Apple’s Unsurprising Earnings

After Apple’s earnings, the more common sentiment I saw was that of surprise. Largely because the prevailing narrative was the iPhone X sales had dropped significantly in demand. Apple’s fiscal Q2 iPhone sales are never as large as the quarter before which is a holiday quarter. But the March quarter has consistently been their second largest when it comes to iPhone sales. Sell-side analysts were hearing rumors of supply chain cuts and some revised their estimates into the low 40 million range. This quarter turned out to be Apple’s second largest March quarter ever. Their best March quarter was in 2015 coming off the heels of the larger screen transition to iPhone 6 and 6 Plus. Apple sold just over 61 million iPhones in the March quarter of 2015 and no March quarter has even come close. This year’s just over 52m was strong, and every March quarter since the record 61 million in 2015, Apple has sold around 50m iPhones. When you look at the fundamentals, even in a lengthening refresh cycle, the size of Apple’s base would suggest drastic YoY drops in quarter sales are not likely. With that said, several important things stood out.

The Unprecedented iPhone
The iPhone is doing unprecedented things. I regularly feel this point is entirely missed, or under-appreciated at least. The iPhone has been swimming against the current of conventional wisdom in almost every way. ASPs are not supposed to rise in a mature market; they are supposed to decline dramatically. Yet Apple again set a March quarter ASP record, as iPhone ASPs continue to rise thanks to consumer’s choosing the higher end iPhones when they upgrade. Two charts from my friend, Horace Dediu of Asymco to emphasize this point.

Conventional wisdom would look at this chart of iPhone ASP of Apple’s full lineup and predict most consumers would choose the lower end models. That is what has historically happened in consumer electronics. Prices come down, and fewer consumers buy the high-end products. Conventional wisdom was you gain market share by lowering prices. However, with the iPhone the reverse is true. Here is iPhone ASP charted over time.

While iPhone ASP was predictably lower than the holiday quarter, it still set a record March quarter ASP thanks to iPhone X. Tim Cook made a fascinating, and important point, on the earnings call. He stated that this iPhone launch cycle was the first one where the highest end model (iPhone X) was the best seller every week since it was released. This is not how the market is supposed to work!

Since the launch of the iPhone 6 and 6 Plus, where Apple moved from one new product to two, the lower-priced model, the smaller 4.7″ screen iPhone has been the bulk of the mix. There was no reason, using history and predictable consumer behavior as our guide, to believe that would change. Since the launch of the iPhone X, more consumers choose the higher-end model than any other model. Remarkable. Unpredented even.

My advice to many is when looking at Apple specifically, it may be time to throw conventional wisdom out the window.

The Undervalued Services Story
While there was a long list of interesting things to dig into with Apple’s earnings, in the interest of not making this article too long, I wanted to look at the services story.

I’ve been bullish on Apple’s growing services business for years. Every data point we could gather suggested that when you condition consumers to pay for things they value, you build a platform and set of products that are prime for increasing revenue opportunities. Here again, we have a chart from Asymco that is helpful to visualize this growing services story.

There is so much about this chart to dive into, but a few highlights:

• The growth in paid subscriptions is significant. I’ve long argued iOS is becoming a platform that plays well with subscription business models. This is a result of conditioning consumers to pay for things they value and having a base of customers who are willing to do so. Any company looking to build a subscription business is wise to prioritize iOS if they are not already.
• On the earnings call, Tim Cook made another important point about Apple’s services. When he was talking about the upside, he explained that he was encouraged that the growth in services was not coming from just one region, or just one revenue stream. This is an important point because it highlights that the services narrative is not a one trick pony. While true most the revenue comes from the App store, the growth in revenue streams from other sources helps diversify the services opportunity and demonstrates the potential for other services as well.
• As Apple’s user base grows, so is the services narrative. Apple’s base is growing, modestly, but still growing. As long as this keeps happening there is no reason to bearish on Apple as a company. The fact is, the more time consumers spend in Apple’s ecosystem, the more they are likely to spend on services. Our research has shown consistently that consumers spend more in year three on services than they do in year one of joining Apple’s ecosystem. This has been a consistent trend line. Which means that the Apple services narrative is a snowball. That snowball is still small, and still only at the top of the mountain.

Apple continues to demonstrate the fundamentals of their business remain strong. It seems so odd they are continually doubted by so many. But often, that doubt is driven by historical anecdotes and conventional wisdom. Both which are demonstrably not useful when building a framework for Apple.