One knock on the App Store for the iPhone and iPod Touch is that consumers’ price-demand elasticity has driven down prices to the point where most games and apps are $.99 or $1.99.  While volume is so high that there’s a big economic reward for a hit app, it’s a lot less than if games and apps were priced in the $10-20 range.  Some large gaming companies have said they won’t conduct large scale game development projects for the iPhone/iPod Touch as long as the pricing is so low.  This must be bothering Apple, which has to realize that attracting more development resources to its platform is the key to winning the smartphone platform land grab.

It’s not surprising that there have been rumors that Apple might release a Premium App Store with $19.99 games.  This would be a huge boon for the entire ecosystem–developers could make more money so would put more resources into the platform, consumers would have access to better quality games and apps, and Apple would sell more devices.

If Apple can create status around premium apps–in the same way the Mac, iPod, and, now, the iPhone, have high status brands–and get people to want the world to see how many premium apps they have, the App Store market could explode.

It’s early days for the App Store on the iPhone and iPod Touch.  The one man fart machine (literally) behind the iPhone Fart App has been making 10k/day.

It’s similar to the early days of search, when gaming search engines to artificially create SEO (search engine optimization) was common.  Just as Yahoo, an early search leader, had a largely human-driven selection process, Apple has a largely human-driven process to give placement to new apps.  Is it possible to ‘game’ the Apple placement process?  Given the huge economic rewards, I’m sure many are trying to figure that out.   I’ve heard from multiple sources that the reviews on apps are often bogus.  Worse, the default setting for a review is one star (out of five), so that if someone writes a review but doesn’t explicitly assign a star rating, the review will be for one star–regardless of the review’s true sentiment.

One thing is clear–making the list of most popular apps is a huge boon to sales.  Success is self-reinforcing.  On the other hand, if you can’t crack the most popular list, it’s difficult to get signficant volume.

Another thing that’s clear is that Apple could make a lot more money for itself and everyone else if it would take a Google mindset to optimizing its most popular list in the App Store.  If the rankings were based on revenue generated (volume * price) instead of just volume, it would move more higher-priced games to the top of the list and drive their sales accordingly.

Interesting article on paidContent discussing the huge upfront payouts and aggressive revenue shares demanded by major music labels of digital media companies.  These economic arrangements obviously have stifled the growth of digital music.  Apparently the major labels feel like they gave away the house to Apple–they only get a paltry 70% revenue share–and don’t want to repeat this mistake.

Many before me have made the relevant comparison between the music industry braintrust and the flat-earth society, so I won’t belabor it here.  It’s amazing how an industry can repeatedly make such obvious strategic blunders.

There are lots of good theories of general group irrationality as well as irrationality in business.  I have my own pet theory that I’d like to share.

I think the more random is the success of an actor (a person or a group), the more unpredictable they will behave once they have achieved success.  By ‘random,’ I mean that if that situation happened 100 times, the actor would not predictably achieve that level of success.   They succeeded in a randomocracy.

The corrollary is that the more an actor’s success is predictable based on objective conditions, the more predictable they will behave.  Their behiavior will stem from a continued reliance on the conditions that led to success.  If success is achieved in a meritocracy, where rational decision-making rules, expect the actor to be extremely rational.  On the other hand, when the conditions surrounding an actor’s success are random, the person or group will have nothing predictable to fall back on.  So, their behavior will degenerate into unpredictability–which is by definition irrational.

The logic doesn’t work both ways, but it does correlate.  That is, just because someone successful is irrational does not  mean that their success was random.  Though it makes it more likely.  Just because someone successful is rational doesn’t mean that their success was predictable.

But if there is a person or group whose success has been a fluke–that is, you would not expect the same outcome in an alternate history–it’s safe to expect them to be unpredictable and irrational.

In the case of the music industry, success of an artist or a band is extremely unpredictable.  There is a well-documented body of psychological research on the randomness of popularity for music.  If there is anything that predictably leads to success in popular music–and I think it makes a relatively small contribution at that–it’s acting unpredictably.  Hence the typical behavior of pop music artists.

