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AAPL App Store: Games Dominance Is an Opportunity

Apple Inc. (AAPL) doesn’t talk as much about its App Store as the high profile iPhone, iPad and Mac divisions. If anything, it’s treated as a supporting act, with App Store games highlighted at launch events to show off the graphics capabilities of the latest iPhone or iPad.

Despite the App Store being in the shadows, AAPL makes a lot of money from the App Store, to the tune of more than $10 billion in revenue for 2013. That may not seem like much compared to the $19.5 billion the company collected in the last quarter alone for iPhone sales, but the App Store is profitable, high growth and something that could be even more important to the company in years to come.

App Store games, APPL metal
Source: Apple

App Store Profitability and Growth

Besides its own in-house developed apps (like Pages), Apple doesn’t pay any of the development or marketing costs of apps. It provides the staff and infrastructure to keep the lights on and to review submitted apps, but that’s about it. In return, it collects 30% of the selling price of all apps and any in-app purchases.

So when Electronic Arts (EA) sells a $4.99 copy of Dead Space for iOS, Apple pockets $1.50 in revenue. Every time a player pays for a “10 Power Node Pack” from within Dead Space, that’s another 60 cents in AAPL’s coffers.

It’s a pretty sweet deal for Apple, and one that’s been a big part of pushing the iTunes/Software/Services division into being the fourth largest source of revenue for the company, not far behind the Mac division. According to Apple CEO Tim Cook, strong App Store results have turned iTunes into AAPL’s fastest growing business.

App Store Games: Over-Reliance?

While the increasing importance of the App Store is a positive for a company that’s otherwise dependent on hardware, a piece by Quartz’s Leo Mirani rings alarm bells about Apple’s reliance on games for App Store Revenue.

AAPL released its list of the 10 highest grossing apps for 2014, nine of which were games. The article cites data from Macquarie Research showing App Store games account for 75% of total App Store revenue. Further, Macquarie forecasts app sales growth will gradually decline, from the 40% levels seen in 2013 to less than 15% in 2020.

If the assumption is made that iPhone (and iPads) remain as premium-priced devices preventing Apple from growing mobile market share at rates it has in the past, then the reasoning goes that maintaining high App Store revenue growth requires AAPL to broaden the appeal of its apps.

In other words, the current reliance on App Store games is worrisome — Apple needs to get customers to buy apps in other categories (health, automation, education and security for example) in order to keep that App Store revenue growing.

I agree that boosting the sales of other apps categories than games is a worthwhile goal, but the App Store is already a bigger boon than people realize.

Reviewing the complete Best of 2014 App Store list, four of the 10 most downloaded paid apps are from categories other than games. In the most downloaded free apps list, only one of the 10 is a game.

So people are downloading apps other than games and they’re willing to pay for apps other than games. The challenge seems to be more on the part of app developers in convincing people to pay for content. That can be tough considering many of the other categories include complementary apps — for example, the Fitbit app that ties Fitbit’s activity trackers and data to iOS devices. Fitbit is unlikely to ever charge for this health app, choosing instead to makes its money on the hardware.

Other apps like productivity tools aren’t the sort of thing that people accumulate a collection of. They buy one or two they like and stick with them. Games, on the other hand, are entertainment and there’s always something new to play.

App Store Games: An Opportunity

Rather than hand-wringing about the over-sized share of revenue App Store Games represent, I look at the strength of iOS games as a huge opportunity for AAPL.

With the power of the A8 and A8X CPUs used in the latest Apple devices, along with Metal — AAPL’s new game development technology — App Store games can rival the quality of previous generation video game console titles. Keep pushing the quality of the games and many players will pay more for them, either through direct app price or in-app purchases.

Increased revenue per-sale can go a long way toward preventing the slowing rate of growth among iPhone and iPad sales from causing a corresponding slowing in App Store sales.

Or, better yet, add a new product category that can leverage that library of iOS App Store games.

Apple has a successful set-top streaming box in the Apple TV. It already runs iOS, an operating system that supports game controllers. Third-party controllers from Logitech (LOGI) and others are already on the market.

Revamp the Apple TV to also run video games and suddenly you have an inexpensive rival to existing video game consoles. It not only costs less for the hardware purchase, the App Store library of hundreds of thousands of cheap games is going to appeal to parents. More discerning gamers will find even premium titles cost $5 or $10 instead of the $50 or $60 for a console video game. As a bonus, they’ll also be able to play those games on  the go on their iPhone or iPad.

So AAPL’s reliance on App Store games really is a glass half empty/glass half full thing. I look at it as a good thing. And I think that by continuing to promote iOS as a gaming platform through premium game development and by enabling gameplay on the Apple TV, that glass could get much fuller over the next five years.

As of this writing, Brad Moon did not hold a position in any of the aforementioned securities.

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Article printed from InvestorPlace Media, https://investorplace.com/2014/12/app-store-games-aapl/.

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