The Apple App Monster

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Citigroup (C) analyst Richard Gardner said on Jan. 13 that sales in the fourth quarter could be below 4 million units, down from 6.9 million in the third quarter.)

Apple's challenge in software will be to create a way for developers to make a healthy profit at the same time it does. The company has software tools that make it possible to create an application in weeks rather than several months. It also keeps just 30% of the sales price for applications instead of the 50% many wireless carriers charge. (If the application is free, Apple takes nothing.) And because the App Store is part of the iTunes online store, where 100 million people already buy music, a popular application can quickly attract millions of downloads—creating sizeable audiences that are attracting advertiser attention.

Developers are finding ways to make money while charging little or nothing for their software. Startup Tapulous has given away more than 5.5 million copies of its eponymous game, which tests music fans' ability to tap their iPhone to the beat of their favorite songs. The popularity of the free offering has drawn advertisers and persuaded CEO Bart Decrem to start charging $4.99 for a version with more features. Decrem says the combined sales and advertising revenue allowed the 10-person startup to turn a profit in December, six months ahead of schedule.

Broker TD Ameritrade offers its stock-trading application for free and makes money from trading commissions. It didn't have to pay anything for the software, either. A five-person outfit in Argentina called iStockTrader developed the program in exchange for a cut of any trades.

Apple's rivals point out that these are early days. While mobile-phone giant Nokia is developing its own app store, it can also help developers get their applications pre-installed on mobile phones so consumers don't have to download them. That can end up being more profitable for the developer than being in Apple's App Store. "We want to make money for ourselves and our partners by maintaining the value so the price doesn't gravitate to zero," says Tero Ojanperä, executive vice-president of Nokia Services.

Still, Andrew Fisher, CEO of music-software maker Shazam, sees developers gravitating toward Apple because of the company's momentum. It's a twist on the PC market, where the best applications appeared first, and sometimes only, on PCs with Windows. This time, the one benefiting is Apple. "That's the position Apple has established," says Fisher. "[The more software they offer], the more justifications there are for people to buy iPhones."

Burrows is a senior writer for BusinessWeek, based in Silicon Valley .