Music executives, held accountable for the unpredictable outcomes of their musicians, enjoy success from similarly random factors.  Why should they be expected to act rationally?

Applying this theory becomes most useful when industries and social constellations that masquearade as meritocracies are revealed to be randomocracies.  I’m sure you can think of many of those.

TradeComet.com, which runs a tiny B2B search engine, SourceTool.com, is suing Google for “starving” them of traffic by raising their AdWords CPC prices from $.05-.10 to $5-10.  The Bloomberg article says that the price increase was to “protect Google’s monopoly and prop up a partner Web site for business searches.”  It’s laughable to think that Google actually targeted a site of SourceTool.com’s size.  100b market cap companies have bigger fish to fry.

But it’s indicative of what I think will be an important trend–Google’s near-monopolistic power over a huge market will attract growing legal scrutiny, and eventually the DOJ will break it up.

On that note, I wonder if the recession will catalyze civil litigation, particularly troubled businesses suing healthy ones.  I have no data on the topic, but it seems intuitive in the same way that global economic downturns historically lead to trade wars.

Great post on Zero Hedge regarding momentum:

Since the start of ‘08, the S&P has declined by 43%. Yet, if you only held the market on days following a down day, you would have earned a cumulative return of 36%. In contrast, if you only held the market on days following an up day, the cumulative return would have been -58%. In terms of daily (close-to-close) returns, the average return since the start of ‘08 following down days has been 0.28% while the average return following up days has been -0.62%.

I would guess that a few periods last fall when it seemed like the market see-sawed up and down over 5% a day account for a big piece of the described trend, but it’s staggering nonetheless.

While I continue to be bearish in the medium-term, it’s hard to not expect a bounce tomorrow.

Today I spoke with a company doing CPA marketing in the credit space.  Apparently Capital One has shut down all online applications.  Every other major card issuer has dramatically tightened their acceptance criteria.  That has brutally shrunk the credit card marketing space.  Everyone in the space is hurting–from the issuers on down the value chain.  Amazing, since it wasn’t too long ago that CreditCards.com was filing an S-1 that showed great growth and near 50% EBITDA margins.  No more.

This has one obvious parallel–mortgage, which in ‘07 also went through a brutal contraction.   It’s not cyclical, either, since neither mortgage nor credit cards will return to the frothiness of the recent past in the next few decades, if ever.

Very few in the mortgage space saw it coming, and I don’t think many in the credit card space did, either.

What vertical could be next?

The other major financial vertical is insurance.  I don’t see auto as vulnerable unless the government decides to make it voluntary, but that seems improbable.  Health?  Given the regulatory changes on the horizon, there could be risk.  But I actually think health stands to benefit as Obama will likely create some sort of national program that will mandate a competitive market.

Education?  It’s probably the sexiest vertical now, but the for-profit players are heavily regulated and therefore face regulatory risk.  That said, it’s hard to imagine that any political official would lay a hand on the industry in today’s economy.

Then again, it was hard to imagine a few years ago that the mortgage and credit card verticals were about to get mauled.

The S&P was up 2.69% today despite worse-than-expected data on job losses.  The logic is that bad economic news is good because it will force a government stimulus package.  Except nothing the government has done yet has kept unemployment from skyrocketing and the financial system from remaining fundamentally insolvent.  Maybe logic isn’t the right word.

Recently I’ve explained how lead gen businesses gain competitive advantages through a positive feedback loop driven by scale and technology, through efficient traffic buying, and through conversion and optimization.  In this post, I’m going to cover the final piece of the puzzle, the competitive advantages that can be achieved through customer relationships, or distribution (confusingly, many in the industry also use ‘distribution’ to refer to their consumer audience.)

These advantages take different forms across verticals.  It’s most pronounced in verticals such as home improvement/home services and insurance, where geo-targeted leads can be sold multiple times.  This creates huge variance in lead monetization between stronger and weaker players.

