iPhone Users Are Predictably Irrational

Over the last year or so, I've visited the topic of iPhone Apps and what they're good for several times. I must say I've angered some of my readers who saw my resistance to this great new wave as being purely bull-headed. Now that WorldMate for the iPhone is here, and our commitment to serving users on this platform is clear, we can come back to a discussion that's a little more level-headed.

My chief concern was how the AppStore marketing platform – which consists mainly of the best-seller lists, skews the platform towards cheap gizmos. Or basically – my argument is that:

The marketplace that Apple has created does not allow a company like WorldMate to charge the a price for its product that is in line with the product's value.

As I've spent some time writing a rather long piece - here are my main themes up front...

• There are dozens of thousands of smartphone users who think WorldMate is worth at least $100 per year
• A rational ROI analysis shows that WorldMate is worth at least $100 per year
• If WorldMate is to make money on the iPhone platform – It can't do that on a few dollars per user.
• Apple's App Store set-up triggered a consumer behavior called "Price Anchoring" which makes iPhone users believe that a price of $1-2 is adequate for apps, without any real rationale
• This makes it very hard to build a scalable business on selling iPhone apps.
  

Now you know what I think - let me try to explain.

This discussion is by nature an economics discussion, so let's start by figuring out the "Right value" or "Right price" for the product.

WorldMate for other platforms (e.g. BlackBerry, Windows Mobile) retails for $99/yr. We've done quite a bit of price-testing before settling on this price, and we were considered one of the most successful app developers on these platforms. So you can state as a fact that:

There are dozens of thousands of smartphone users who think WorldMate is worth at least $100 per year

Otherwise they wouldn't have paid, right? But of course you could always argue that these people weren't thinking straight.

So - maybe a better way of justifying the price is by calculating the economical value. What WorldMate essentially does is save you time and get you out of trouble while traveling on business. We inform you of things in advance and provide you info quickly – so you won't miss your flight, get lost, etc., and we help you optimize – for instance find another flight when you need to change your schedule, or when your existing flight was delayed / canceled. So basically what we do is save you time. Now our average customer travels over 10 times a year and probably spends around $20,000 on business trips on a yearly basis. He costs his employer around $100 per hour in general, and double that while traveling. So – if we save our customer one hour a year – for instance by telling him he can leave for the airport an hour late cause the flight is delayed, or by giving him a map to his destination which saves him getting lost – the ROI is positive. If ever we manage to get him home a day early or enable an impromptu meeting while traveling (e.g. using our Connections social network) – that's easily a 5-x ROI.

Now one may argue that we need to look at the alternative cost – what replacement products are there. Let's assume that there are 2-3 free products or mobile websites out there that could replace WorldMate for free. If it'll take you one hour to find them, or, if these products are not as well integreated as WorldMate such that over the course of a year of usage it'll take you one more hour to get the info from them that WorldMate would have gotten for you automatically – then again, you paid your $100 to get these "Free" products – i.e. you paid more than you'd have paid for WorldMate anyway. So the bottom line is I think I can safely say:

A rational ROI analysis shows that WorldMate is worth at least $100 per year

Yet another way to examine this is how much does it actually cost us – what's our cost per user?
The platform we have cost quite a few millions of $ to develop over the last five years. The iPhone app itself cost us ~$150,000 to develop and we're still spending heavily. The content costs per user are meaningful (in the cents to dollars depending on activity). Hosting costs us six figures a year. So we certainly can't be profitable on $0.70 / user unless we serve millions.

If WorldMate is to make money on the iPhone platform – It can't do that on a few dollars per user.

Still – the iPhone customer market sees this differently. We launched a product at a $19.99 introductory price, and while we generally like the sales figures, still we see comments like "how could this be worth $20". Wait a minute - we've just shown how the product is worth 5 times this?

So what is it? Are iPhone users less rational? - not likely; Are they underpaid? Is their time not worth as much? Not really - recent surveys from Forrester and Nielsen survey show over 39% have over $100,000 HHI.

So why do iPhone users attribute a lower value or price to WorldMate – or for that matter, any app?

The answer is as simple as it is perplexing. There's a developing field in economics called Behavioral Economics. Simply put, what it studies is how people actually behave – as consumers, deal-makers etc.. You'd think that what's economics does in general – right? Well, not really… Traditional economics assumes people are rational beings. Empirical studies show they just aren't. And Behavioral Economics tries to understand this conundrum. There's a great book in the field called Predictably Irrational, written by Professor Dan Ariely of MIT, and one of the phenomena it describes is "Price Anchoring"

Price Anchoring in simple terms is the fact that the first price you see for something, is what you'll expect it's worth, regardless whether this price makes any rational sense. I especially like the story about the experiment they did where they told people to write the last two digits of their Social Security Number next to the name of a product – as a price. And then asked the same people how much they really think the product is worth. Lo and behold – people whose SSN ended in high numbers, ended up thinking the products are worth more than did the people whose SSN ends in low numbers. Incidentally, we're talking about highly rational MIT MBA students... Further studies show that it's then very hard to change that "anchor" – the initial impression of price, no matter how irrelevant, affects the long term perception of value, or "appropriate price".

How does this apply to the App Store?

When Apple gave early iPhone developers an incentive to price everything at $0.99, it actually made its customers perceive of iPhone Apps as worth $0.99, $1.99, maybe a few $ - tops. Regardless of the actual value created, the corresponding value of the content / service or any other rational aspect.

So for most iPhone users, the equation is simple:

"The adequate price for an iPhone App is $1, maybe $2…"

Oops. How do we make money in such a market? What's the long-term outlook like? Can this change over time? Does Apple care and will it attempt to change it?

Frankly, we'll see. We do have some great ideas about how to monetize, but we'll have to live and learn. I'd welcome thoughts and opinions.

Some interesting reads:

• FierceWireless: If you're trying to make money, dump your iPhone strategy
• TechCrunch: Report: iPhone Applications Are Getting Cheaper
• Silicon Alley Insider: Apple's Relationship With iPhone Developers: 'Reluctant Tolerance'
• And of course - Predictably Irrational