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The economics of In-App Purchase

With iPhone OS 3.0, Apple introduced in-app purchasing. The idea is that applications can charge for additional functionality (or game levels), content subscriptions, or pay-per-use features.

There are two interesting caveats, though:

  1. An app can only offer in-app purchasing if the app isn’t free.
  2. Content within the app can be priced on a timed subscription (e.g. a month’s worth of ESPN-something for $5), but the app itself cannot. Based on comments from Apple, some level of basic functionality seems required without subscription charges. (The specifics of this, as usual, are a mystery to us. But I’ve written enough about that for a while.)

The latter is a fairly straightforward restriction: no subscription-priced applications. I can’t charge $1/month for a social farting to-do flashlight. I need to charge only once for the application — say, $1 — and have it work forever as promised. But then I can offer separate buyable features (Twitter integration?) directly from the app, and maybe, under some very vague guidelines, I might be able to time-limit those and charge you $3/month for them.

But the former restriction — only paid apps can charge for add-ons — is much more interesting. Because without that limitation, we could have solved one of the biggest problems for publishing in the App Store: the ability to offer a demo for customers to evaluate before buying.

We’ve faked it so far in two ways:

By imposing the free-stays-free rule on in-app purchase, we can’t offer a free version that you can then upgrade from within the app itself. But I don’t think that’s a problem that Apple intends to solve.

But it will further entrench a growing App Store reality: a price of $0.99 for nearly every app.

Free apps will move in droves to $0.99 so they can start using in-app purchase. And many paid apps will drop from higher prices to $0.99, hoping to drive up sales volume and sell additional features later, possibly by subscription, from within the app.

I bet, by next summer’s iPhone launch, nearly every major app and game will cost $0.99.

And that may not be a bad thing. Even if only half of Instapaper Free users had paid $0.99 instead, it would dramatically exceed the revenue from Instapaper Pro.

We may be about to see a lot of Free/Lite apps disappear.