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Application Marketplaces and the Money Trail

Frederick Chong
Microsoft Corporation

March 2008

Summary: The author of this article suggests that the forces of democratizing the tools of production, democratizing distribution, and connecting consumers and producers—as well as democratizing monetization—are essential for stimulating the long-tail software economy. (12 printed pages)

Contents

Introduction: The Long-Tail Market Opportunity
Applying Long-Tail Forces to the Software Industry
Application-Marketplace Architecture
Value Propositions
Conclusion
Acknowledgements

Introduction: The Long-Tail Market Opportunity

The software industry is currently at an inflexion point, where the reward of "long-tail economics" is garnering significant attention from technology entrepreneurs and innovators alike. Many are wondering if the same business model that Amazon.com, Netflix, and iTunes used to build their success can be applied similarly to make money in the markets of long-tail software consumers and niche applications.

Although it has always been common knowledge that there is significant untapped software revenue in the small-medium businesses (SMB) market, this long-tail market has been largely ignored by major software players up till the recent advent of the software-as-a-service (SaaS) computing model.

However, reaching and selling to SMBs poses unique technical and business challenges. In our first article, "Architecture Strategies for Catching the Long Tail," we outlined key multi-tenancy and application delivery hurdles that needed to be addressed by SaaS independent software vendors (ISVs). From a business perspective, software vendors must balance the cost of customer acquisition with the humble margins that they gain from acquiring each additional SMB. Therefore, the ISV's ability to leverage highly effective market channels can make or break their quests to monetize in the long-tail market.

Cc325712.App_Marketplaces_Fig01(en-us,MSDN.10).gif

Figure 1. Long-tail business software-buyer market

Aside from SMBs, there are also increasing opportunities for software developers to make money through niche applications. At the moment, Facebook is perhaps the best evidence of a successful long-tail application marketplace. Facebook applications not only help drive massive Internet traffic to third-party Web sites, but also help generate ad revenues that are paid out to the developers of the long-tail applications.

However, social-network applications are just one type of a monetizable long-tail application. Thousands of other custom applications have been created for specific user and business scenarios. More frequently than not, these applications are developed by using simple development tools such as Microsoft Office Access. Some of these are homegrown line-of-business (LOB) applications that serve the needs of individual departments within business organizations; others might be tracking or productivity tools that are developed by hobbyists for private uses.

Many of these applications are not available or reused publicly, never mind reselling to third parties. With an appropriate online market channel in place, these niche applications could become the merchandise of a profitable long-tail application market.

Cc325712.App_Marketplaces_Fig02(en-us,MSDN.10).gif

Figure 2. Long-tail software-applications market

Applying Long-Tail Forces to the Software Industry

In Chris Anderson's landmark book "The Long Tail," Anderson noted that the three forces that drive the long-tail business models of Amazon.com, Netflix, and iTunes are:

· Democratizing the tools of production.

· Democratizing distribution.

· Connecting consumers and producers.

In this article, we suggest that these three forces—and an additional one for democratizing monetization—are just as essential for stimulating the long-tail software economy. Let's examine each of these forces in more detail.

Cc325712.App_Marketplaces_Fig03(en-us,MSDN.10).gif

Figure 3. Forces of long-tail software economy

Force #1: Democratizing the Tools of Production

Whether it's building a business, consumer, or social application, the tools for developing software applications have come a long way since the days of assembly languages. RAD tools such as Ruby on Rails and Office Access 2007 enable data-driven applications to be created without having to write a lot of code.

Furthermore, hosted-application builders from startups such as Coghead and Longjump provide hosted tooling and application runtime environments, so that application developers can be productive immediately and without having to worry about deploying their finished applications.

Using mashup platform such as Microsoft Popfly, Web enthusiasts easily can create Web applications that overlay data and services from multiple sources across the Internet.

The current version of Microsoft Office SharePoint Designer simplifies the tasks of building composite applications by producing application templates and Web part components that can be composed with other software modules to create custom business applications. In addition, through Office SharePoint Designer's integration with Office Live, custom business applications for SMBs can be designed, built, and deployed quickly—saving the developer from having to deal with the complexity of coding and deploying three-tier Web applications.

