8% of the general American population has one of these devices.

How To Use These Numbers

Combine this data with your own numbers about how large of a market your product is addressing. For Exit Strategy NYC, our addressable market consists of all subway riding New Yorkers. In 2008, there were about 5M weekday riders and about 3M Saturday riders [MTA's ridership numbers]. The Saturday number is the more relevant one as it better captures subway usage by NYC residents rather than regional commuters. Neither number counts unique riders though, and given that there are 8M residents of NYC our addressable market size is probably somewhere in between these numbers. Let’s say 6M subway riders.

New Yorkers probably skew more techie than average, so let’s assume 10% (rather than 8%) have an Apple device. Also, Exit Strategy NYC works on both iPhone and iPod Touch devices. If your app requires phone/gps/camera/internet to work well, exclude iPod Touch users from your calculations.

How many Apple device toting subway riding New Yorkers are there?  Well 6M subway riders with 10% penetration = 600,000 potential users.

“But How Many People Will Actually Buy My App!?”

Entrepreneurs are optimists by nature, and it’s tempting to think that 100% of people will buy your product. After all, your product is awesome, right? But reality is a quite different story. In fact, only about 3% of users have purchased the most popular paid apps. To determine that number, I used sales figures from one of the all time best selling paid apps, Firemint’s Flight Control game. According to Firemint’s Alexandra Peters, sales to date have been 1.4 million. As a percentage of the 45M Apple devices, this is ~ 3%.

You should expect a similar upper bound of 3% to apply to whatever market vertical you’re addressing. Of course it’s possible that your app meets some crucial compelling need and therefore achieves a higher penetration rate in your vertical. But don’t count on it — it’s equally possible that your app gets lost in the noise and can’t get traction. Flight control has held a constant spot on the top paid app list for months now. Few others have this advantage.

Realistic Unit Sales Calculations

Returning to the Exit Strategy NYC figures, we knew that if we had an effective marketing and press strategy, we could probably achieve something close to this 3% penetration figure — perhaps higher as many New Yorkers are very passionate about the subway (see? there’s that ever-present entrepreneurial optimism!). 3% of the 600,000 subway riding devices would mean 18,000 unit sales. Does this translate to $18,000 total sales? Our maximum penetration figure was based on a 99c app, but what effect would Exit Strategy NYC’s $1.99 or $2.99 price point have on total sales figures?

Factoring in price into market sizing is difficult. Based on our own informal market surveying, we estimated that the most profitable price point would be $2.99 or $1.99. Around 75% of people willing to pay 99c would also pay $1.99 or $2.99. So 75% of 18,000 units at those prices works out to an ballpark range of around $27k – $40k. Like all software, the app’s unit costs are zero, it’s important to focus on maximizing dollar sales rather than unit sales.

A Growing Platform

One thing to remember is that the user base for apps is growing by leaps and bounds. In their latest quarter, Apple sold 5 million iPhones and 3 million iPod Touches. This means that the potential market for an app grew by more than 20% in only 3 months!

Non-Apple Platforms

One last thing to note: The iPhone certainly dominates headlines, but it’s not the only game in town. In fact, Blackberry outsells the iPhone every day. And in a town dominated by Wall Street, it seems like everyone and their mother owns a Blackberry. Realizing this, we carefully designed Exit Strategy NYC to be easily portable across different mobile platforms. Our app is available for iPhone, iPod Touch, Blackberry Bold, Curve, and Storm, Android Phones, and even as an e-book on Amazon Kindle.  Combined, the Exit Strategy App reaches a significant portion of New Yorkers.

But are device sales a good indicator of a platform’s expected app sales?

Stay tuned to Back of the Envelope to find out.

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To understand why naive first-time developers have this mindset, you only have to turn to the figures being tossed out by the major iPhone ad networks.  Last summer, Admob was talking about $30 CPM brand ads and calling that “low end.”  Similarly, Medialets talks about their Dockers ads which paid in the $20-30 CPM range.  Even in today’s tough advertising market, Admob company continues to cite rather high “$12 to $14 average CPM” figures.

