Freemium and the iPhone App Store: The in-app purchasing model really works

One of the best decisions Apple made for the iOS App Store was to open up in-app purchasing to free apps. (It was initially for paid apps only.) This has allowed app developers — especially game developers — to really take advantage of the “freemium” model.

The best evidence: Today, 14 of the top 25 highest-grossing iPhone apps are totally free to download, generating revenue from in-app purchases. (I don’t know if Apple includes iAd revenue in those tallies, but it can’t include ad revenue from other ad networks. And it doesn’t take revenue into account from other marketplaces, such as Amazon’s Kindle store.)

Why does this work? Because free apps are downloaded many times more than paid apps — perhaps 5X to 10X more. That can dramatically boost any other natural network effects an app has, which is especially relevant for social games. And all of this means a much larger user base to eventually do in-app purchases, which, in turn, could generate more revenue than if the app costs money in the first place.

(Importantly, this also increases costs, including server, bandwidth, and support. So make sure you have a revenue or funding model to cover the expenses.)

Will this work for your app? It depends how mainstream it is, how addictive it is, what sort of network effects it generates, your ability to generate a profit after paying for expenses, and how well you can convert users into revenue generators, by convincing them to add-on features or credits via in-app purchasing.

But given the high ratio of “free” apps on Apple’s highest-grossing list, it seems to be doing well, particularly for games. (And especially for well-funded companies with established virtual-goods business models, like Zynga.) There’s no way from the outside to tell if these apps are as profitable as they would be as paid apps with smaller user bases. But at least the gross revenue appears to be there.

If you’re designing an App Store today, it seems foolish to do so without some sort of simple in-app purchasing mechanics. I expect Apple to eventually add this feature to its Mac App Store, for example.

Also: Foursquare Radar and the art of creating a coincidence