How the Apple iPhone ecosystem works

August 14, 2008: 1:24 PM ET

This past February an excitable Belgian software executive named Bart Decrem and a quiet Australian ex-McKinsey consultant named Andrew Lacy had an epiphany. A few months earlier, in November, Steve Jobs had said Apple (AAPL) eventually would allow software developers to write programs for the company's elegant iPhone. Jobs didn't say when, and he didn't share details of how Apple would work with outsiders. But it was an exciting prospect because cell-phone makers don't typically allow anybody but their phone-company customers to place software on phones.

By February Decrem and Lacy realized that independent hackers already were finding ways to break into the iPhone and insert their own applications. The duo each had been passing time as entrepreneurs in residence at Silicon Valley venture firms, Decrem at Doll Capital and Lacy at Foundation Capital. Together with a third co-founder, noted Mac developer Mike Lee, they decided to start a company that would position itself for the day Apple opened its doors.

That day turned out to be July 10, when Apple debuted its App Store with much fanfare. The company that Decrem and Lacy founded, Tapulous, already is one of the most popular providers of free applications for the iPhone. Jobs told the Wall Street Journal last week that Apple alone would see an additional $360 million in annual revenue as a result of the App Store, if current sales trends persist. Apple keeps about 30% of the revenues its developers collect for their applications. (Not everyone is so enamored with Apple's endeavor.)

It has become cliche to note that Apple is revolutionizing the mobile phone business.  Tapulous illustrates why. "This is about a cell phone finally becoming a computer that is always on and always knows where you are," says Lacy. And because that computer has a gorgeous screen and simple Web browsing, it unleashes endless opportunities for creative entrepreneurs.

Though Tapulous, like most App Store developers, so far isn't generating a cent, its fast rise is a good illustration of where that money will come from -- for startups and for Apple. Tapulous has released two free applications, a game called Tap Tap Revenge, modeled after a popular arcade dance game, and Twinkle, an application that lets iPhone users send messasges over Twitter or Tapulous's own system. In about a month, the game has attracted 1.2 million downloads, while Twinkle has 100,000 users. Tap Tap Revenge started with 20 songs from independent artists that users play for free. App Store rules prohibit Tapulous from linking its game with a user's iTunes music library. But the startup plans a program to allow music labels to submit their songs directly to Tapulous.

Boasts Decrem: "That means we are a whole new distribution channel for music." Not surprisingly, Tapulous plans to start inserting ads into its games. With more than a million users and growing -- and only eight employees -- it's easy to see how such a company could generate profits relatively quickly. (The company also plans to offer a premium version of Tap Tap Revenge in September for $10.)

Expect Tapulous to make a mainstream splash. It has raised only $1.8 million, a pittance in Silicon Valley, but its roster of investors is impressive: Software veteran Katrina Garnett, early Google investors Andy Bechtolsheim and Rajeev Motwani, as well as Salesforce.com (CRM) CEO Marc Benioff and Khosla Ventures, whose David Weiden has a hot hand with small consumer-technology startups.

The company has promised two additional applications by the end of summer. One will be FriendBook, a program that lets people exchange business cards by shaking their iPhones at each other. The other is Collage, a way to share photos with friends as well as strangers with nearby iPhones. (Sexy flirting and creepy stalking seem inevitable.)

The Tapulous founders are careful to say they're hopeful their programs will work with phones that run on other systems, including Google's (GOOG) Android, Research in Motion's (RIMM) Blackberry and Symbian, which Nokia (NOK) recently purchased. (RIM is sponsoring an investment fund to back companies like Tapulous, which mimics a similar effort by the Valley's Kleiner Perkins.)

For now, the game belongs to Apple -- and its legion of hungry software developers trying to make a buck off its beautiful inventions.

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Adam Lashinsky
Adam Lashinsky
Senior Editor at Large, Fortune

Adam Lashinsky is a San Francisco-based editor-at-large for FORTUNE, covering Wall Street and Silicon Valley. Lashinsky joined FORTUNE in 2001, after two years as a contributing columnist. Prior to joining FORTUNE, Lashinsky covered Silicon Valley for TheStreet.com and The San Jose Mercury News. A Chicago native, Lashinsky holds a B.A. in history and political science from the University of Illinois at Urbana-Champaign.

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