App Overload: Why Apple Decided to Edit the App Store

(MoneyWatch)  People railed when Apple (AAPL) dropped Wi-Fi finders from the iPhone app store. Back in February, "overtly sexual" apps were sent packing. And now there are rumors that Apple plans to ban "cookie cutter" apps built from templates. But I don't think that Apple is on a series of arbitrary witch hunts.

No, I think the company has found the two-edged quality of the app store's success and is trying to regain control while fending off dangerous competition from Google (GOOG) and others.

Apps have helped make the iPhone a smash. However, apparently they haven't provided a direct financial hit for Apple, which claims to run both the app store and iTunes as "a bit over breakeven":

As [Apple CFO Peter Oppenheimer] says, this isn't a new development. Apple has always maintained that iTunes wasn't a real money maker. It's supposed to help sell iPods, iPhones, and soon, iPads.

For years, industry observers figured that as the iTunes business scaled, this would change. An alternate theory, held by some of Apple's media partners?€"the company was being overly modest about its success.

Maybe Apple is dissembling over the degree of profitability (although there's only so far you can stretch things without making yourself a target for the SEC). Then again, it is far more costly to run a retailing business than most people realize.

Every potential product has to be entered and tracked. Every transaction has an associated cost, even when done online. The retailer must monitor and maintain relations with each of its vendors. Taken together, the business can become massively expensive. Look at the difference between Apple's FY2009 gross margin percentage of 36 percent and Amazon's 22.6 percent, and Amazon gets a good deal more than the 30 percent margin that Apple sees on third-party apps. Retail is a game of efficiency, and the cheaper the individual items -- like single music tracks or most of the iPhone apps -- the more difficult it is to break even, let alone make money.

Furthermore, not only does Apple sell many items from a broad swath of vendors, but it reviews everything App might go in. As of early January, according to GigaOM and data from metrics company Flurry, that included:

• 133,797 apps
• more than 28,000 developers
• only a quarter of the downloads were for paid apps
• the average listed price (including free) was $2.70
• the average app store user spent $4.37 a month
• Apple keeps only 30 percent of the sales price

The App Store contains a lot of incredibly cheap products and a much larger volume of free apps, for which Apple still incurs all the costs of their paid siblings. As the number of apps increases, I think Apple finds itself stretched thin and looking for excuses to cut loose entire categories of product -- particularly when enough users or business partners complain. I would guess that the "minimum user functionality" reasoning that Apple offered over the Wi-Fi finders will pop up repeatedly.

At the same time, Apple is concerned about app developers moving to other platforms like Android. The more robust the apps ecosystem for Google or Microsoft, the more competitive those companies become. I suspect that's why we're seeing evidence of possible future app upgrading pricing tools for developers. Instead of asking existing customers to pay full price for a new version of an app, the vendor could offer upgrade pricing to make more sales and, possibly, more money in the bank. That makes Apple a financially preferred partner.

Given Apple's usual reluctance to let anyone outside the company (and many inside) know anything about its strategy, I suspect we'll continue to see cryptic lurches this way and that. Apps are a fundamental building block for Apple's mobile platform success, and the company must be sure to keep the good times rolling ... and not sinking.

Image: Flickr user WorldIslandInfo.com, CC 2.0.