A Venture Capitalist’s Perspective on The Future of Mobile Apps: Part 1

Earlier this month, we released our inaugural mobile app store forecast.

Danielle Levitas, SVP of Research & Analysis at App Annie, recently sat down with Eric Liaw of Institutional Venture Partners to get a venture capitalist’s perspective on our findings. (Disclosure: Eric Liaw sits on App Annie’s Board of Directors.)

Here’s part one of that conversation.

Danielle Levitas: Thanks so much for taking the time to sit down with us, Eric. When we first released our forecast, there was a lot of focus in the media on what I would consider one of our “killer stats”: that the app economy is expected to exceed $101B by 2020. Naturally that raises questions around the monetization models that will bolster that growth. Did you have any questions or comment regarding that?

Eric Liaw: From my perspective, I’d want to take a minute to focus on where dollars are going. I think games were clearly the first category to take advantage of the mobile platform of the app economy, and to make money through the app store. They started with single app purchases, which is one-time but have transitioned to a more recurring model. Overall, the in-app purchase model is obviously much more conducive for games. And it works for publishers and consumers because it’s really more of a consumption-based pricing model, meaning publishers earn the most revenue from the consumers that enjoy their product the most as opposed to the one-time only app purchase.

And even games now, by the way, of course have a bunch of in-app purchases. But I think back to four years ago when Rovio was the first big hit on mobile. They built a great franchise but gave consumers way too much value for a dollar! And that ended up being a problem. But then you look at Supercell (Disclosure: IVP is an investor in Supercell) who took the free-to-play model and created a path for consumers who really loved the game, but didn’t have patience and were willing to spend more to advance more quickly could do so. And those who were more casual players who didn’t want to spend a bunch of money to do so could still enjoy the game.

A dynamic pricing model can work really, really well in a lot of businesses, but games really took advantage of it. So I think the one thing that surprised me about the forecast, was that App Annie projected the growth rates as kind of a 20-something percent CAGR on downloads and revenue.

And that makes sense when you’re thinking about just absolute revenue itself. The part that I know isn’t captured, but that I think is important part of the overall story, is the GMV of commerce that is transacted through apps. So if you’re buying something from Amazon on this interface, or booking a ride on Uber, or booking travel — huge things that apps enable, aren’t really captured by the forecast. But if you take the point of view that mobile apps become a conduit to much larger transactions, I think it makes that $101B much bigger.

So there’s a categorization question there. How do you break out the difference between what Amazon sells through dot-com on your laptop or through their own app? It’s probably going to skew more and more, I think, toward apps for a lot of these companies.

Danielle: Absolutely. Just for perspective, we went into this report deliberately doing a a store forecast. But over time we’ll want to take into account things like ad spend, which is anywhere between 80% and 110% of store revenue — we’ll find out. Commerce is multiples of these, so I’m with you in terms of talking more about that.

To your point about GMV and retail, it sounds like if there were verticals you were keeping an eye on even more than retail, it would be travel and transportation. That includes both travel as a broad definition, and then transportation in terms of things like ridesharing, which has been a huge, hot, global activity from an app standpoint.

Any thoughts around digital entertainment publishers that are increasingly making their content available not just through apps, but actually purchasing through stores despite the revenue sharing aspect?

Eric: Yeah, and we’ve talked about it for a while internally. Let’s walk through an example.

Let’s start with the NCAA tournament. You can watch the NCAA tournament through your app, but you get all this dead time, the “your game will be back momentarily” screen, because it’s a live feed, and when it’s a TV time-out, there’s nothing to show on the app stream. Any college basketball fan will tell you there are a lot of of long TV time-outs during the tournament. And if you’re watching on the app, you don’t see an ad because CBS and Turner rightly don’t want to sell that placement for a discount. They want to sell the same rate as over the air, but they can’t yet convince advertisers to pay for the spot because there’s no measurement.

Well, that’s a seasonal event that happens over three weeks in March, but you see the same is true if you are watching, to a lesser extent something like ESPN. Even though ESPN is probably the best on mobile streaming, if I’m watching games on their ESPN app, it’s the same thing. There are still some dead periods. You see that less so if they’re televising an NBA game, which has a broad national audience. But when you start getting to some of their more targeted media packages like college sports for example, there’s a ton of dead time that’s really un-monetized today, that’s being played through apps.

The same is true for CNBC. You can watch the CNBC stream live. There are a handful of advertisers that are ready to buy that inventory and reach the same demographic they’re going after on TV, but you still see a lot of house ads and PSAs. And so I think that is totally untapped. What do I have on my phone? I’ve got FXNOW, which is all the Fox channels, I have CNBC, I have ESPN, WATCH TNT, PAC-12 Now, Golf Channel. They all have the same problem. And so that’s totally untouched.

What people are thinking today for app advertising — for instance using ads to drive app installs — I think that’s actually the tip of the iceberg. When people realize the mobile device is truly a screen, you could run the same ad in in-stream content that people are watching on TV. It’ll be like more like advertising on YouTube than on broadcast or cable TV because it’s immediately actionable. And I think that advertisers are first starting to realize that with Snapchat (Disclosure: IVP is an investor in Snapchat), who is breaking ground with advertisers via mobile video.

Now, the trick is going to be, of course, for advertisers to measure the impact of those ads because people aren’t going to want to tap out and interrupt the stream of what they’re watching. But think about it on an impression basis. Say you’re watching The Avengers on Fox (because cable companies like buying rights to movies as consumers will watch those ad nauseum as opposed to original content). If someone is still watching that stream of The Avengers five years from now, someone is still watching the in-stream ad. But there’s no way to measure it now. It really hasn’t been touched, and those are big dollars.

