Apple's App Store already nearing pace of $1 billion business?

As Apple's 9-month young App Store redefines the smartphone industry and spawns copycats, actual app sales are approaching a frequency that could see the digital shop become a billion-dollar business before year's end.

In a report on quarterly smartphone market trends released Tuesday, Needham & Co. analyst Charlie Wolf noted that the number of applications on the App Store recently surpassed 25,000, with actual downloads exceeding 500 million.

"[T]he iPhone App Store has redefined the smartphone industry," he said. "In a game of 'follow the leader,' most operating system platforms, including Android, Windows Mobile, Palm and Symbian, announced they were opening similar online stores."

Attempting to quantify actual dollars generated from app sales (which Apple doesn't report specifically), the analyst backed his way out of a reported $303 million increase in the company's 'music-related sales' for December quarter, which includes sales from the App Store/iTunes Store. Assuming iTunes sales were flat year-over-year but iPod accessory sales grew in line with the players themselves, he subtracted $100 million to arrive at an App Store sales estimate of $203 million for the three-month period ending December.

If accurate, the assessment would have the App Store generating approximately $800 million on a yearly basis, already surpassing a "neutral" case scenario for the 2009 calendar year outlined by fellow analyst Gene Munster of Piper Jaffray last June. With the number of applications downloaded each quarter only increasing, it's conceivable the store could reach the $1 billion milestone and possibly Munster's $1.2 billion "Aggressive" case scenario by year's end.

Meanwhile, Wolf doesn't believe Apple is concerned with rising third-party app stores like Cydia and others, as described in detail yesterday, because the goal of the App Store is to lock subscribers into the platform. Apple runs it as a breakeven operation.

In his view, the smartphone market had been a "major bust" until the App Store came along and software started selling hardware again, as was the case with personal computers.

"In our opinion, the iTunes App Store has achieved such a compelling first-mover advantage that it's effectively consigned its would-be competitors to a second-class citizenship," he wrote.

iPhone Sales Steady

Looking at iPhone sales, the Street veteran also used his report Tuesday to soften the negativity of IDC figures showing a 37% decline in iPhone shipments from September to December.

"The decline chiefly reflected IDC's practice of measuring shipments into the carrier channel rather than sales out of the channel," he wrote (emphasis added). In contrast, the analyst estimated sales out of the channel actually remained flat at 4.7 million units in both the September and December quarters.

Wolf recommends looking at the number of new subscribers, not sales into the channel, as a much more reliable metric of how the iPhone is faring.  In the fourth quarter, the iPhone added 4.4 million new subscribers globally to outperform the BlackBerry's 3.5 million.



However, his findings do not include the current quarter's results, which may reflect the economy's continued woes.

Trends and Issues in Apps

Returning to the App Store, Wolf also outlined three emerging trends and issues in the market for mobile applications. First is what he referred to as "garage" developers, who write apps for the iPhone on nights or weekends in very small, one- to three-person shops. Second was the discovery challenge, which is summarized as the difficulty for a given application to get noticed. While Wolf takes note of the third-party web sites reviewing new applications, such as our Backpage Blogs, he is concerned that enough developers won't find a financially rewarding experience to keep the store robust with fresh content.

The discovery challenge leads to Wolf's third point, a "rush to the bottom." If there are too many low-priced apps, leading more developers to abandon their efforts for a lack of revenue, the creation of more "serious" applications could be hampered. In the analyst's opinion, Apple must solve these problems in order to maintain its competitive advantage in locking subscribers to the iPhone platform.

This comes after other recent challenges (1, 2) for the iPhone developer community.