Apple’s Services Strategy? A Little Bit of Everything (Premium)

Apple’s problem, of course, is that it’s a one-product company—the iPhone still represents about 62 percent of its overall revenues—and sales of that product are down and are expected to continue falling. This leaves Apple vulnerable, especially since it hasn’t been able to augment or replace the iPhone with another hit hardware product, as it had in the past when it transitioned from Mac to iPod to iPhone.

Indeed, Apple’s other hardware lines—which include Mac, iPad, Apple Watch, Apple TV, and peripherals—are each challenging in that they sell in far lower volume than iPhone and are refreshed even less frequently. Apple’s traditional model of selling new hardware to new and existing customers each year has started to wear thin at the edges.

Yes, Apple is correctly criticized for letting many of its non-iPhone devices wallow unchanged and non-upgraded for years. But most of what’s happening isn’t Apple’s fault. For example, smartphone sales were down across the entire industry last year, indicating a worldwide saturation with no obvious new locale on the horizon to bolster sales going forward. Device quality, too, is up across the industry, and consumers are holding on to their phones for longer than ever. These two factors have combined to undercut Apple’s decade-long strategy.

But Apple has already started changing. The company successfully raised the average selling price (ASP) of the iPhone in both 2017 and 2018—thanks to the new and more expensive iPhone X, XS, and XS Max models—helping to stem some of the revenue fall-offs from a decline in unit sales. That strategy, which I call Apple Jacked, is bad for consumers in that paying more for something that was already very expensive and has always been sold at obscenely-high margins is always bad.

But it also betrays the real genius of Tim Cook, a man who has no particular skill in product design but is perhaps unrivaled when it comes to numbers. Remember, Cook’s claim to fame is that he maximized Apple’s margins and revenues by relocating all of Apple’s manufacturing to the regulatory and low wages wonderland that is China. Figuring out which new iPhones to introduce at which higher new prices to maximize revenues was likely child’s play for him.

I should also acknowledge a flaw in my Apple Jacked complaint. Which is that raising the ASP of the iPhone (and Apple’s other products)—by about 20 percent overall, from what I can tell—can be somewhat justified by the reality that its customers are holding on to the devices for longer than ever before. If a $750 iPhone was expected to last 2-3 years back in, say, 2015, then perhaps spending $1000 on iPhone that lasts 3-4 years or more doesn’t represent a real-world price increase. Especially since virtually no one actually pays the full price of an iPhone up-front. Instead, that cost is spread out via monthly payments that are often further minimized by a trade-in. For which Apple, not coincidentally, is now offering more value for, further sweetening the deal.

Consider the iPhone XS. This device starts at a staggering $1000, but it can be had for just $42 per month over two years. If you have a trade-in phone, it can be had for as little as $30 per month, lowering the effective price of the device to just $700. Not chump change, for sure, but more in-line with iPhone prices from a few years back. Also, since most will hold on to their iPhone XS for three years or more, they will experience one or more years in which they are not paying any monthly fee for the device. That will seem like a gift, of sorts. Regardless, to most, $30 per month seems a lot more palatable than a one-time $1000 charge.

Cook’s numbers game can only get Apple so far, of course. And that’s where Apple’s truly big bet on services comes in. Here, Apple is playing the same game that Microsoft is in its transitions to a cloud services giant: Instead of weathering the ups and downs of product release cycles, where revenues tend to jump when new products are released and then fall when they are not, Apple is seeking to normalize monthly and quarterly revenues through subscription services.

That $30 to $42 monthly fee for an entry-level iPhone XS should be viewed in that light: It’s better for Apple to receive a predictable amount of money every month for two years than it is to receive $1000 once with no idea when or even if that customer will ever upgrade in the future. It’s the real reason that Apple started its iPhone Upgrade Program, which keeps its most loyal customers on the monthly fee cycle for life, effectively. (I’m curious if changing market conditions have blunted the attractiveness of this program, which is a bit of a never-ending payment treadmill.)