Ready for the brutal truth?  Most iPhone ads networks today pay around $0.50 CPM. In case you don’t know how to digest that statement, I’ve rewritten here in plain english: 1000 people have to look at your application’s ad just to earn you a measly 50 cents.  What about those $30 CPM figures?  They’re just marketing fluff.

If you want the truth, ask the folks on the front line: actual developers.  Bo Wang’s Galaxy Impact, an ad supported app with over 160,000 downloads, showed an eCPM (effective CPM) of $0.23.  App developer John Kelsey says he sees about $0.50 CPM. Pinch Media CEO Greg Yardley’s “appstore secrets” presentation reports a typical CPM range of 50c – $2 CPM (slide 24) and then in the comments section, Greg quotes developers saying ad rates had dropped to $0.38 CPM. Another developer running CPC ads says he sees $0.01-$0.03c / click.  The truth is that “Most Ad-Funded iPhone Apps Don’t Earn Enough To Buy A Sandwich”

Why the discrepancy?  Fill rate is partially responsible.  Even if a $30 CPM premium ad does exist, it’s not going to run in your app 100% of the time.  In fact, most of the time apps displays remnant (ie NOT premium) ad inventory.  As one developer says “NO ONE can maintain the fill rate at decent cpm”.

Additionally, every ad network wants to attract app developers bad.  Really bad.  So they pitch journalists with juicy stories of high CPMs and ‘case studies’ on developers making sick amounts of money.  Greystripe gets a press piece penned about an “iPhone Beer Pong App Making $7,000 A Month From Ads.”  Adwhirl gets Techcrunch to write “Just How Much Money Can Free iPhone Apps Make? Quite A Bit” which claims apps can make $5000 a day.  And Medialets highlights their $20-30 CPM Dockers ad.  These are the exceptions rather than the rules.  It’s marketing as usual.

The purpose of this post isn’t to point fingers at the ad networks or accuse anyone of lying.  I love ads and I love free apps.  And I love the entrepreneurial spirit in these impressive iPhone ad network companies.  But there’s an important message here for first-time app developers: if you’re considering quitting your cushy job to make $5,000 a day with a fart app, don’t do it.  Always run your back of the envelope calculations first, and don’t assume your app will get anything higher than a $0.50 CPM. Basing your assumptions on $30 CPMs will leave you high and dry.

As usual, readers, I love hearing your comments and questions.  So don’t be shy!

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Exit Strategy NYC is an iPhone, Blackberry, and Android app that answers the quintessential New Yorker’s question: “Where should I stand on the subway platform?” After months of full-time subway riding, we’ve created detailed diagrams for hundreds of NYC stations, eliminating the guesswork and frustration from subway riding. 

The project launched with an article from the New York Times and quickly got covered by Wired Magazine, NY Post, NY Mag etc (full list of press here).

The locations of the subway exits and transfer points have never before been collected on a large scale in NYC. Similar projects have been done in Toronto and Tokyo. We’re extremely excited to introduce this to New York City.

Soon i’ll be writing more about the thinking behind this app and the experience developing across three different mobile platforms.  But for now, buy it and let us know what you think…we hope you love it!

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(This is the second of a two part post.   The first part can be found here)

The ubiquitous iPhone/iPod Touch devices are stealing Bug Labs’s thunder.  To understand why, realize that the iPod/iPhone are no longer mere personal music devices carried around in a pocket.  Instead, they’re increasingly purchased as stand-alone devices that serve a specific purpose.  For example, my brother in law’s restaurant (No 7 in Brooklyn) uses a dedicated iPod Touch with the Pandora app to play streaming music all night long.  Previously they would have needed XM Radio or a full computer to serve this same purpose.  Was the iPod Touch intended to be mounted on the wall of a restaurant (like a thermostat) and stream music for eternity?  Certainly not.  But at $200, it’s a great investment for this purpose.

Back to Bug Labs for a moment.  A classic product example the company has used: you want to build an alarm clock with GPS that wakes you up as you reach your destination on the train.  Great idea.  So you start with the base module (Bugbase, $249).  Then you add a GPS module (BUGlocate, $99).  And a speaker (BUGsound, $99).  Cost: about $450.  Can you do this with an Apple device?  Yes.  How?  Well folks, you probably guessed it — “There’s An App For That!” iNap costs 99c.

