The "App Economy" Needs Risk Management

A blog about business and economics.
Nov. 19 2012 9:21 AM

The "App Economy" Needs Risk Management

The growth of the app economy is one of the most promising trends in American economic life. But a great David Streitfeld piece over the weekend observes that while lots of people are writing apps and lots of money is being spent on apps, relatively few people are actually making meaningul money this way. Apple has paid out in total over $6.5 billion to app developers, but it's distributed very unevenly. One survey of game developers showed that 25 percent had earned less than $200. Only a quarter made more than $30,000. But 4 percent had made over $1 million. 

The pattern here will be familiar to anyone who's worked in the book publishing or movie industry.

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These are "hits" oriented industries. The way they work is that there's a lower bound on how much a movie can fail, but practically no ceiling on how much money a hit film can earn (especially when you consider merchandise, licensing, resale to cable, sequels, etc.) so a studio can lose money on most of the films it produces and still earn a healthy profit. So if you look ex post at Hollywood over any span of time, most of the people have been working on money-losing ventures. Book publishing is the same way. Publishers don't aim to hit tons of singles where most of their books earn a modest profit. Instead they swing for the fences, hoping to score a few huge hits in any given year that compensate for a lot of modest failures.

The difference is that both of those industries are substantially organized around risk management as a consequence. If you write a book the way it works is that you are responsible for writing it, and the publisher handles the production and marketing and helps with editing and PR.

Since both you and the publisher are putting in work, the revenue that comes in from the book is split between the author and the publisher. But in addition, a book contract almost invariably gives the author an "advance" to help mitigate risk. The advance is basically a loan. When the book starts selling, the author doesn't initially get any royalties. Instead what would have been your royalties goes to the publisher to pay back your advance. But it's a non-recourse loan. If you never earn enough author-side royalties to pay back your advance, the publisher doesn't come after you to collect the debt. And since it's not technically a loan, failure to repay your advance doesn't count against your credit rating. It doesn't hurt you at all, except in the sense that if your book had done better people would be more eager to bid on your second book. What this does for you as a writer is transform book publishing from an incredibly risky business to one with a guaranteed payout—if you deliver your book on time, you get a nice check even if the book is a flop.

Film doesn't work quite the same way, but the idea of a "movie studio" operates on a similar principle. By aggregating a bunch of films together, you can ensure that the directors and actors all get paid even though each individual film is a very risky product. The app economy would benefit from its own forms of risk-management business organization so as to make it a bit more viable for people to participate over the long haul.

And of course public policy helps too. Creating a workable individual health insurance market as the Affordable Care Act aspires to do would at least lift one big chunk of idiosyncratic risk off the shoulders of lone wolf software developers. Longstanding programs like Social Security do something similar.

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