Apple (NASDAQ:AAPL) and the companies that sell software for the iPhone and iPod touch at the App Store have lost over $450 million to piracy since the store opened in July 2008 according to an analysis by 24/7 Wall St. There have been over 3 billion applications downloaded since the App program began.  Bernstein analyst, Toni Sacconaghi, estimated that between 13% and 21% of those downloads are from paid applications. According to this analysis, the average price of an application purchased at the App Store is $3.  Sacconaghi estimated that Apple’s revenue from the App Store is between $60 million and $110 million per quarter.  That amount has certainly increased since this research report was published because of the rapid growth of the number of applications. 

However, behind all this success lies an insidious force that has plagued the music, software, and movie industry for decades.  Developers of iPhone applications have reported alarming piracy rates for their software, and the ease with which users may obtain pirated versions of paid applications for free is only increasing.  The total number of applications available at the store, including those which are free and those which require payment, is in excess of 100,000.

Anyone who is familiar with the iPhone is likely to know that these phones can be “jailbroken” or, to use the more common term “unlocked”. Jailbreaking an iPhone modifies the OEM Apple iPhone OS.  This allows the user to circumvent the limitations put on the phone by Apple. Apart from the ability to modify the OS itself to allow for customizing of icons, backgrounds, functionality and processes, a jailbroken iPhone permits the installation of applications from sources other than the iTunes store.  It is even possible to use an unlocked phone for access to carrier services other than AT&T (NYSE:T) and the Apple-assigned retailers outside the US. The great majority of iPhones sold in China are unlocked and Apple partner, China Unicom (NYSE:CHU), have only begun to sell locked phones in the last three months

Most iPhone users have not jailbroken their phones. This is likely a result of the perception that this process is incredibly technical for many non-tech savvy owners.  Others may fear that Apple might retaliate.  No rabid Apple fanatic would risk being placed on a DO NOT SELL list!  However, the technical barriers to jailbreaking an iPhone or iPod touch are rapidly decreasing.  The original process required at least some programming ability.  The most recent jailbreak software makes the process accessible to even most Luddites, so the number of jailbroken iPhones will only increase.

It is difficult to get precise figures for the number of iPhones and iPod touches that have been jailbroken.  Jay Freeman, operator of Cydia, a renegade app store that can be found on almost any jailbroken iPhone or iPod touch device is probably the best source for this estimate. Freeman told Wired Magazine in August 2009  that he has received over 4 million unique visitors to his store.  This represents about 10% of iPhones and iTouches that existed at that time.  The jailbreaking process has only become easier since August, and if that figure is still about 10% of all Apple devices that can access the App Store, that would mean that the total number of jailbroken devices today is approximately 7.5 million assuming that total worldwide sales of the iPhone and iPod touch are now 75 million.  It is important to note that not all people who jailbreak their iPhones are pirates.  Pinch Media, a company that specializes in mobile software analytics, has found that only 40% of jailbroken devices use pirated software.

While it is difficult to get a firm grasp on exact piracy rates, some developers have put features in their software that prompts it to “phone home” when the phone has been cracked.  Developer testimonials put the figure much higher than many analyst would expect.  Developers Neptune Interactive Inc and Smells Like Donkey Inc have reported piracy rates has high as 90% for their game $1.99 Tap-Fu, and claim that it was available in a pirated version within 40 minutes of its release on the App Store.  Web Scout Inc. reports a 75% piracy rate for its $0.99 iCombat game.  The developer of the $4.99 art program, Layers, reports a piracy rate of 75%, and Fish Labs reports 95% for its $7 Rally Master Pro 3D. Piracy rates almost certainly increase with the cost of an application.  TomTom’s US & Canada GPS product for the iPhone, which retails for $79.99, ranks second in handheld application downloads on piratebay.com, a file-sharing torrent.  The top 100 downloads listed at piratebay.com is littered with expensive TomTom and Garmin GPS products.  A conservative estimate of the average piracy rate is that for every paid application developed and sold at the App Store 3 more are pirated.

There have been over 3 billion downloads since the inception of the App Store.  Assuming the proportion of those that are paid apps falls in the middle of the Bernstein estimate, 17% or 510 million of these were paid applications.  Based on our review of current information, paid applications have a piracy rate of around 75%.  That supports the figure that for every paid download, there have been 3 pirated downloads.  That puts the number of pirate downloads at 1.53 billion.  If the average price of a paid application is $3, that is $4.59 billion dollars in losses split between Apple and the application developers.  That is, of course, assuming that all of those pirates would have made purchases had the application not been available to them for free.  This is almost certainly not the case.  A fair estimate of the proportion of people who would have used the App Store if they did not use pirated applications is about 10%. This estimate yields about $459 million in lost revenue for Apple and application developers.

Apple, which takes 30% of  the revenue generated by downloads at the App Store has lost about $140 million from piracy. If Apple’s revenue was between $500 million and $700 million from the App Store since its launch, that is a significant loss.  Despite this fact, Apple has been mute on the subject and done nothing to prevent acts of piracy, which is not unlike the stance it has taken on illegal music downloads to iPods.  Even though piracy has caused a big financial loss for Apple, the income from the App Store is dwarfed by sales of iPhones and iPod touches.  As big a problem as $150 million is for Apple, the $310 million cost of piracy to developers really makes it their problem. Apple intends to ignore the piracy of applications and will focus on the tens of billions of dollars that it makes on its hardware.

Garrett W. McIntyre with Phil MacDonald

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