Ap­ple Ser­vices Take Off

How iCloud, Ap­ple Music & the App Store Could Be the Key to Ap­ple’s Fu­ture Suc­cess

iPhone Life Magazine - - Contents - by David Aver­bach

How Ap­ple's fu­ture may lie in iCloud, the App Store, and Ap­ple Music.

Ap­ple kicked off this year with the high­est-gross­ing quar­ter of all time, earn­ing $78.4 bil­lion in rev­enue. In the first quar­ter, Ap­ple beat an­a­lyst's ex­pec­ta­tions and re­versed its trend of de­clin­ing rev­enue. There are a num­ber of rea­sons for the strong per­for­mance, in­clud­ing high de­mand for the iPhone 7 Plus, as well as strong sales in China. One of the most in­ter­est­ing trends to emerge from Ap­ple's earn­ings call though was the sud­den growth in Ap­ple's ser­vices cat­e­gory.

Ser­vices is a catch-all sec­tion of Ap­ple's earn­ings clas­si­fi­ca­tion for the many ways the com­pany earns money from users en­gag­ing with its ecosys­tem. This in­cludes the iTunes Store, App Store, Ap­ple Music, Ap­ple Pay, and iCloud. The ser­vices cat­e­gory earned $7.2 bil­lion in rev­enue this quar­ter, which ac­counts for roughly 9 per­cent of Ap­ple's rev­enue. The cat­e­gory is up 18 per­cent year-over-year and Tim Cook in­di­cated that he be­lieves Ap­ple can dou­ble the sec­tor by 2020. To put these num­bers in con­text, if Ap­ple split out its ser­vices sec­tor into its own com­pany, that com­pany would al­ready rank 112th in Forbes's list of for­tune 500 com­pa­nies, which is close to Mc- Don­alds and Time Warner. If Ap­ple is able to dou­ble its ser­vices sec­tor, it would be the 54th top com­pany, just above Cisco. The strong growth in Ap­ple's ser­vices is not only sig­nif­i­cant in its con­tri­bu­tion to Ap­ple's strong quar­ter but also be­cause it marks a pos­si­ble shift in strat­egy for Ap­ple as it tries to con­tinue its decade of amaz­ing growth.

When you think of Ap­ple's biggest com­peti­tors, the two names that come to mind are Mi­crosoft and Google. What's in­ter­est­ing, how­ever, is that both of these com­pa­nies earn their rev­enue in a very dif­fer­ent way than Ap­ple. Ap­ple earns al­most all of its rev­enue from sell­ing hard­ware (69 per­cent from iPhone sales alone). Mean­while, Google fa­mously lets man­u­fac­tur­ers use its An­droid op­er­at­ing sys­tem for free. This does not mean that Google isn't mak­ing money from An­droid though. Google makes money from An­droid in two ways: sell­ing apps through the Google Play Store and sell­ing mo­bile ad­ver­tis­ing through the many ser­vices it has baked into An­droid, such as mo­bile search and Gmail. Mi­crosoft also earns the ma­jor­ity of its rev­enue through sell­ing soft­ware and ser­vices, such as Of­fice 365.

The fact that nei­ther of Ap­ple's ma­jor com­peti­tors earns the ma­jor­ity of its rev­enue by sell­ing hard­ware is not sur­pris­ing. Not a sin­gle For­tune 100 com­pany other than Ap­ple earns the ma­jor­ity of its rev­enue sell­ing con­sumer elec­tron­ics. You have to sell a mind-bog­gling amount of elec­tron­ics in or­der to earn enough rev­enue to crack the For­tune 100. In or­der to suc­ceed in sell­ing con­sumer elec­tron­ics, com­pa­nies must reg­u­larly in­vent rev­o­lu­tion­ary tech­nol­ogy that dis­rupts en­tire in­dus­tries. This is the crux of Ap­ple's cur­rent predica­ment. Ap­ple has not re­leased a ma­jor new prod­uct cat­e­gory since the iPad in 2010. While the iPhone will con­tinue to be Ap­ple's ma­jor rev­enue gen­er­a­tor for the fore­see­able

“The strong growth in Ap­ple’s ser­vices marks a pos­si­ble shift in strat­egy for Ap­ple as it tries to con­tinue its decade of amaz­ing growth.”

fu­ture, its sales are no longer grow­ing at the same pace they once did. In or­der for Ap­ple to con­tinue to be one of the most valu­able com­pa­nies in the world, it will ei­ther need to re­lease a rev­o­lu­tion­ary new prod­uct at some point in the very near fu­ture or it will need to grow its rev­enue in an­other way.

This is what makes Ap­ple's ser­vices such an in­ter­est­ing rev­enue stream. iPhone sales growth has be­gun to slow not be­cause peo­ple are no longer us­ing Ap­ple's flag­ship de­vice, but be­cause so many al­ready use iPhones. Ap­ple has be­gun to reach mar­ket sat­u­ra­tion. Last year, Tim Cook re­vealed in an earn­ings call that there are over a bil­lion Ap­ple de­vices in ac­tive use world­wide. Per­son­ally, I use six Ap­ple prod­ucts on a daily ba­sis (iPhone, iPad, Ap­ple Watch, Ap­ple TV, Macbook, and an iMac).

