Apple's annual ritual of touting the prodigious growth of its App Store brought forth some breathtaking numbers: $20 billion paid out to developers just last year, 40% growth in 2016, 2.2 million apps available. Sales have about tripled over the past three years. And if 2017's growth keeps pace, the App Store will do more business this year than Oracle -- the world's second-largest software company. But for all the success Apple has had selling apps on behalf of a myriad of developers, it seems as though its just scratching the surface of what might be possible.
Take for example subscription services, which became available in all 25 App Store categories last fall. When iPhone, iPad, or AppleTV customers sign up for a service through the store, Apple not only gets paid once, but on an ongoing basis. This has been the source of some contention with providers who pass along a significant portion of their revenue to content owners, e.g. Spotify. But when the synergy works, it's a major marketing channel for the app developer and a major win for Apple. Look for this segment to expand substantially in the next several years as app developers embrace software-as-a-service models akin to how modern software is sold to businesses.
Subscription services incidentally grew 74% last year, reaching $2.7 billion. That small slice of Apple's business is bigger than all of Twitter. The overall App Store? It was more than 10 times larger than that. With $20 billion paid to developers and Apple taking a 30% cut, App Store revenues were somewhere north of $28 billion in 2016. If that figure again grows by 40%, Apple will eclipse $39 billion next year. By way of imperfect comparison, Oracle's fiscal year 2016 had a $37 billion topline.
The significant revenue combined with growth that has compounded at 40% annually since at least 2013 raises an intriguing question: Is there more Apple could do? The company sells a relatively small chunk of the world's smartphones, around 1 in 8 currently. But because the typical iPhone or iPad is used longer than most Android devices, Apple has a bit more than twice that operating system share among active devices. Tim Cook and company took a major step in 2016 toward growing that share with the iPhone SE, which launched at $399 and became the lowest-priced iPhone ever.
Still, that move was a relatively modest one as the SE came with a 4-inch screen, which is an outlier among modern smartphones. While the small form factor holds an appeal for Apple aficionados who grew used to that size in the iPhone 5 era, it was -- and is -- unlikely to attract a major groundswell of Android converts. There is also the matter of price, which is a bargain by iPhone standards but still pricey in much of the world where $100 models are common.
This discussion of iPhone pricing might seem like a digression as would a continued deeper dive into whether Apple should offer an entry-level tablet at perhaps $199, but it isn't. Consider that the App Store's sales are a function of two variables: The number of active iOS users multiplied by the average App Store spend per user. It's completely reasonable to argue that incremental customers to the iOS ecosystem would spend less on average than the current user base does. Most high-spend customers are already Apple users and many that opt for Android phones are choosing them to save money.
But lower average spend doesn't mean zero spend, especially as the category matures. For most of you, it's likely you make more use of your smartphone today than you did five years ago. That comes not only from a wider array of apps, but from the elevation of the smartphone to main computing device. Consider that someone just using premium Dropbox and Spotify is spending north of $200 annually on those two services alone. Then realize there are not only paid games, in-app purchases for free ones, but also a wide array of subscription video like Netflix and HBO Now -- two of the popular sellers on the App Store -- that could easily yield an annual bill for software and services that's greater than the cost of an iPhone.
Against that backdrop, it becomes reasonable to argue that Apple should do whatever it takes to get a bigger slice of the smartphone and tablet pies, pushing for share gains on iOS. The company already sells its own services, including iCloud storage upgrades and Apple Music, and has long been rumored to be joining the crowded field of video-streaming purveyors. Even if newcomers to iOS are lower spenders, it is worth considering again that formula above. For existing iOS customers, just assume the average spend is X and the user base is Y. Now imagine a targeted effort to grow a new class of less-lucrative users who only spend 0.5 * X and might only initially represent 0.25 * Y. Whatever variables you use for X and Y and whatever coefficients you choose (X is well north of half a billion and Y is somewhere around $40), the gain is incremental.
Of course, there is a challenge here for Apple: Any offering of less expensive hardware carries with it some risk of consumers spending less on the stuff where the company makes most of its money. But it's again worth mentioning that the smartphone market is maturing. While nearly every teen and adult on the planet will have one, there already exists saturation in the world's richest economies. Even some developing world like countries like China have passed the hypergrowth phase.
Still, that doesn't argue against the core premise. The longer the next cohort of buyers has their smartphones, the more their app purchasing, subscription buying, et al. will resemble the existing base. And the more Apple can grow the App Store overall, the more it has a recurring revenue business that, while related to continued sales of high-margin iPhones, doesn't boom and bust precisely along with them.
But whatever path Apple takes, watchers of the company should consider these annual self-congratulatory press releases a good sign. They mean the company cares about App Store growth and the developer community that makes it possible. With a reminder that past performance is no indicator of future results, it would take just four more years of 40% growth for the App Store to be a bigger business than Microsoft is today. That isn't to suggest that come 2020 the App Store will in fact achieve that milestone nor that Microsoft is standing still waiting for that to happen. But it does help calibrate how important the business has become -- and how much potential it still has.