And if iNap didn’t exist, you could easily create it.  Most people associate Apple’s App Store with cheap games, free communication apps, and simple utilities.  But there’s an entire half of the App Store that the mainstream media has overlooked: high end apps. There are dozens of $200+ medical apps (Lexi-Comp), $450 salesforce software apps (MyAccountsToGo), and $900 camera surveillance apps (iRa Pro).

But wait, there’s more!  In addition to high end apps, there’s a whole other section of apps that will never see the light of day on the app store: enterprise apps. These Apps aren’t designed to be sold publicly — they’re proprietary in-house applications designed by companies and deployed for internal use under Apple’s enterprise distribution program.  The point is that the Apple devices are powerful and versatile enough to fit almost any need.

Consider the minimalist design of the iPod Touch and the iPhone and you start to realize they’re the ultimate hardware devices. A single large touchscreen. The screen is the primary input and output method.  It can be used to display a single large button.  Or a thousand small buttons.  Or just enough buttons to represent an on-screen keyboard.  Or to represent an on-screen piano keyboard.  The user interface is infinitely configurable.

Additionally, these devices have accelerometers, location awareness, audio inputs and outputs, memory storage, internet access.  To top it all off, there is a well documented and robust SDK (software development kit) and a very active community of developers.  And the devices are cheap.  An iPod touch retails for around $200.

Bug Labs’ saving grace right now is that their hardware itself is open-source, modular,  and infinitely configurable.  Can you add a temperature sensor to an iPod touch?  No.  But it’s coming. When Apple announced their iPhone/iPod 3.0 OS due out this summer, the addition of ‘Copy/Paste’ stole the headlines.  But tucked quietly into the announcement was the fact that these devices will soon be able to interact freely with the outside world through bluetooth and via the devices’ 30 pin dock connector.  That opens an entirely new marketplace: companies creating custom accessories or interfaces for talking to existing devices.  This is a game changer.

Previously, the iPod Touch and the iPhone devices could only interact with external speaker docks.  But now, the consumer, business, and scientific applications are endless. Expect the generic devices to come first: input devices (external keyboards, game controllers), output devices (monitors, LCD display boards), readers (bar codes, RFID, infrared), sensors (temperature, water, heat, weight, chemical).  Soon, more specialized accessories serving different market verticals will follow: medical equipment, sound mixing boards, lighting control, video production equipment etc.

Are you starting to see why I’m worried for Bug Labs? There are 37 million iPod Touch and iPhones in the wild and most people are very comfortable using the devices.  They’re extremely powerful hardware devices.  They’re cheap and readily available.  The user interface is infinitely configurable.  They support powerful custom software development and in house application deployment.  There’s already a thriving high end market for software on apple devices.  With the advent of custom hardware accessories and interfaces, Apple devices will become the dominant platform for interacting and controlling all sorts of equipment across many verticals.  Bug Labs’ is going to have to change strategy quickly.  They’ll need to shift their goal from creating the dominant open source hardware platform and start focusing on building around the Apple devices.  A recent article suggests that this is already happening.

Still need convincing about Apple’s upcoming dominance?  Check the latest edition of Newsweek:  The Military is using the iPod Touch as a handheld field device.  Amazing.

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Bug Labs is a fascinating NYC startup that builds a “modular, open source system for building devices.” Basically, they have a collection of programmable hardware modules that snap together to make custom devices.

I have to admit: the idea baffled me at first.  It seemed like Bug Labs makes a really cool device for technology hobbyists and students — similar to the Arduino or my friend Michael’s company Nerdkits. Bug Labs also focuses heavily on developing a passionate community of users.  But isn’t the product basically a toy aimed at a very narrow niche?!  Why was the company worthy of investment from one of New York’s top VC firms, Union Square Ventures?

Things became clearer when I had a chance to sit down with Matt Cholerton at the Bug Labs offices this past winter.  He demoed the device for me and explained the real uses for the company’s product: rapid prototyping, market testing, and serving the long tail of manufacturing.

