Apple - the billion user services company?

Stuart Lauchlan Profile picture for user slauchlan January 26, 2016
Could Apple make a shift to a services-dominant business model? Not any time soon certainly, but longer term, CEO Tim Cook clearly sees opportunities.

Tim Cook

The highest ever recorded quarterly profits and revenues in the company’s history, but what’s interesting from Apple’s numbers yesterday is the emphasis placed on services, perhaps hinting at a pitch towards a new business model?

The company turned in net profit for Q116 of $18.4 billion on revenues of $75.9 billion. But what caught Wall Street’s attention was the flatlining of iPhone sales - 74.8 million compared with 74.5 million a year ago - and a lowering of revenue predictions for the current quarter.

iPhone revenue for the quarter rose to $51.6 billion, but that’s less than one percent growth year-on-year. Meanwhile Mac and iPad revenues are down 2.9% and 21.2% year-on-year, to $6.8 billion and $7.1 billion respectively.

So does that mean that beautiful product isn’t the banker it once was for Apple? CEO Tim Cook alluded to a slower upgrade path for the iPhone:

The number of people who had an iPhone prior to the iPhone 6 and 6 Plus announcements - so this was in September of 2014 - that have not yet upgraded to a 6, 6 Plus or 6s or 6s Plus is now 60%. So, another way to think about that is 40% have, 60% have not.

That matters because:

A growing portion of our revenue is directly driven by our existing installed base.

Our installed base has been growing very fast and has recently reached a major milestone, crossing one billion active devices for the first time.

This, he argues, is an “unbelievable asset” as it opens up a services market opportunity for Apple:

Because our customers are very satisfied and engaged, they spend a lot of time on their devices and purchase apps, content, and other services.

Because our installed base has grown quickly, we have also seen an acceleration in the growth of our services business, another large and important source of recurring revenues.

Services thinking

For the latest quarter, Apple points to services revenues of $6.1 billion. That includes revenue from iTunes, the App Store, AppleCare, iCloud, Apple Pay, licensing, as well as a one-off $548 million gained from a patent infringement dispute.

Crucially though, even without that one-off item, services revenue of $5.5 billion is still a record high for the firm and, in stark contrast to the iPhone numbers, represents a 15% year-on-year growth rate.

Accounting for services growth is a tricky business, admitted Chief Financial Officer Luca Maestri:

The vast majority of the services we provide to our customers, for instance, apps, movies and TV shows, are tied to our installed base of devices, rather than to current quarter sales.

For some of these services, such as content, we recognize revenue based on transaction value. For some of the services, such as the App Store, we share a portion of the value of each transaction with the app developer and only recognize revenue on the portion that we keep.

Maestri advises that to understand the scale of the services being delivered to the installed base and how fast this business is growing, you need to look at purchases in addition to revenue:

When we aggregate the purchase value of services tied to our installed base during fiscal 2015, it adds up to more than $31 billion. That's an increase of 23% over fiscal 2014. In the recent December quarter, purchases of installed base services reached $8.9 billion, which is a growth rate of 24% year-over-year.

The size and growth of these services tied to our installed base compare favorably to other services companies. Our installed base services are also quite profitable, with gross margins that, on a purchase value basis, are similar to our company average.

So more consumer-focused services are on the card. The company is said to be planning to make subscription content available through its News app. That would enable publishers with paywalls to control who sees their content and provide better analytics opportunities.

Why that’s important can be seen in the contrasting fortunes of two major newspapers this week. The paywalled Times and Sunday Times are breaking even, while the ‘wide open’ The Guardian is looking at slashing 20% from its budget after losing more than £100 million over the past year.

What is of interest is whether alliances with the likes of IBM and Cisco are precursors to an enterprise cloud services pitch from Apple? Cook’s not being drawn on that one:

I do think that the assets that we have in this area are huge…In terms of our future plans, I wouldn't want to comment about any particular thing, but obviously, with breaking [services revenue] out, we wouldn't be breaking it out if it wasn't an area that was very important to us in the future.

My take

There’s a long way to go before we could realistically think of Apple as a services-led company. Even in its slowed-down growth phase, the iPhone still accounted for 68% of Apple’s total revenue, against 8% for services.

What Cook, in advising Wall Street to pay closer attention to services growth, is trying to do is to pitch a line that increases in services revenue will offset decline in product revenue.

The problem is, the gap between the current revenue contributions is too great for that to be feasible in the short to mid-term.

But as a longer term direction of travel, the idea poses some interesting possibilities.

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