And this shift from big bang releases to normalized subscription payments is the real reason that Apple is moving much more heavily into services. What if that $30 to $42 monthly fee could become $50? Or $75? Or … $100?

What’s interesting is that Apple has been using this model to some degree for years. It’s just become a bigger focus as the blockbuster iPhone business has slowed.

For example, the App Store generates an enormous amount of revenue that is split between ad hoc purchases—for apps, movies, TV shows, and other content—and monthly subscriptions generated by third-party apps. This store is so lucrative for Apple that some app developers—most notably Amazon, Netflix, and Spotify—refuse to play the game. So they make their iOS apps harder for their own customers to use because they don’t want to hand Apple 30 or 15 percent of their revenues for basically nothing.

Apple Care might also be considered part of this scheme. When you take part in the iPhone Upgrade Program, you are automatically enrolled in Apple Care, and that cost is subsumed as part of your monthly fee. But others can add Apple Care during purchase time, and for a short period of time afterward, when they buy an Apple device. This effectively raises the ASP of the device, to my mind, though Apple likely puts the costs of the service and the revenues it generates into its growing services group.

Apple has also long offered iCloud storage as a paid monthly service. This can be viewed as being similar to OneDrive, Google Drive, and Dropbox. But in the Apple ecosystem, it’s also somewhat more necessary because iCloud is where your iPhone and iPad device backups are stored, and Apple isn’t giving away that storage for free. If you have a multi-Apple device household like I do, you will almost certainly have to pay Apple for iCloud storage every month, even if you don’t use the service for photos, documents, or other content. Ching goes the cash register.

Beyond these, Apple Music is perhaps Apple’s most visible services success so far and the inspiration for what’s to come. It is available only as a paid monthly service—unlike market leader Spotify, which also offers a free and ad-supported tier—and it already has over 50 million subscribers paying Apple $10 per month. Clearly, this is the model for Apple’s coming services expansion, which will include both a video service—I assume it will be called Apple TV—and a news service that I likewise assume will be called Apple News.

Those two services will be announced on Monday and it’s fair to say that many, myself included, are starting to obsess a bit over them. But there are two more coming Apple services that haven’t gotten a much press. And I think they each have the potential to drive the firm’s services revenues to new heights.

The first is yet another game streaming service which I think of as Apple Games. First reported by Cheddar back in January, Apple Games is, yep, a video game service with a monthly fee, one that “would function like Netflix for games” and addresses mobile gaming specifically. That market is expected to become a $100 billion industry overall by 2021.

The other is Apple’s coming credit card, which should be to finances what Apple Health and Apple Watch are to health and fitness. This is a canny move on Apple’s part, and it will help its users set spending goals, track rewards, and manage account balances through the Apple Wallet app.

Which leads me to the future: Clearly, health services are an obvious place for expansion going forward as well. I’m curious to see what features Apple adds to Watch going forward and whether it will find ways to tack on a monthly fee for certain services related to that. You know they will.

I’m also curious about service bundling. That dream of $50 or $75 or even $100 monthly fees for customers can best be realized by Apple bundling its services into tiers so that customers can get them together instead of a la carte. An all-in Apple subscription could be quite lucrative. And savvy, since it would work to further another of Apple’s aims, to keep its customer base locked inside the walled garden of its insular ecosystem.

Finally, there are some obvious questions. The big one, from my perspective, is how open Apple’s services will be. After all, Apple Music is on Android, and iTunes has long been available on Windows. AirPlay 2 and iTunes are coming to smart TVs and, I believe, rival set-top boxes too. Will Apple open most or all of its coming services to rival platforms too?

I don’t believe so.

Apple only embraces rival platforms when it must. The ulterior motive behind this services push isn’t to “replace” iPhone revenues with services revenues but rather to augment them and turn services into a top-tier revenue generator to propel future growth. I assume the goal here is for a new Apple to emerge in which iPhone and services revenues are the firm’s one-two punch. And if Apple were to spread its services too broadly, it could actually harm the iPhone and the massive revenues it generates.

But, remember. Tim Cook is a numbers man. He would never let that happen.