I’m all for Apple pursuing a nice services revenue stream to complement their hardware business. Besides a nice padding to already high-margin device sales, services tend to offer things that customers really want any way. If they don’t buy it from Apple, they’re going to buy it from someone else. Why let Amazon or Google reap all that extra benefit?
However, I’ve already covered why it would be wrong for Apple to prioritize service revenue above hardware revenue. Apple sells services in order to sell more hardware. It should never be the other way around. If apple could achieve Netflix-like scale and rake in $200+ million in streaming net income per year, so what? Is that worth spending $2 or $3 billion per year on media? That’s not significant enough to sacrifice their hardware business. Apple doesn’t need a media streaming business any more than Tesla needs to sell more flamethrowers.
When I was working in the PC industry, I witnessed what happened when years of annual double-digit PC sales growth plateaued. Gateway Computers tried to say that software and service revenue was the panacea. We launched a huge push internally titled “Beyond the Box” in which we tried to get customers to sign up for various subscriptions or buy more software. The hope was that PC unit sales might decline but we’d make it up with our current customers by going for higher revenue per customer.
It worked short-term but not in the long run. Eventually our installed user base shrunk to the point that it outweighed our higher revenue per customer. I still remember one Gateway VP saying that “We tried so hard to push ‘Beyond the Box’ but instead we found out that without the box, there is no beyond”. Apple will have the same problem.
Apple needs more hardware customers, not richer ones. And when global iPhone market share is at under 20% it’s incorrect to say that they’re just not enough people on the planet for Apple to sell new iPhones to. Theoretically, Apple could reap double-digit sales increases for years to come if they could steal from Android.
Service revenue growth comes from two directions. First, current iPhone users may decide to purchase more Apple services above and beyond what they were paying for. Second, Apple could try and get new service customers via new iPhone converts.
The point of this whole post is that Apple needs to find new customers, not just trying to milk more money out of their current customers. Milking more money out of their current customers is a short term play that will roughly follow the same track as their installed device base. The more active devices that are in use, the higher the service revenue will be. And the lower the base, the lower the service revenue.
But if Apple actively prioritizes hardware sales first, they will get the service revenue as an added bonus. Most Apple service revenue is going to come from Apple iPhone users. Even for Apple services on the Amazon Echo or Android devices, it’s a safe bet that these are households where the account holders are iPhone users. Like iPhone users who already owned an Amazon Echo in the kitchen or households where a teenager is on Android but everyone else in the family is on iOS.
So if Apple pursues hardware sales, they will get a nice bump in service revenue. If they pursue service revenue in a way that is disconnected from hardware, they could actually see a decrease in hardware sales and an eventual decrease in service revenue.
The question becomes “How do they increase hardware sales?”.
Where there’s smoke, there is often fire. And I think that there may be something to all of the rumors that iPhone unit sales are down this year. It’s starting to look like Apple is coming close to the end of the road with finding more of the high-income customers who value quality and craftsmanship above price. Even if I’m wrong, Apple will eventually tap this market segment out. What then?
There are two options for growth which businesses have relied on for decades in the face of plateauing sales. Offer something that the competition doesn’t have. Or offer a lower cost version of what you are selling.
A couple of years back, it was in vogue for financial analysts to call on Apple to offer a low-cost iPhone after the iPhone 6s failed to live up to the iPhone 6 sales. I stand by my earlier assessment of that solution. That would have been a grave mistake. In hindsight, the premium phone market still 3 more years of healthy growth. If Apple had done that, we probably wouldn’t have the almost all screen iPhone X with FaceID. Big investments need big volume.
Keep iOS Exclusives
Before Apple goes down the low-cost iPhone route, they need to make an honest attempt to steal customers from Android by offering exclusive content and features. This will allow the iPhone to retain its premium brand image. FaceID is only really secure on iOS, TouchID doesn’t exist on Android yet, and AirPods work best on iOS. This is a great start, but all of these advantages are temporary and will be overcome by Android in the future.