This point should need no further elaboration; the improvement in application-development tools is essential to growing the wide selection of software choices that we have today, and the tools are getting even better as we speak.

Force #2: Democratizing Distribution

Compared to physical goods, software has some advantages when it comes to storage and distribution—thanks to its digital form. In many ways, software has as "birthright" the capability to be distributed via the Internet. However, this ease of duplication is a double-edged sword—allowing easy software piracy, too. So, for software, force #2 really should be called "Democratizing legal distribution."

On the other hand, distributing niche software and physical commodities are similar in the sense that they can both use aggregators to lower the cost of selling. For software, the cost of selling is much more than transporting the bits from one computer to another; there are also the issues of consumer trust, brand and quality association, and effective marketing to potential users.

In the digital world of computer viruses, phishing attacks, and malware and spyware, a lesser known micro-ISV has much to gain by selling its long-tail applications through well-established aggregators. A small-business owner is much more likely to buy a project-management application that is listed on the Microsoft Windows marketplace than to buy directly from the Web site of an unknown micro-ISV.

Although distributing software online does not always require the trucking of physical goods from stores to buyers (except when selling shrink-wrapped software, which is still a common kind of commerce transaction), the delivery of hosted software services does require server infrastructure and data-center operation support to host and run the application services.

In many situations, it is not cost-effective for an ISV to build and run its own operational infrastructure. Instead, it is frequently beneficial for SaaS ISVs to have their applications hosted by professional SaaS-hosting companies. Software-service delivery is the subject of our recent article, "ISVs Are from Mars, and Hosters Are from Venus." Look around at the companies that provide application-hosting services, and you will notice that many hosters are also aggregators of software services who provide the market channels for the ISVs that they host.

However, the task of coordinating service delivery with the SaaS hoster still might be too tedious for ISVs who produce long-tail applications. This is why we are seeing new breeds of startups that provide one-stop shops for ISVs to develop, host, market, and deliver long-tail applications.

Force #3: Connecting Supply and Demand

Technologies that connect consumers of long-tail applications are what help to drive increasing demand for niche software. Anderson calls these types of technologies "filters." Search-engine results, reviews, user recommendations, blog opinions, and application-usage data: All of this information influences user perceptions, behaviors, and habits, and eventually determines whether an application is going to be widely adopted by its target users.

Take social applications on Facebook, for instance. Various filters at the site not only reduce the cost of searches; ultimately, they also influence the success and adoption of these applications. (See the filters in Figure 4.)

Cc325712.App_Marketplaces_Fig04(en-us,MSDN.10).gif

Figure 4. Filters at the Facebook Web Site

As you might have guessed, a one-size-fits-all filter will not do the best job of connecting users with the applications that they want to find. We see from the preceding Facebook example that, depending on the user's goal, the user can choose among the multiple filters to find applications that are categorized according to popularity, activities, active users, or published date.

Not to be neglected is the observation that the purpose of a Web site acts also as a filter: Facebook is the filter for social-network applications, Office Live is the filter for LOB applications that are built for SMBs, and so on.

Force #4: Democratizing Monetization

In addition to the three "classic" long-tail forces that were mentioned earlier, we think that new business models and mechanisms that lower the bar to make money online also can stimulate the supply side in the long-tail software economy.

The recent proliferation of Facebook applications illustrates this point very well; developers of Facebook applications not only drive traffic to their own sites through Facebook's social-network platform, but also they get to keep 100 percent of the ad revenue that is attributed to their applications.

Fundamentally, the ad-funded model changes the vectors of why, when, and how software is paid for. As a result, the ad-funded model not only provides opportunities for micro-ISVs to get paid, but also reduces the up-front cost of trying out and using software—thus, removing some barriers to drive demand further and encourage software adoption.

Ad-funding is not the only model to monetize long-tail applications. Traditional licensing, subscription, and transaction models all are still valid means for the ISV to get paid. The key point here is that the supply curve of long-tail software is likely to grow when there are effective mechanisms for the developers to be compensated for their work.

