Apple (AAPL) on Tuesday reported earnings that beat analysts’ expectations on both revenue and earnings per share. The company’s stock was up nearly 7% late on Wednesday morning, propelling the tech giant to a $1 trillion market cap.
But what stood out the most in the company’s Q2 2019 report was how much its services segment grew over the last quarter.
With iPhone sales stalling and the Chinese smartphone market dominated by home-grown handset makers, Apple has increasingly turned toward services for its next major growth opportunity. And with the business growing 16% year-over-year with $11.5 billion in revenue through the quarter, Apple’s services are proving to be a boon for the company.
There’s no doubt the iPhone will continue to be a steady source of revenue for Apple for the foreseeable future. But as its services side matures, the tech giant is beginning to look a lot more like some of its biggest Silicon Valley rivals, including Microsoft (MSFT) and Google (GOOG, GOOGL). That is, Apple is becoming a software company.
The services bet
Apple’s services segment is currently made up of iCloud, iTunes, the App Store, Apple Pay, AppleCare and Apple News+
The tech giant’s bet on services has been in the making for some time. Back in January 2017, CEO Tim Cook announced that he wanted Apple’s services to double in revenue by 2020. That means the segment will have to hit $48 billion a year by that deadline based on the company’s 2016 services revenue.
But that estimate came before Apple announced its Apple News+, its Apple TV+ and Apple Arcade offerings, which are expected to add to the services segment’s revenue when they debut later this year.
“The all-important Services business remains a linchpin to the company's valuation as we believe on a standalone basis this segment is worth between $400 billion and $450 billion and is still in the early days of being fully monetized with a new streaming service set to be officially unveiled/GA in the next 6 months that will compete with the likes of Netflix, Disney, and Amazon among others,” Wedbush analysts Daniel Ives and Strecker Backe wrote in a research note.
But Apple will have to get the pricing right on its Apple TV+ streaming service if it’s to truly take on its main rivals in the sector. We’re still waiting on pricing information from Apple, but with Disney+ set to launch at $6.99 per month and Netflix’s entry-level plan starting at $8.99, Apple will need to price its offering aggressively.
While Apple’s transition to a services company comes as the tech giant’s iPhone sales have slowed, this isn’t a sleight-of-hand move to take the focus off of Apple’s iPhone troubles. The company currently has more than 1 billion active devices on the market, and pushing those users towards services represents a huge opportunity.
“Apple’s focus on services is justified. It is not an attempt to distract investors from declining iPhone sales — it is the natural extension of the hardware/software ecosystem Apple has built,” Loop Ventures’ Gene Munster wrote in a research note following Apple’s earnings report.
Microsoft and Google, some of Apple’s biggest rivals, are already well entrenched in the software space, with Google offering not only its massive search engine business and Android operating system, but Google Music and Google Play Movies and TV, as well, though Google doesn’t produce original shows or movies.
Microsoft, meanwhile, has its Windows business, not to mention its already enormous cloud segment, which continues to see massive growth. Microsoft has leveraged that cloud business to help push its own market cap to $1 trillion.
Sure, both Microsoft and Google offer their own hardware, with Microsoft selling its Surface line of products and Xbox console and Google its Pixel smartphones and tablet, but they don’t come anywhere near their respective software businesses.
iPhone will still be important
While Apple is leaning more toward software and services, and will continue to do so until the next major advancement in hardware comes along, iPhone sales will remain important to the company.
The iPhone still accounts for the vast majority of Apple’s revenue, and will continue to do so until the services segment is fully matured.
Apple’s install base is what makes the services business viable in the first place, so it will be imperative for the company to entice consumers to upgrade their existing handsets, and bring on new users.
But make no mistake — it will be services that help push the company going forward.
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