It’s time for Apple to mash the accelerator and add exclusivity that can’t be replicated on Android. That is original video content. Until now, Apple has had it relatively easy. They never really had to fight for iPhone growth. Apple simply made as many iPhones as they could and they all sold out. This may not always be the case.
If the premium iPhone market starts to stall, Apple needs to do something that haven’t needed to do in the past. Offering video services that you can only get on iOS, maybe for free, is a proven way to get customers to change their spending habits. When Howard Stern moved to SiriusXMcustomers changed platforms. When CBS made Star Trek Discovery exclusive, customers signed up for a new service. Media exclusivity has a power that transcends above our habits. And it can’t be replicated by other platforms.
Apple has the cash to build a huge wall of media exclusivity. It would be the height of insanity to give away this potential advantage in the name of starting a streaming business that is ultimately insignificant.
Hardware Pricing Re-Visited
Apple may also need to reconsider their hardware pricing as well. If Apple truly wanted to sell their media services at a profit, it may be better to cut the price on devices such as the Apple TV or HomePod than to offer the services on Amazon’s platform. Gross margins on the Apple TV or HomePod become almost irrelevant if their purpose is to support the iPhone ecosystem.
I also would have no problem with Apple dabbling with a “low-cost iPhone” if growth of the premium segment turns out to be over. Only, I’d encourage Apple to consider creating another brand. I’ve written before that if Apple chose to play the low-cost game, they could devastate the competition. They have the volume, purchasing power, and manufacturing know-how to be extremely formidable in the low-end market. The only reason Apple hasn’t done it yet is because they don’t want to exchange high-margin iPhone sales with lower-margin devices.
However, I think that if Apple created another brand of phone it could be done right. They could use lower cost materials, share some under-the-hood components, and only sell online. There shouldn’t be an Apple logo anywhere on this device. If Apple did this cheaper iOS phone they could probably have a quality device for $299 and rock Android’s world. Especially in the developing nations where people sell their privacy to get a decent phone that they can afford. With Apple they could have both.
And Apple would get two major things. First, as iOS market share increases so does the stranglehold that iMessage has on retaining iPhone users. And second, all of these new iPhone users would probably purchase Apple services. iCloud, Apple Music, and iTunes sales would all go up.
Which brings me back to my original assertion. If Apple chooses to prioritize hardware sales, either by exclusive content or lower priced devices, service revenue will go up. This is the right way to do it. Without hardware, there are no services.
When I was working in the PC industry, I witnessed what happened when years of annual double-digit PC sales growth plateaued. Gateway Computers tried to say that software and service revenue was the panacea. We launched a huge push internally titled “Beyond the Box” in which we tried to get customers to sign up for various subscriptions or buy more software. The hope was that PC unit sales might decline but we’d make it up with our current customers by going for higher revenue per customer.
It worked short-term but not in the long run. Eventually our installed user base shrunk to the point that it outweighed our higher revenue per customer. I still remember one Gateway VP saying that “We tried so hard to push ‘Beyond the Box’ but instead we found out that without the box, there is no beyond”. Apple will have the same problem.
Apple needs more hardware customers, not richer ones. And when global iPhone market share is at under 20% it’s incorrect to say that they’re just not enough people on the planet for Apple to sell new iPhones to. Theoretically, Apple could reap double-digit sales increases for years to come if they could steal from Android.
Service revenue growth comes from two directions. First, current iPhone users may decide to purchase more Apple services above and beyond what they were paying for. Second, Apple could try and get new service customers via new iPhone converts.
The point of this whole post is that Apple needs to find new customers, not just trying to milk more money out of their current customers. Milking more money out of their current customers is a short term play that will roughly follow the same track as their installed device base. The more active devices that are in use, the higher the service revenue will be. And the lower the base, the lower the service revenue.
But if Apple actively prioritizes hardware sales first, they will get the service revenue as an added bonus. Most Apple service revenue is going to come from Apple iPhone users. Even for Apple services on the Amazon Echo or Android devices, it’s a safe bet that these are households where the account holders are iPhone users. Like iPhone users who already owned an Amazon Echo in the kitchen or households where a teenager is on Android but everyone else in the family is on iOS.