Most long-tail applications will never command the kind of price tags that are displayed on top-selling software. However, with production tools and distribution democratized, it might take only a very short time and almost no capital investment to build long-tail software. In fact, when the long-tail software economy takes off, we likely will see many more micro-ISVs creating applications as fast as they can (in a matter of days or weeks) and living off the aggregate income from multiple long-tail applications.

Application-Marketplace Architecture

The long-tail software economy is not a prediction about the future. The presence and works of the four forces are already evident in current technology business trends and most recently, in the increasing attentions that are placed on application-marketplace development.

In this section, we examine the architecture of the application marketplace to better understand how an application marketplace can act as the unification medium for manipulating the four forces, to unleash the economic potentials of the long-tail software market.

Cc325712.App_Marketplaces_Fig05(en-us,MSDN.10).gif

Figure 5. Architecture components of application marketplaces

The application-marketplace architecture consists of four loosely coupled modules: marketplace services, application designer and workspace, business operation services, and social networks. These four modules work together to provide an end-to-end solution implementation that would put into play the long-tail forces.

Marketplace Services

Marketplace services are offered through a public-facing Web site. As in any other commercial Web site, the user interface of the marketplace Web site influences and helps mold the first impressions of the marketplace customers.

The business model affects the types of marketplace services that are being offered to one or more groups of partners and customers: the ISV who sells applications (and optionally creates or hosts applications at the marketplace), end users who buy applications, and partners and value-added resellers who repackage and resell applications with their own set of value-added services. If the marketplace also provides application-hosting services to its ISV partners, it might choose not to have any hosting partners and, therefore, does not offer its marketplace services to other hosters (potential competitors).

The application catalog functions as a directory that customers can use for discovering, viewing, and buying published applications. In order to provide a better search and an improved buying experience, the application catalog might implement various types of filters that use additional criteria—such as application category and popularity—to help the users narrow down their choice of candidate applications.

In addition to the application catalog, the marketplace also exposes a set of administration applications that customers can use to edit their account profiles and manage business transactions at the marketplace. For example, an ISV can use the administration application to edit and post the company description, revise the pricing of their published applications, and view revenue reports of applications that are sold through the marketplace. Similarly, a small business can use the administration application to subscribe or unsubscribe to applications and check the outstanding payments for its marketplace account.

Business Operation Services

While the marketplace services provide the public interfaces for the marketplace customers to publish applications and perform commercial transactions, the business operation services are a collection of infrastructure and management services that operate behind the scenes to support the marketplace services.

The identity-management module provides a core set of authentication, access-control, and entitlement services that other business operation services use to secure business data and marketplace transactions.

The monetization module makes it possible for application providers to sell applications by using various pricing models, such as charging for user-license subscription, application transactions, or revenue from online ad displays. To support a monetization scheme effectively, the marketplace should offer solutions to help an ISV define and enforce its application pricing policy (for example, $20 per user license per month), as well as implement revenue-reporting engines that will provide visibility into the income stream for published applications.

The metering and billing module uses the defined policy and usage data that is logged through the monetization module to generate invoices and bill the customers. The billing engine can offer billing-on-behalf services to the ISV by collecting fees from the business users and crediting the revenue-split payment into the ISV bank accounts.

Application marketplaces frequently provide self-service registration to ISVs or business users for signing up as a new tenant. When the tenant-management and subscription module receives a new registration request, a tenant-provisioning workflow is started and interacts with the identity-management module to create a new organization and administrator user for the new tenant account. The provisioning workflow also creates new entitlement records for the new organization, so that subsequent application subscriptions can be tracked and metered properly. Finally, the workflow triggers a sub-workflow within the hosted-application runtime infrastructure to provision a new set of metadata that is used to configure and instantiate the application environment for the new tenant.

Social Networks

A social network at the marketplace not only enables the applications users and providers to interact with each other, but it also relies heavily on user-generated content to help users find quality applications and to provide ISVs with market intelligence.

Through a ranking and reputation system, users can get a sense of what other users think about the usability and quality of the applications. These opinions also serve as information that the application providers can use to improve on future versions of the applications.