BUG is intended less for individual hobbyists and more for companies that can use BUG to rapidly make prototypes of new electronic devices (think handheld electronics: digital cameras, alarm clocks, location based devices).  BUG allows companies to market-test new device concepts before beginning a expensive round of mass production.

Additionally, BUG is perfect when there simply isn’t a big enough market to mass produce a device — this is what Bug Labs calls the “long tail of gadgets.” For example, perhaps some utility company needs twenty very specific custom device for their field technicians?  Enter Bug Labs.

Bug Labs has a really cool thing going and I love the idea of capturing the long tail of device manufacturing.  It’s an incredibly non-traditional idea for a startup and innovative hardware companies are rare these days.

Bug Labs is certainly our most “out there” investment.
-Fred Wilson, Union Square Ventures

BUG’s configurability is based on its modular design.  Modules are added to the base unit ($249) and each adds specific device functionality:  a motion detector/accelerometer ($59), a GPS receiver ($99), a full-color, hi-res, touch-sensitive LCD screen ($119), an audio module with a speaker/microphone/mini-stereo jacks ($99), and a 2gb extendable memory chip ($10).

And here’s where I start to worry.  Can you think of any other devices that have ALL of these features and more?  Oh right, the iPhone/iPod Touch. These two ubiquitous little devices might just pull out the rug from under Bug Labs…

(Continue reading part two of this blog post)

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To say that Apple’s App Store is thriving would be an understatement.  There have been 800 million downloads across Apple’s 30 million iPhones and iPod Touches — meaning on average each device has downloaded 27 apps.  The App Store now has over 25,000 apps and 250+ are added every day.

In such a crowded marketplace, how can an app possibly get noticed?

As developers know all too well, the key to being noticed is getting the app into the top-selling lists. Pinch Media’s data shows that “appearing on a top 100 list increases daily new users by an average of 2.3x” and appearing in the top 10 or top 25 list can mean an order of magnitude gain.

App developers have told me they’d do anything short of cutting their toes off to get into the top 10, top 50, whatever. That often includes lowering the price of their app.
-Dan Frommer, Silicon Alley Insider

So let’s say you have an app that’s selling for $1.99.  Sales are ok, but you want to make more money.  So you cut your price to 99c in an attempt to get on the best-selling list.  It’s perfectly logical after all:  the variable cost per unit is zero.  If you can increase sales 2.3x but earn half as much on each sale, you’ll come out a winner.

So obviously there’s a strong incentive for developers to cut their prices and concentrate on doing whatever it takes to get into that top 100 list.  And therein lies developers’ biggest complaint: the app store calculates popularity by unit downloads — without taking price into consideration. This structure has created immense competition and downward pricing pressure.  In February, the average top-50 app sold for $2.39 which is down 34% from $3.63 only two months prior.

Many have called on Apple to sort the list by total revenue rather than unit downloads. For example consider one purchase of a $10 app equivalent to ten purchases of a $1 app for ranking purposes.  This would highlight the apps creating the most value rather than the most downloads and it would help app developers sustain higher pricing.

But let’s talk about Apple’s dirty little secret: they want apps to be cheap.  The cheaper the apps, the more downloads — and the more value the user gets from the device.  This helps sell more devices, and although lower app prices does mean less app store revenue (Apple takes a 30% cut of app sales), that money is peanuts compared to Apple’s $425 profit/phone. In fact, Apple has said publicly that the app store is being run as a break-even service:

We’re thinking about the App Store in the same way that we think about the iTunes store. While it will generate some revenues, it will be a small profit generator, and just as with the iTunes store making iPods more attractive, we think the App Store will make the iPhone and iPod Touch more attractive to customers. We’ll hopefully see an indirect return by selling more iPhones and iPod Touches.
-Peter Oppenheimer, Apple’s CFO and SVP

The download pricing pressure caused by the per-unit ranking method is seriously hurting developers.  Is this a sustainable model?  No.  Developers will get fed up and leave eventually.  But right now it’s a one horse race: no other mobile platform has achieved much traction.  The most money for developers still lies in writing software for the iPhone.  And until Apple’s hand is forced by competition making significant inroads, a la Amazon forcing Apple to make iTunes DRM free, Apple won’t change a thing.  Everything is perfectly aligned in their favor.

