Tim Cook, Apple's CEO, normally goes through the quarterly earnings call without skipping a beat. Nearly every time he speaks, Cook reminds everyone "This is Tim" and then gives a polished answer to whatever question he's answering. Yesterday, though, something different happened and it wasn't just the dropping of the self introduction. Apple had just delivered a quarter that narrowly exceeded expectations -- even though the company reported its first annual revenue decline since 2001.
Cook reeled off some highlights: Apple saw a record number of switchers from Android to iPhone, the company's services business grew 24% to $6.3 billion, Apple Music has industry leading customer satisfaction in streaming. Then, as always, the question-and-answer segment followed and one moment seemed to set Cook off. Steve Milunovich, currently at UBS but a Wall Street analyst for decades, asked: "The question is ... does Apple today have a grand strategy for what you want to do? I know you won't tell us what it us, but do you know what you want to do over the next three to maybe five years?" (Edited for length.)
Cook replied more politely than many might have. "We have the strongest pipeline that we've ever had and we're really confident about the things in it. But as usual, we're not going to talk about what's ahead," he said.
Milunovich tried to follow up and Cook essentially blew him off with a one-sentence reply. I can't be in Cook's head. But given that Apple is typically working 2-3 generations ahead on iPhone, Apple Watch, et al. and has been upping R&D spending by billions of dollars, it's likely he was churning through less generous replies. The idea that Apple doesn't have a 3-5 year plan is so beyond absurd it is a bit odd that a veteran analyst would pose that question. That the very asking implies Apple is rudderless suggests a captain lost at sea.
Some of that sentiment is understandable. On a unit basis, sales of iPhone, iPad and Mac were all down for fiscal 2016 (which just ended). The Apple Watch has seen decent sales in its first 18 months, but certainly hasn't established itself as a blockbuster -- at least not yet. While Apple Music has seen a strong first year, Spotify continues to add paying customers faster. In the meantime, Apple's long dalliance with video content owners about launching a cable-like service has yet to bear fruit as competing services from Dish (SlingTV), Sony (Playstation Vue), and AT&T (the soon to launch DirecTV Now) have become reality.
But the criticism typically misses a lot of what makes Apple. The blockbuster product introduction cycle isn't something the company has full control over. It produced mega-hits with iPod (2001), iPhone (2007) and iPad (2010). The first is all-but dead. The third is a bit moribund for the time being, with 82% share of the $200+ tablet market, according to CEO Luca Maestri, but flat sales for quite some time. The second of them, iPhone, is nothing short of the greater blockbuster in the history of consumer electronics and computing. (Note that gaps of 6 and 3 years also don't imply any regularly to this kind of thing.)
iPhone's profit-spinning abilities helped Apple net another $9 billion for the quarter and another $17.1 billion is forecast for the upcoming one (based on the midpoint of Apple's guidance). Save for a one-time weirdness from Fannie Mae, Apple's next quarterly earnings will be the second-largest in history. But the all-time number one was Apple's $18.4 billion from last year's holiday quarter, which illustrates the problem.
Apple has fallen into a trap where it's grown and earns so much that realistically there's left little room to do more without a new catalyst. This isn't technically the Law of Large Numbers, but it's a reality that many companies have faced before. Consider that Apple's new wireless AirPods headphones are almost certainly going to be a $1+ billion product in their first year (look for an official launch Thursday at the event where the new Macs will be unveiled). But with Apple having sold $233 billion of goods and services last year, even 3-4 times that $1 billion is just a few percent growth.
Such is the case with Apple's services business, which yielded $24.3 billion for the year. That's good for 115th place on the Fortune 500 and is roughly equivalent to all of Facebook's revenue. Apple says they expect services to be a Fortune 100 company next year which means at least another 15% growth. This is nothing but good news given that a lot of it is recurring revenue, like music subscriptions, iCloud storage and in-app purchases that often repeat. But the margins on that business overall are lower than the high 30% range Apple gets selling hardware (38% last quarter). And the absolute numbers -- like for those AirPods -- remain small.
Whatever Apple might be doing in the automotive space (more on this in a future column) it won't bring in any revenue over the next 4-5 years. Which brings us back to Milunovich's question, however indelicate. Apple most certainly does have a plan. It includes selling another billion iPhones before the decade is over, along with at least 200 million iPads and Macs. It probably has a wide forecast range for the Apple Watch, though lower prices this year along with new models suggest there is at least some growth to be had there.
It may include a TV offering, if the contract terms are ever to Apple's liking. If 10 million people were paying Apple $30 a month for an over-the-top video service, that would be (1) quite an achievement (2) close to $4 billion a year. You can see how this is one of those businesses that is nice to have, but not a need to have. (Keep in mind there are under 100 million cable/satellite households in the U.S. and whatever Apple could offer would be U.S. only at first. Getting to 10 million won't be nearly as easy as it was with Apple Music, which had broader geography and less of an entrenched competitor beyond Apple itself.)
There are very real possibilities Apple will expand its wearable technology into healthcare, though FDA regulations make that a slog. And Apple might well roll out a variant of the Amazon Echo, though Cook wasn't especially excited the idea when asked broadly about an assistant in the home vs. one on the phone (the already built-in "Hey Siri" function).
For a step-wise change in any of the older product lines, Mac or iPhone or iPad, Apple quite literally can do only one thing: change the price. But even if they take more dramatic action than the iPhone SE, Apple's cheapest ever iPhone at $399, the company will neither attempt to compete at the low end of the market nor will it see dramatic revenue growth. The latter will be challenging because lower prices obviously mean less money per sale even as total units sold increase. And it's possible Apple does nothing on pricing, content to skim nearly all the profits on its relatively small shares of the computer and smartphone markets.
It is worth noting, though, that a larger base of iPhone, Mac and iPad users would help that services business. Apple wouldn't say what it hopes that $24 billion will grow to by 2020, but $50 billion seems plausible. If Apple could triple its user base rather than grow it by 50-100% -- which should happen organically over the next few years even at current pricing -- it could see much larger services revenues even if the next cohort of customers spends less on average.
If I could tell you what else Apple was planning, I wouldn't be writing about it; I'd be in a garage somewhere designing something to work with it. It's possible that Cook, for all his insider knowledge, also can't say with certainty what Apple will deliver next. The company has famously scrapped work deep in progress (the automotive project is apparently already being restructured) and will often delay launches until they are good and ready. That Apple Watch was launched before the software was truly usable and without a clear marketing message is a mistake Cook is unlikely to repeat.
As of now, that leaves Apple churning out billions in profits, buying back stock, and biding its time. By any normal analysis, this is exactly what they ought to be doing. There's a whole bunch of reasonable criticisms of Cook one could level, but the company has grown revenues and profits massively under his leadership -- so much so that the "large numbers" have made further growth challenging. Apple nevertheless seems poised to grow overall in the holiday quarter from last year, even though lower margins and higher spending will make a profit record unlikely. When the next earnings call rolls around, perhaps Cook will bring back the "This is Tim" routine. And perhaps he won't hear a question that contains an embedded slight.