Danielle: Right. It’s a fascinating opportunity. Let’s go back to geography, because of one of the core ways people examine the market is through that lens. So one of the key findings in our forecast is that China on the whole is overtaking the United States in terms of app store revenue early this year. In addition to iOS and Google Play, you have third-party Android stores. We expect that in 2017, the combination of Google Play plus those third-party stores will be bigger in aggregate than iOS.

Were you surprised by China moving to #1 this soon? And what do you think about mature versus emerging markets driving the next wave of growth?

Eric: Actually, China’s growth didn’t surprise me. When you think about developed / first-world markets, they had access to Internet — and even phones — first. Historically, they got landlines first, then wireless laptops, then mobile.

In comparison, China is somewhere in between. But for the vast majority of the population, their first on-ramp to the Internet is likely through mobile. So all of their spending starts on that device, whereas for people like us in the US, we some of our spend winds up on mobile devices, but still spend on laptops or desktops.

So if you think about the aggregate spend digitally across those three categories, mobile versus laptop versus desktop, or maybe it’s two with computer versus mobile device, I’m sure the US total is higher than China. But because China’s spenders concentrate on one channel, essentially, it makes sense that the data shows China is outgrowing the US.

Danielle: That’s a really good point. As a VC, are there any countries in particular that are the ones you believe are going to fundamentally move the needle over the next couple of years in terms of their role in the app economy? Which are the ones you’re most interested in making bets on, or watching more closely than others?

Eric: Actually, I’d argue that you can’t make a geographically driven bet. I think the amazing thing about mobile platforms, thanks to the App Store and Google Play, is that they’re essentially global from day one. Again, if you look at games, as we discussed earlier they were the first sector to take advantage of the platform and make real dollars.

In most areas of technology, the US is the leader. But when it comes to gaming, I’d say that out of all the regions in the world, we’re probably third out of three (among Asia, Europe and the Americas). Two of the biggest gaming companies are in Europe: Supercell and King. And GungHo Online is big in Asia. For the US, we have Machine Zone and Kabam.

Another area you can look at is messaging. Let’s face it: messaging apps are more advanced in other countries than they are here — or at least people in other countries have been using them longer. So I think it’s hard to focus on a geography and say we expect a leader to come from the US — or any specific geography — on mobile platforms.

Instead, what I think you have to do is look for traction. As an investor, you have to look for apps and services that get some traction wherever they might be. And maybe the extrapolation is: Are they going to find an audience globally?

Danielle: Excellent observation. That’s really one of the beautiful things about apps, is that even though we see a few regions really rocket up the publisher rankings year over year, it’s technically an equal playing field as far as location is concerned.

One of the things I’m eager to get your take on is the app market maturity model we put forward. Ultimately, when a market is new and you start seeding devices, the first thing that has to happen is the download, right? You have to get those installs on board.

And then, as a user, you start to understand which apps are delivering value. You discover new ones through the stores and through social elements, since most apps have a social aspects built into them these days. And then, based on that, you start to understand the value of the app. From there, usage starts to evolve as you begin using certain apps more and more frequently.

So your overall time in mobile grows quite dramatically, and then revenue comes into play; meanwhile value and time continue to go up, driving even more revenue.

What comments or counterpoints do you have on the model? Is there anything specifically that resonated with you?

Eric: I think the general thinking makes sense, especially in regard to downloads. Maybe I’m picking nits, but I don’t think the download number ever really flattens out — maybe it stops increasing at the same rate, but I don’t think it actually flattens out.

The relative ranking, or steepness of the relative height of the usage vsersus revenue curves makes sense to me, but I actually think that at some point revenue accelerates well past usage. My intuitive observation would be that while usage continues to go up, the revenue curve would inflect more aggressively past usage and continue to increase.

Now why do I think this? Because at that point, even mature markets like the US and Western Europe will start to look a little bit more like developing markets, where your spend starts to concentrate on mobile. And if that’s the case, then actually the revenue growth opportunities should be a lot larger.

Danielle: I love that. And what I’d say is that this was done to some extent from a store-centric point of view. When you layer on all the additional monetization opportunities, especially what we talked about before — advertising and GMV with commerce and so forth — then all of a sudden it’s not just about roughly $100 spent per device in Japan. It’s potentially not just hundreds, but thousands of dollars a year being transacted through that device.

This is part one of a two-part interview. Come back in a few days for part two.

Want to learn more about our forecast? Join us on Wednesday, March 9 at 10 AM Pacific Time. Danielle Levitas will be leading a webinar that digs deeper into our findings.

Eric Liaw joined IVP in 2011. He is focused primarily on later-stage investments in high growth companies across a variety of sectors including enterprise software, Internet, and mobile. Eric serves as a Board Director or Observer for IVP portfolio companies AdRoll, App Annie, Mindbody (MB), OnDeck (ONDK), RetailMeNot (SALE), Supercell (SoftBank), The Honest Company, Wikia, and ZipRecruiter and led IVP’s investment in GitHub and Klarna. He previously served as a Board Director for Dropcam (GOOG) and was actively involved with DeNA, HomeAway (AWAY), MarkMonitor (TRI), and Varolii (NUAN).

Eric holds a B.A. in Economics with a minor in Computer Science and an M.S. in Management Science and Engineering, both from Stanford University.

Originally published at blog.appannie.com on March 7, 2016.