Posted on January 14, 2009 at 8:55am EST. More.

How Apple profits from “ringtone apps”

There is a lot of concern that iTunes, because of the way it is organized around popularity rankings, has been encouraging a race-to-the-bottom in App Store prices, creating an environment where only 99 cent “ringtone apps” are economically viable. Sean Devine believes that Apple is approving so many cheap apps because they want to create high switching costs for users. That’s a reasonable motive but I don’t see how the current policies are accomplishing that.

Yesterday it dawned on me that Apple has a very boring and practical incentive to prefer a store of many cheap apps over fewer higher priced ones. When a customer makes a purchase, Apple charges his credit card and holds on to the money, making payments to developers monthly. If your account balance is below $250, however, Apple will hold on to the money until it exceeds that threshold. This is a reasonable policy, as otherwise a lot of money would be wasted on transaction costs.

However, it means that for every 99 cent app that sells fewer than 357 copies per month (remember the developer share is 70%), Apple gets to earn interest on the money it is holding for the developer. That may not sound like a crazy high number, but that’s because you’ve been reading success stories about people whose sales figures were crazy high numbers. I’ll bet most of the 99 cent apps are selling fewer than the 12 copies a day needed to break $250 every month, and even though interest rates are terrible, Apple is making money on them.