Ap­ple has done an amaz­ing job of build­ing an in­te­grated ecosys­tem be­tween iOS and MacOS. Every­thing from text mes­sages to pho­tos to doc­u­ments in­stantly syncs be­tween all of my de­vices. This puts Ap­ple in an in­cred­i­ble po­si­tion to build up its ser­vices.

Users are will­ing to use Ap­ple's ser­vices over com­peti­tors, be­cause they know Ap­ple in­te­grates these ser­vices into its ecosys­tem bet­ter than any­one else. Ap­ple launched its music stream­ing ser­vice Ap­ple Music in June 2015, and de­spite having al­most no fea­tures dis­tin­guish­ing it from its com­peti­tors, Ap­ple Music al­ready has over 20 mil­lion pay­ing cus­tomers. It is now the sec­ond largest stream­ing ser­vice in the world, be­hind Spo­tify, which has 50 mil­lion pay­ing sub­scribers.

The strength of Ap­ple's ecosys­tem also gives it a near mo­nop­oly on cer­tain types of ser­vices, such as iCloud backup and app pur­chases. The amount of rev­enue the App Store gen­er­ates for Ap­ple has con­tin­ued to grow de­spite the fact that it has been around since the iPhone 3G. In 2016, the App Store gen­er­ated $8.5 bil­lion of rev­enue for Ap­ple, which rep­re­sented over 40 per­cent growth year-over-year. We can at­tribute the suc­cess of the App Store to two fac­tors: First, that users have be­come ac­cus­tomed to sub­scrib­ing to ser­vices through the App Store. Other than games, the top rev­enue­gen­er­at­ing apps are ser­vices such as Net­flix and Pan­dora. Sec­ondly, while the Ap­ple TV and the Ap­ple Watch have a min­i­mal im­pact on Ap­ple's bot­tom line, they ex­pand Ap­ple's ecosys­tem, mak­ing it more likely that peo­ple will pay for Ap­ple's many other ser­vices.

One of the most in­ter­est­ing of Ap­ple's ser­vices is Ap­ple Pay. The vast ma­jor­ity of the one bil­lion Ap­ple de­vices that are ac­tive in the world are tied to Ap­ple IDs with valid credit card in­for­ma­tion. With Ap­ple Pay, Ap­ple is at­tempt­ing to lever­age this pur­chas­ing power by mak­ing it dead sim­ple for its users to make pur­chases at both brick-and-mor­tar lo­ca­tions and on­line through their Ap­ple de­vices. If you've ever used Ap­ple Pay, you un­der­stand just how con­ve­nient it is. You can make in-store pur­chases by sim­ply tap­ping your Ap­ple Watch or your iPhone against the credit card pro­ces­sor. I use Ap­ple Pay ev­ery chance I get, be­cause it's much faster than nor­mal credit card trans­ac­tions (es­pe­cially with the new chip read­ers). While cur­rently only a small per­cent­age of stores ac­cept Ap­ple Pay, if Ap­ple is able to make Ap­ple Pay more uni­ver­sally ac­cepted, it could be­come a huge rev­enue stream for the com­pany. Ap­ple re­port­edly charges mer­chants a 0.15 per­cent trans­ac­tion fee on all pur­chases. While earn­ing $0.15 for ev­ery hun­dred dol­lars pro­cessed may sound like an in­signif­i­cant amount, as we slowly progress to­ward a cash-free so­ci­ety, Ap­ple Pay may even­tu­ally process enough trans­ac­tions to make the ser­vice a sub­stan­tial rev­enue stream for the com­pany.

While most an­a­lysts have fo­cused on whether or not Ap­ple can launch “the next big thing,” ser­vices may rep­re­sent an al­ter­na­tive path for­ward for the com­pany. Many of Ap­ple's ex­ist­ing ser­vices are grow­ing rapidly, and Ap­ple has seem­ingly just scratched the sur­face of what it can of­fer in this sec­tor. As the iPhone be­comes a more cen­tral part of our lives, there will be a lot of op­por­tu­ni­ties for Ap­ple to add valu­able ser­vices that its users will hap­pily pay small sub­scrip­tion fees for. It may be eas­ier to try to grow rev­enue by sell­ing its users a host of cheap monthly subscriptions (or bundling them into one large monthly sub­scrip­tion like Ama­zon does with Ama­zon Prime) than it would be to try to con­vince more con­sumers to buy the iPhone ev­ery year. If Ap­ple con­tin­ues to be able to mon­e­tize cus­tomers through its ser­vices, it could even­tu­ally even flip Ap­ple's busi­ness model on its head. We may even­tu­ally see the day when they use iPhones and iPads to get peo­ple into Ap­ple's ecosys­tem. The power of Ap­ple's ecosys­tem and its in­tense cus­tomer loy­alty are some of Ap­ple's great­est re­sources, and the tech gi­ant is just be­gin­ning to find ways to mon­e­tize these as­sets.

“Users are will­ing to use Ap­ple’s ser­vices over com­peti­tors, be­cause they know Ap­ple in­te­grates these ser­vices into its ecosys­tem bet­ter than any­one else.”

David Aver­bach is the CEO and Publisher of iPhone Life mag­a­zine. David has an ob­ses­sion with all things Ap­ple. He grew up on Macs and now has a MacBook Pro, iPhone, iPad, Ap­ple TV, and an Ap­ple Watch. David en­joys trav­el­ing and Ul­ti­mate Fris­bee. He has been to over 20 coun­tries. To con­tact David, email him at David@iphonelife.com.

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