Many business professionals now are connected with their ex-classmates, colleagues, and business partners through social networks. In this world in which business success hinges on "whom you know," social-network connections can be leveraged to mine valuable information that is stored in the subscribed applications. For example, a business partner from an external social network might recommend potential sales leads to a business tenant at the marketplace. The recommendation becomes customer data that is stored in a CRM application that is purchased through the marketplace.

Application Designer and Workspace

The application workspace is the container that hosts the user interface for business users to interact with the applications. Besides providing the dashboard for using the subscribed applications, the workspace also can include features that enable the users to interact more directly with marketplace services—for instance, including links to purchase additional applications at the marketplace.

The kind of user experience that a marketplace can build into the workspace is virtually limitless. However, simplicity, ease of collaboration, and the ability for third parties to monetize should be the key tenets for creating the application-workspace fabric.

To mitigate performance and security concerns, there usually are constraints on the types of computations that the third-party applications can execute in a hosted runtime environment. As such, the developer should be allowed to create only application features that are contained within the defined computation boundaries of the hosted runtime environment.

For example, the development environment could impose constraints over custom business-workflow loops and implement branching logic to ensure that workflows will always terminate. In addition, the development tool also can set customization boundaries on application object models—optimizing system performance by ensuring that database schemas are not overly complex.

It is important to note that the hosted version of the application designer and workspace module is just one mode of user experience. This experience is most beneficial when the target user base has heterogeneous operating-system platforms and the browser is the lowest common denominator that can be relied upon to interact with the applications.

There are other hybrid modes of design and runtime experiences in which these workspace modules are not hosted by the marketplace. For example, the application might be designed with Office Access running on the application developer's computer. When the application is completed, its metadata is published to the marketplace. Subsequently, business users who have purchased the application have the option of running the application on their own desktop or within an application runtime environment that is hosted by the marketplace.

Creating a brand-new application platform can be a huge undertaking. Instead of building one from scratch, third parties can create and customize their own application designer and workspace sandboxes by using existing products such as the Microsoft Windows SharePoint Services and Microsoft CRM 4.0. These platforms already offer tools for creating applications that can be imported and exported out of the runtime environment as metadata, which can facilitate the process of publishing and subscription applications to and from marketplaces.

Value Propositions

By acting as an aggregator and putting the four forces into orchestrated play, application marketplaces can benefit and enable new business models for the ISV, hosters, and enterprises.

ISV Value Propositions

For the ISV, the application marketplace is a market channel into which it can tap to broaden its customer reach. The Facebook application marketplace offers third-party Web sites the chance to market and grow application adoption through the viral effects that take place among registered Facebook users.

Contrasted with traditional market channels in the brick-and-mortar economy, online application marketplaces not only reduce the cost and latency of shipping bits to software outlets, but they also tame the tyranny of time and space by connecting ISVs with the wide Internet user population.

Hoster Value Propositions

Application marketplaces enable hosters to differentiate themselves from their competitors by becoming the market channel and filter for their ISVs and business users, respectively. To become a market channel for ISVs, a hoster should look beyond the classic hosting services that it currently offers to focus on establishing aggregator-related business services and branding.

The differences in the two service models can be seen through a parallel example of consumer goods that are sold at a large no-name warehouse that provides storage services versus the same consumer goods that are sold at Costco. Although in each case the physical marketplace is a large warehouse, Costco is a more attractive venue for sellers and buyers because of the wholesale aggregator branding and additional commercial services (such as warranty, return policy, checkout, payment, and inventory control) that Costco offers to its suppliers and customers.

Enterprise Value Propositions

For enterprises, application marketplaces can be the mechanism for unlocking and monetizing intellectual property assets, broadening the partner ecosystem, driving new innovation, and creating additional revenue streams.

For example, a car manufacturer can create for its partners and customers a domain-specific application marketplace that features industrial-design and supply-chain applications for the automotive industry. Applications that are purchased from the marketplace are provisioned to an industry-specific application workspace in which the car manufacturer's suppliers, car dealers, and design shops transact, interact, and collaborate with one another.

