Misunderstanding Apple Services

Jean-Louis Gassée
Monday Note
Published in
5 min readAug 7, 2017

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by Jean-Louis Gassée

Apple’s quarterly numbers show positive Mac numbers, stable iPhone revenue, and a return to growing iPad sales. But the story that has grabbed the headlines is the growth of the Services business. Has Apple Services suddenly become the company’s Next Big Thing?

The headlines played like a ‘stop the presses’ moment from a 1940’s thriller:

Apple’s service biz now the size of a Fortune 100 company (CNBC)

Apple’s services business alone now the size of a Fortune 100 company, beats out Facebook. (AppleInsider)

Apple’s services business now the size of a Fortune 100 company (iMore)

Apple’s services division is now the size of a Fortune 100 company (itbusiness)

The punchy, echoed sentiment is shorthand for a salient fact disclosed in Apple’s latest quarterly numbers, released on August 1st, 2017. Services revenue for the last four quarters reached $27.8B, figuratively placing Apple’s Services 98th on the Fortune 100 List:

If Apple Services were a standalone company, its $27.8B in revenue would just squeak past Facebook’s $27.6 (although I’m not sure we’re comparing the same four quarters).

(Hungry for more facts? The 10-Q SEC filing is here. As always, I direct your attention to the Management Discussion & Analysis section on page 25. You can also turn to iMore’s well-rendered transcript of the Earnings conference call, and Tim Cook’s August 2nd CNBC interview with Josh Lipton.)

Last May, Tim Cook said he expected the Services business to double by 2020. That would be about $55B, right behind United Technologies, 50th in Fortune’s list. From there, it’s an easy jump to the eternal quest for Apple’s next big revenue generator, something as powerful as the iPhone, or the meteoric rise of the iPad before its subsequent fall (now reversed, it seems).

The picture of Apple Services’ growth compared to Facebook, courtesy of Horace @asymco Dediu, is tantalizing:

Apple Services is doing well, with accelerating growth…

…while Facebook's own growth slows down.

It’s an attractive comparison, if a bit grasping. Apple Services has only recently begun its growth spurt; Facebook isn’t exactly finished.

But the biggest misunderstanding isn’t the theoretical placement in the Fortune 100 list, or the comparisons to Facebook. It’s the consideration of Apple Services as a self-standing business. Remove “Apple” from “Apple Services”…would this stand-alone “Services” company enjoy the same success were it to service Android phones or Windows PCs?

Apple Services is an important member of the supporting cast that pushes the volume and margins for the main act: Apple Personal Computers. These come in three sizes, small (iPhone), medium (iPad), and large (Mac). If rumors of the addition of a cellular modem are true, we may even see the Watch, today an iPhone accessory, added to the cast as the newest and smallest performer.

Everything else that Apple offers has one raison d’être: Fueling the company’s main hardware act without which Apple is nothing. As an example, headphones, earphones, loudspeaker sales, and music distribution revenue aren’t the goal (note the fall in music purchases on Horace’s chart above).

With Services, Apple enjoys the benefits of a virtuous circle: Hardware sales create Services revenue opportunities; Services makes hardware more attractive and “stickier”. Like Apple Stores, Services are part of the ecosystem. Such is the satisfying simplicity and robustness of Apple’s business model.

History provides another interesting angle — and shows how the Services “giant” was long in coming.

Apple’s modern services efforts were born when the company acquired SoundJam MP in 2000 and rebranded the music synchronization program as iTunes the next year. iTunes introduced two key innovations: Selling music “by the slice”, one song at a time versus the age-old album bundle; and “micro-payments”, 69 cents for each downloaded song. Apple funded your purchases until your balance reached the credit card company’s minimum charge amount — typically $2.50 to $5. (Rumor has it that, in the beginning, Apple may have eaten the card transaction fees for low purchase amounts in order to get iTunes music sales going.)

In October 2001, just a few months after the iTunes launch, the iPod appeared. In 2003, the iTunes Store launched, creating an ecosystem, a virtuous circle of downloadable music that fueled hardware sales, while increasing iPod numbers fueled iTunes revenue. By 2006, iPod revenue reached $7.7B, surpassing the Mac’s $7.4. (As reported that same year, Music plus Software and Services already reached $3.2B — but these numbers are imprecise, they include some accessories.)

It’s sometimes difficult to recall, but at the time, Apple was still struggling: Windows PCs outnumbered Macs nearly 20-to-1. Also fading from memory are the names of the other big players at the time:

Gartner has the top four players in the U.S. PC market as Dell (32 percent), HP (18.9 percent), Gateway (6.2 percent) and Apple (4.6 percent).

- Macworld, July, 2006

iPod numbers provided a welcome contrast to Apple’s image: Winning big in a highly visible product category.

And there was something else that was even more important, something that no one knew at the time: the iPod was a dress rehearsal for the iPhone. Increasingly smaller iPods helped Apple master the process of miniaturization and put in place the institutional knowledge and partnerships that were required to manufacture large quantities of the stunningly small iPhones.

After preaching the Web Apps gospel out of necessity, Apple soon disclosed a Software Development Kit for native iPhone apps and, in the Spring of 2008, the App Store opened its doors…or floodgates. In a neat alignment of past and future, iTunes’ micro-payments formula and data delivery system became the backbone of the App Store. Music, movies, apps…they’re all just ones and zeroes, and iTunes has been delivering bits since 2001.

Apple Services is a key component that ensures the durability of Apple’s personal computers business. But the “Next Big Thing”? It’s big, but it’s not new and it’s not a ‘thing’.

JLG@mondaynote.com

One last note: Tim Cook has opined that Augmented Reality will be big, a nice way to make iDevices more attractive, more helpful, and more fun. I agree. The ARKit running on the company’s large installed base (100M or more) of “unfragmented” iPhones is a way to generate more Services revenue (apps, mostly). But, again, it’s not the Holy Next Big Thing.

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