Tomi Ahonen has collected a lot of good data about the iPhone app ecosystem and applies solid analysis to reach the conclusion that, from an economic standpoint, on average, it is a waste of developers’ time to build iPhone apps. The data is good but the conclusion is dubious.
This is a case study for the classic “How to Lie with Statistics,” in this case by accident. It’s like asserting that because, from an economic standpoint, on average, startups can’t raise money and startups fail it follows that entrepreneurs should pack up their bags and stop starting new companies and stop trying to raise money. Or that, because so few make it to pro sports and even there the injury rate is so high, high school and college students should stop trying to go pro. Or, as Freakonomics told it, drug dealers should quit the biz.
Well, there are many who feel this way but the ranks of founders, pro sports wannabes and corner dealers are growing. There are several things going on here…
Almost everyone learns about basic stats metrics such as averages and medians in the context of commonly-observed and often symmetric distributions such as the normal distribution. They make a lot of sense there. Applying them to a highly asymmetric distribution, such as iPhone app revenues or startup founder returns, without even knowing the shape of the distribution because granular data is not available, is likely to mislead the common reader. I know this because I’ve spent a couple of months studying angel returns and trying to separate reality from urban legend. More on this later.
From startups to pro sports to gambling, it is very human to pursue large statistically unlikely returns. Differently from gambling, as one invests more time in startups and sports, one hopefully gets better. And differently from sports where one gets only a couple of chances to go pro, startups don’t have this restriction. A serial entrepreneur can do many startups. In the process the entrepreneur hopefully becomes smarter, learns from past successes and mistakes and developers a bigger & better network, thereby improving the odds of success next time.
Repeat play is particularly important in games where the chances of success in any given game are very small. This includes both starting companies and joining companies as employees. If you are hot stuff, you are move likely to land a job at a hot startup.
Here is an example from angel investing based on data I’ve been looking at data recently: 68% of all angel investors lose all their money, primarily because they do too few investments. A change in portfolio size from 5 to 10 investments and 5 to 25 investments increases return at the beginning of the top quartile by 54% and 200%, respectively. (The angel at the beginning of the top quartile has better returns than 75% of angels and worse returns than 25% of angels.) The distribution of angel returns is surely not similar to similar to iPhone apps so the example is purely illustrative.
Then there is the fact that many iPhone app developers build apps while having other jobs that provide cash, in many cases more than a typical developer salary because mobile development skills are in short supply. Therefore, we should be comparing expected returns from startup equity to expected returns from iPhone app development. It is a lot easier to start an iPhone app company than many other types of companies. Therefore, we should not be comparing the return on founding equity of a startup backed by high-quality angels and VCs. Instead, we should be comparing the differences in net cash together with the return on equity that non-founders get. I don’t have great data on this but from what I know I’d argue that, outside of lasting bubble markets, non-founders and non-execs don’t make that much on equity.
Last but not least, economics is not the whole story. Some people fall in love with code and startups. It gives them a sense of purpose and a way to express their creativity. With iPhone apps where it often takes a developer or two to build a basic app, entrepreneurs also get a lot of control and a higher likelihood of calling the shots as a CEO or an exec. I have several friends who are doing iPhone apps because they can be their own boss through a combination of consulting and self-employment. They could be founders and even execs at other startups but it’s unlikely that’ll be CEOs.
To recap, Tomi’s analysis uses good data and good reasoning but it misses the forest for the trees. This doesn’t mean everyone should pile on the mobile app bubble. My point is simply that this type of by-the-numbers analysis misses the point of why so many have gotten into mobile development.
Let me know what you think in the comments or at @simeons.
Tagged: angel investing, angel returns, Apple, Apple AppStore economics, AppStore economics, iPhone, Mobile, startup economics, startups
