The Apple Services Misunderstanding

by Jean-Louis Gassée

With Apple’s latest Services announcements, the skeptics sing the same old refrain: Apple cynically exploits customers by imprisoning them inside its Walled Garden. But there might be a better explanation, one that’s based on a trusting relationship between Apple Services and Apple customers.

Once upon a time, I held a simple, purist view of Apple’s Services business: Its one and only raison d’être was to push up the volumes and margins of Apple’s personal computers. These were the real moneymakers, in whatever form: watches, phones, tablets, laptops, desktops…

Indeed, Apple’s hardware makes extraordinary amounts of money. In the 2018 FY (Fiscal Year) that ended last September, personal computer revenues exceeded $210B, a number that doesn’t include the Watch, which is still bundled in the Other Products category.

But a closer look at numbers shows a twist to the “one and only business” story. While overall Apple revenue grew from $233.7B to $265.6B (+13.6%) between FY 2015 and FY 2018, Services grew from $19.9B to $37.2B — an increase of 87%. Put another way, more than half of Apple’s total sales increase over those three years ($31.9B) was contributed by a $17.3B increment in Services. In the first quarter of FY 2019, Services’ $10.9B revenue represents more than 13% of Apple’s $84B sales for the Holidays season.

Apple CEO Tim Cook hasn’t been shy about the future of the Services business. In 2017, he projected $50B in revenue by 2020, a number that would put Apple Services between #59 Lockheed Martin and #60 AIG on the Fortune 500 list. Given last quarter’s $10.9B, Cook’s prediction is beginning to look conservative.

The former bit player has now earned a place at the front of the stage, and the transformation into a main character of Apple’s story has set tongues wagging.

The most often heard explanation for the Services surge is that Apple needs to compensate for sagging iPhone revenues. While commenters often fall into the “Orphan Number” trap by looking at iPhone sales without also examining the worldwide stagnation of smartphone numbers, it’s indisputable that the iPhone go-go years, the likes of which we’ll probably never see again, are behind us.

Business Theory tells us that in a saturated market, revenue growth can be achieved two ways: By cutting prices to take business from competitors — which we saw in the PC market with its race to the bottom; or by increasing revenue from existing customers, cynically referred to as Milking The Base.

The latter is how many see the progressive iPhone price increases accompanied by expanded Services offerings, a view that was reinforced by the highly polished presentation of new services on March 25th at the Steve Jobs theater (watch it here). Apple News+, Apple Arcade, an updated Apple TV app, the stylish Apple Card and new streaming content under the Apple TV+ brand, with a closing Oprah Winfrey homily.

Because the only service that’s actually available is the $10/month Apple News+, many critics pointed to the vagueness and lack of detail in the other products. Predictably, some commenters went further, accusing Apple of losing their religion. In a piece titled The Incredibly Shrinking Apple, Farhad Manjoo contends that “Steve Jobs wanted to put a ding in the universe. Today, Apple wants to ding your pocketbook”. What Manjoo and others conveniently omit is that Steve Jobs started dinging our pocketbooks long ago when he started Apple Services in order to sell iTunes Music and movies, books, and even the originally misbegotten me.com (now iCloud services).

How will the new services fare? Apple News+, “a magazine subscription service that grants access to a catalog of over 300 periodicals”, looks like a no-brainer; Apple claims 200,000 new subscribers in the first 48 hours after the launch. Having my favorite magazines — literary (of course), carnographic, naturalistic — on all my devices as I travel or luxuriate on the couch is an iPad fantasy finally come true…after nine years of waiting.(Many, like my friend and Monday Note co-author Frédéric Filloux, are less pleased; they foresee the ruin of magazines and newspapers by services such as Apple News+.)

Financially, the new services’ impact is hard to predict. Noted (as in rational and reliable) analyst Neil Cybart offers his view behind the Above Avalon paywall. His March 28th analysis concludes thusly:

… within three years, Apple can generate approximately $8B of revenue and $4B of profit per year from the services announced earlier this week. This amounts to boosting overall revenue and gross profit by 3% to 5%.

For Apple, $8B/year sounds modest, but it’s a significant contribution to the $50B/year 2020 goal.

Another observer I know privately sees the growing network of services as a defensive move: They make life increasingly safe and pleasant, which is a way to keep Apple customers “inside”, to make sure they stay in the ecosystem.

In his Apple Plus — brand versus subscription analysis, Benedict Evans doesn’t deny that there’s a defensive side to the new Apple Services [emphasis added]…

“These subscription services are about cutting churn and driving incremental revenue …plus more reasons (especially the Card) why it’s harder to switch from iPhone to Android.”

…but he also takes a more global view of how the tech industry is changing.

Evans contends that we’ve passed through the epoch when the focus was on making the technology work, when we argued about defragging disks, and tinkered with the internal working of devices. We have ascended to a new layer of interaction with technology where we worry about our privacy, our safety, our data, about the reliability of information:

“Apple has talked about privacy for a while, and sometimes curation, but these products make that much more tangible. The old Apple promise was that you don’t have to worry if the tech works. The new promise is you don’t have to worry if the tech is scamming you.

In Evans’ analysis, trust is at the center of the relationship between Apple Services and its customers:

“Trusted, secure, private, no ads, no scams, no tricks you have to watch for (scammy in-app purchases in games, scammy/weird credit card charges) — it’s all curated.”

Will customers appreciate, intellectually, this new relationship? Perhaps. But at the visceral level — the one that really counts — Apple’s new promise can work. This is a much better way to think (and emote) about the new Services than reducing the analysis to yet another ding to our pocketbooks.

Time will tell, of course. The usual Matter Of Implementation needs to be catered to. In particular, it’ll be interesting to watch the new Apple TV+ content Apple is driving with Steven Spielberg and others. I didn’t believe Netflix could succeed producing content. Nor did I think Amazon could. So…

— JLG@mondaynote.com