Not all of the applications that are used in the workspace have to be created by the car manufacturer. Third-party software vendors will be attracted to develop software for the domain-specific marketplace if there are profits to be made (4th force). With revenue-sharing opportunities through licensing, paid transactions, and higher-margin (higher than B2C) B2B online-advertising monetization models, enterprises can harness third-party–generated content and creativity to drive innovation at its application marketplace.

Social networks can also play a crucial part in enhancing the liveliness of the marketplace when businesses have a common forum to discuss and discover economic, regulatory, consumer, and technology trends that are influencing the direction of the industry. It is not difficult to envision such domain-specific application marketplaces being replicated in other industries that provide financial, transportation, communications, and travel and hospitality services.

In addition to being a revenue channel, the application marketplace is also a practical manifestation of Web 2.0 within the enterprise corporate firewall. In a typical enterprise in which there is a mandate to balance empowerment and governance, an internal application marketplace can be an effective mechanism to help achieve the two (often) conflicting goals.

Currently, business units in many enterprises rely on their corporate IT departments to provide custom application solutions that are tailored to their specific organizational needs. Often, these are small and specific applications that are used for tracking projects, collaborating with fellow employees, reporting on results, or procuring assets and resources.

An enterprise can encourage self-service innovation by creating an internal application marketplace and enabling individual employees to create IT solutions by using a hosted-application development and workspace sandbox. When such an application infrastructure is available, the tasks of creating department-specific application solutions then can be delegated to individuals who are most knowledgeable about the business problems. Creative employees can help themselves to develop the business solutions that they need, but they must do so within the bounds of corporate policies that are enforced through the application sandbox.

Such an arrangement benefits the corporate IT departments, too, as the departments now can focus on the infrastructure tasks that they solve best—for example, integrating application sandboxes with Active Directory to provide single sign-on, and securing and backing up databases that are used for storing application data.

When custom applications are integrated with internal social networks, users can leverage the connections and information that is exchanged through these networks to improve the quality of their output.

In addition to the application sandboxes, completed applications can be published to a corporate-wide application catalog, so that other business divisions can discover, subscribe to, and customize solutions to match their specific needs.

In a nutshell, an application marketplace empowers employees to innovate solutions for their business accountabilities within an agile, reusable, and enforceable corporate policy-governed framework.

Conclusion

The application marketplace need not—and, indeed, should not—be a single-player game. The architecture components that we have defined for an application marketplace can be mapped to corresponding business strategies for playing in the long-tail software market. The architecture consists of four loosely coupled modules:

· Public-facing marketplace services—Facilitate the commercial transactions of publishing, selling, and buying applications

· Behind-the-scenes operational and business services—Manage tenants and support commercial activities at the application marketplace

· Application runtime platform and hosting infrastructure—Enables software applications to operate securely and reliably 24 hours a day, 7 days a week

· Social network—Acts as the fabric for searching, connecting, and interacting with buyers, sellers, and users with common interests

To partake in the application-marketplace actions, some businesses might immediately identify existing business functions that can be enhanced by adding the architecture components that were previously mentioned.

· A hoster can focus on creating specific hosting environments for applications that are sold at their affiliated marketplaces—for example, creating and offering Office SharePoint or Dynamic hosting solutions to ISVs who sell Office SharePoint and CRM applications at the marketplaces.

· A well-established value-added reseller who has existing business relationships with SMBs in its specific geographies could expand its reach and services by creating and offering application-marketplace services to attract additional ISVs, hosters, and SMBs.

· An enterprise might want to transform itself to become the (social-network) "hub" of business interactions for its existing suppliers, customers, and channel partners. By leveraging network effects, this hub could garner a significant user base that, in turn, becomes a magnet for attracting third parties to create and sell business applications.

Software and services (S+S) accurately represents the information world in which we live today. Consumers in the S+S world benefit from a growing catalog of technology and spending choices, in both mainstream and niche long-tail computing solutions. These consumer choices are mirrored by the myriad economic opportunities that are presented to technology providers—the opportunities to create wealth in the traditional way, and the added options to blaze new money trails as guided by the long-tail forces.

Acknowledgements

Thanks to members of the S+S Amigos—Gianpaolo Carraro, Eugenio Pace, and Masashi Narumoto—for their valuable insights and feedback.

 

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