One last point:  The upcoming iPhone 3.0 software supports a subscription pricing model for apps.  To be 100% clear, the new software will support in-app purchasing which asks the user to pay each month to continue using the application (rather than an automatic recurring subscription payment system like many people envisioned — the difference is subtle but important).  Some have reacted negatively to the subscription pricing announcement, fearing that apps will suddenly turn into crippleware and try to charge for every feature that was previously free.  This may be true at first, but ultimately it’s a free market and the problems will sort themselves out.  The simple truth is that the lack of a subscription pricing model was leaving money on the table.  It’s nice to see that being remedied.

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Greg Yardley, CEO of Pinch Media gave a fascinating presentation at last night’s NYC iPhone Developer Meetup.  Greg’s slides were chock full of numbers and data gathered by Pinch Media’s iPhone analytics platform.  As you might expect, I was in heaven.

Greg demonstrated his evidence that a free ad-supported app rarely earns more than a 99c app. After Apple’s 30% cut, this 99c becomes 70c.  So what does it take to make 70 cents through advertising?

The Pinch Media numbers show that free apps, as a category, tend to be used 6.6 times more often than paid apps (this figure incorporates both the increased download popularity of free apps and also the slightly decreased frequency-of-use of free apps versus paid apps).  On average, free applications are used heavily at first but usage levels off quickly — the average app lifetime is 12 runs.

So compared to a single paid app, making an app free results in 6.6x more app uses and at an average lifetime of 12 runs/app = 80 sessions. Remember that the paid app makes 70c.  So the question becomes “Can the average free application make up 70c in advertising revenue across 80 usage sessions?”

Greg’s answer: “Hell No.” Assuming one ad is shown per each session, this requires a CPM of $8.75.  Unfortunately, typical CPMs are 50c – $2.00, far below the point required to match the paid app’s revenue.  Unless your app can serve 18 ads per session (assuming a worst case 50c CPM), or there’s some especially ‘sticky’ property that makes users reliably use your app repeatedly, Greg concludes that charging for your app is generally a good idea.

Slides from the presentation below:

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For a good example, check out this screenshot of the description for ‘Wobble• Bikini• Fun.’  The app’s developers have cleverly included the names of all the top applications and terms like ‘fart’ and ‘weather’ so that their app will show up for any of these search terms and get more traffic and downloads.  In other cases, I’ve seen descriptions that ‘also recommend these fun apps’ and then proceed to include the name of every top application.  Very smart.

Let’s also talk about the name of this app for a second: ‘Fun’ is part of the name…brilliant!  Guess what the top search result for ‘fun’ is?  You guessed it.  As long as they’re going this route, why not just name the app ‘fun• naked• girls• inside’? By the way, this 99c app is the #5 best selling paid application as of press time (or clicking ‘post’ rather).

One last thing.  Notice the final line of the long paragraph:  “And – people of both sex will love it.”  Isn’t the grammatically correct term “sexes”?  And wouldn’t writing “both genders” or “guys and girls will both love it” say the same thing in a less awkward way?

Alas, these clever developers have realized the power of the popular search term “sex.” This app ranks third for a search of “sex”  — right behind the official Sex and the City application.

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The idea is simple — click the ‘start’ button and as soon as the background changes color, click ‘stop’.

Dumb little game, right?

A Sneaky iPhone Web App

But wait!  Look closely at the screenshot and you’ll notice a google advertisement placed adjacent to the stop button.  When the background color changes, the user panics and grabs for the stop button.  This panicked movement combines with the inexact finger navigation inherent on the iPhone to cause the user to click the advertisement by accident (I did this repeatedly in my attempts to play the game).

Furthermore, because the ads are contextually targeted to the ‘reflex’ theme, medical and legal ads appear which surely fetch the developer a pretty penny each time someone accidentally clicks the ads.  Brilliantly evil, no?

Check it out for yourself.

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