So if Apple pursues hardware sales, they will get a nice bump in service revenue. If they pursue service revenue in a way that is disconnected from hardware, they could actually see a decrease in hardware sales and an eventual decrease in service revenue.
The question becomes “How do they increase hardware sales?”.
Where there’s smoke, there is often fire. And I think that there may be something to all of the rumors that iPhone unit sales are down this year. It’s starting to look like Apple is coming close to the end of the road with finding more of the high-income customers who value quality and craftsmanship above price. Even if I’m wrong, Apple will eventually tap this market segment out. What then?
There are two options for growth which businesses have relied on for decades in the face of plateauing sales. Offer something that the competition doesn’t have. Or offer a lower cost version of what you are selling.
A couple of years back, it was in vogue for financial analysts to call on Apple to offer a low-cost iPhone after the iPhone 6s failed to live up to the iPhone 6 sales. I stand by my earlier assessment of that solution. That would have been a grave mistake. In hindsight, the premium phone market still 3 more years of healthy growth. If Apple had done that, we probably wouldn’t have the almost all screen iPhone X with FaceID. Big investments need big volume.
Keep iOS Exclusives
Before Apple goes down the low-cost iPhone route, they need to make an honest attempt to steal customers from Android by offering exclusive content and features. This will allow the iPhone to retain its premium brand image. FaceID is only really secure on iOS, TouchID doesn’t exist on Android yet, and AirPods work best on iOS. This is a great start, but all of these advantages are temporary and will be overcome by Android in the future.
It’s time for Apple to mash the accelerator and add exclusivity that can’t be replicated on Android. That is original video content. Until now, Apple has had it relatively easy. They never really had to fight for iPhone growth. Apple simply made as many iPhones as they could and they all sold out. This may not always be the case.
If the premium iPhone market starts to stall, Apple needs to do something that haven’t needed to do in the past. Offering video services that you can only get on iOS, maybe for free, is a proven way to get customers to change their spending habits. When Howard Stern moved to SiriusXMcustomers changed platforms. When CBS made Star Trek Discovery exclusive, customers signed up for a new service. Media exclusivity has a power that transcends above our habits. And it can’t be replicated by other platforms.
Apple has the cash to build a huge wall of media exclusivity. It would be the height of insanity to give away this potential advantage in the name of starting a streaming business that is ultimately insignificant.
Hardware Pricing Re-Visited
Apple may also need to reconsider their hardware pricing as well. If Apple truly wanted to sell their media services at a profit, it may be better to cut the price on devices such as the Apple TV or HomePod than to offer the services on Amazon’s platform. Gross margins on the Apple TV or HomePod become almost irrelevant if their purpose is to support the iPhone ecosystem.
I also would have no problem with Apple dabbling with a “low-cost iPhone” if growth of the premium segment turns out to be over. Only, I’d encourage Apple to consider creating another brand. I’ve written before that if Apple chose to play the low-cost game, they could devastate the competition. They have the volume, purchasing power, and manufacturing know-how to be extremely formidable in the low-end market. The only reason Apple hasn’t done it yet is because they don’t want to exchange high-margin iPhone sales with lower-margin devices.
However, I think that if Apple created another brand of phone it could be done right. They could use lower cost materials, share some under-the-hood components, and only sell online. There shouldn’t be an Apple logo anywhere on this device. If Apple did this cheaper iOS phone they could probably have a quality device for $299 and rock Android’s world. Especially in the developing nations where people sell their privacy to get a decent phone that they can afford. With Apple they could have both.
And Apple would get two major things. First, as iOS market share increases so does the stranglehold that iMessage has on retaining iPhone users. And second, all of these new iPhone users would probably purchase Apple services. iCloud, Apple Music, and iTunes sales would all go up.
Which brings me back to my original assertion. If Apple chooses to prioritize hardware sales, either by exclusive content or lower priced devices, service revenue will go up. This is the right way to do it. Without hardware, there are no services.
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