In these verticals, lead generators face a chicken-and-egg problem as they scale.  If they want to generate leads in a new location, they want to first have agents (insurance) or contractors (home improvement) to which they can sell.  But in order to get those agents/contractors to sign on as customers, they need to have leads to sell them.

In most cases, a lead generator attempting to scale into new locales will generate leads before building up a big customer base.  They will be forced to sell most of the leads they generate to lead aggregators (I define a lead aggregator as a lead gen company that generates less than 50% of its leads from internal traffic sources) that have strong disribution.   This can be more profitable for the lead generator than the alternative–not selling a lead–but it can hurt.  Lead aggregators will typically offer  30-40%  payouts, meaning the lead generator is giving up a lot of upside.  This is testament to the value of having a strong lead distribution network, which is huge when you think about the value of a lead sold once vs. 3, 4, or 5 times.  Companies such as ServiceMagic, ReliableRemodeler.com, Netquote, and Insureme all have large distribution networks that represent significant competitive advantages.

Lead gen companies can also differentiate themselves by building trust with their customers.  This might not seem like a big deal, except it is when you’re dealing in the murky world of online marketing.  Countless lead gen companies have shot themselves in the foot by letting their lead quality suffer as they try to generate more volume.  One of the wonderful ironies of the space is that every lead gen company claims to have great lead quality, yet most complain about the quality of their competitors.

In this context, a lead gen company that can rigorously control quality over the long-term can built up extremely valuable relationship capital with their customers.  These customers will be the first to benefit from a customer’s increased lead spend and the last to get cut back.

In addition, customer goodwill also enables lead gen companies with scale to exercise pricing power.  Like oil and unlike a giant box of cereal from Costco, lead pricing increases with more demand.  A lead gen company with scale and deep customer relationships can push price increases on to their customers by explaining that the price increases are necessary to increase volume while maintaining quality.  This is true on one level, but it’s also true that this is how a lead gen company at scale can enhance its margins.  That can only happen, of course, because of the powerful competitive advantages it enjoys.

IACI just announced less-than-stellar Q4 results.  The stock continues to languish near 52 week lows.

On a brighter note, ServiceMagic posted heroic numbers given the brutal consumer slowdown.  Revenue was $25.3m, up 15% y-o-y, while EBITDA was $2m, flat  y-o-y.  They are in a highly seasonal business–in Q3 they were at 34m/8m.

ServiceMagic dominates its vertical (home improvement/home services) more than any other lead gen company.   Given the significant economies of scale in a vertically-oriented lead gen business, they have a dominant strategic position.

Yet they are buried in IACI, where ASK.com, Match.com, and others get far more attention, and happen to be dramatically inferior businesses.

Comscore has a press release out on a recent study with the headline, “Smartphones Provide Extra Mana for Mobile Games Industry as Audience for Downloaded Games Grows 17 Percent.”

In an article covering the study, Ars Technica headlines, “Study: iPhone leading the pack in mobile phone gaming.  A new study has revealed that smartphone gaming is exploding, and the iPhone is at ground zero.”

Neither the study nor Ars’ article mentions the iPod Touch. Yet the iPod Touch is selling at 5x the rate of the iPhone, so obviously it is driving this trend.  It’s the reason why competing platforms like the Blackberry have no chance to keep up with the quality of games and other apps available on the iPhone.

As I’ve noted before, the killer edge Apple has with the iPhone and iPod Touch is that they are economic complements, like peanut butter and jelly.  More sales of each attract more developer resources to the platform.   This means better apps will be available for each device, driving more sales, attracting development, and so forth.

The study found that iPhone users are 9x as likely to download games to their phones as users of other smartphones. I would bet that they are also downloading many more games on average than non iPhone users, meaning the volume of games downloaded by iPhone users dwarfs that of non-users.   That doesn’t even include downloads on the iPod Touch, and it also doesn’t include downloads of non-gaming apps–another area where Apple is blowing the competition away.