Even when apps on Smartphones are free they are capable of generating revenue. Some new research shows that in some instances the sale of virtual goods is overtaking advertising.

These findings come from Flurry and relate to data collected from a sample of leading iOS social networking and social gaming applications, with a combined reach of 2.2 million daily active users. (Note that because Google's Android Market does not yet support in-app purchases, micro-transactions, this model is not yet viable for Android apps which are therefore currently missing out a potential source of income).

The chart reveals that during 2010, revenue increasingly shifts from advertising to virtual goods sales until reaching a proportion of more than 80% from virtual goods.

Flurry comments:

Admittedly, the idea that consumers acquiring virtual swords, gold coins and respect points can outperform advertising seems counter-intuitive; however, this phenomenon is neither new nor unique to the iOS platform.

Quoting video game analyst Michael Pachter of Wedbush Morgan Securities, it reports that virtual goods sales already represent the primary source of revenue for social gaming on Facebook with income having grown from approximately $600 million in 2008 to $1 billion in 2009. Patcher forecasts that social gaming will generate nearly $1.6 billion this year, and grow to more than $4 billion by 2013.

Flurry argues that one factor responsible for low advertising levels may be advertising agencies' slow acceptance of mobile as a media platform, with skepticism about the viability of social games and social mobile media as a channel for advertisement and suggests that both the agencies and the brands they represent and therefore missing the opportunity to reach a mass market of consumers who have adopted smartphone platforms. 

Their report concludes

As social games continue to expand their consumer reach, demonstrating their ability to attract an audience beyond teenagers using iPod touches, their relevance will increase. In fact, with mobile social game critical mass now rivaling TV prime time viewership, Flurry anticipates a stronger ad revenue generation through mobile social networking and games in 2011. Over the next 18 to 24 months, Flurry predicts strong revenue growth from both virtual goods and advertising revenue from social gaming.