Strategic pricing and the app store

In honor of today's anticipated new iPhone announcement, I've been thinking about app pricing in the iTunes store and some of the interesting network effects and strategic behavior I've been observing lateley.

Anyone who has an iPhone/iPad or other smartphone has probably searched for a particular app and found several similar ones priced at points such as free, $.99, $1.99, $4.99, $9.99.  If you're anything like me you're initially drawn to the free one and then you have a second thought and wonder if the 99cent or $1.99 might have some features to set it apart.  So you turn to the user ratings and read a few "crowd-sourced" reviews which will likely range from "zero stars - worst app ever - crashes constantly!!@&*^!" to "This app RULZZZZ!!! Download now! THis changed my life!!!"

 These ratings can be helpful, however the pheonomenon of rigging app ratings has gotten a lot of press lately and has gotten apple's attention.  A developer has a huge incentive to get itself into the top 10 or top 25 lists as these are featured in the store and provide a huge boost to sales. One unfortunate paradox about user rating systems and getting information from peers and social networks is that as that information becomes more useful, the incentive to manipulate it also becomes greater and thus the integrity of the system can suffer, eliminating the usefullness.  How do we make sense of reviews like this, and how do we use prices as signals to underlying quality of software that is typically difficult to try before you buy?

Software is a particularly interesting pricing puzzle because, once the development is complete, the marginal cost is zero.  It costs a developer the exact same amount to produce an app of a given quality level if they sell one or sell one billion of them. (You might argue that customer support costs increase with higher sales, which is probably true but in the app store there's not really a help desk to maintain or software support lines that you might see in traditional software so I think for apps this seems like it should be a fairly minimal consideration?)

All products which are able to be distributed digitally have zero cost to reproduce and thus pricing is very much a demand-side consideration.  The same is true with MP3's, games, movies, Kindle books, etc.  The relatively brief history of pricing in the app store (a good discussion of this can be found here) shows that it didn't take long to have a "race to the bottom" and for consumers to come to expect apps to be either free or $.99.  Some developers attempted to use timing to price discriminate and extract a bit more from early adopters, then lowering the price to reach a broader market, but consumers became frustrated by this and have largely caught on and learned to wait out the price drops and sales.

Developers next figured out ways to leverage advertising revenue in apps as well as in-app purchases and make a price of "Free" profitable.  Perhaps nobody has been doing this better than The Smurfs who have shockingly been selling in-game digital "smurfberries" to the tune of $3-4 million dollars a month.  However, the legacy of the Smurf game will likely be that it raked in many of those dollars as a result of children unsuspectingly clicking the "buy" button and racking up huge charges on their parents' phones. Even for adults, it seems that some less-ethical developers use the strategy of super-high pricing with the hope a few people accidentally click on it (what we would call a "trembling-hand equilibrium" in game theory).  I've seen this particularly in apps that fall into what I would call the "drunk college student" demographic ... for instance, this app called "I Am Rich" which provides you with a full screen picture of a ruby (and nothing else!) for the low-low price of $999.

So what are we to make of pricing strategies in the app store?  A few things: (1) there is a great deal of congestion and competition of apps at the $.99 and $0 price points and small differences can have dramatic revenue impacts here - this is a good example of the "superstar effect" in economic theory.
(2) There are important signals transmitted by apps choosing to go with a higher price point but our current mechanisms for screeing those signals and discerning quality are somewhat lacking  (3) Beware the drunken $1000 app click, and don't let your small children know your app store passwords! 

I'll have more posts on this topic in the future, but if anyone is interested in the online/digital economy and the economics of products that are "Free" there is a really excellent book by Chris Anderson that I really highly recommend. 

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