The Services iPhone
Source: (Stratechery)

It was in “2016 that Apple first articulated the so-called “Services Narrative”; after a quarter in which the company’s new iPhone 6S posted relatively disappointing sales, CFO Luca Maestri made the case on the earnings call that it was a mistake to think of Apple as a hardware company, subject to the vagaries of consumer demand.” Since the birth of the services narrative, Apple’s trailing number of paid subscriptions across its suite of services has expanded from 150M to 860M. $AAPL

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Services revenue stood at $24.3B in 2016 and would expand to $68.3B by 2021, with the rate of growth accelerating from mid-teens to mid-20s in the five years before and after Luca coined that sentence. Already this year, with one quarter remaining, services have racked up $58B in revenue. Not only has the segment grown, but it has also become a more integral piece of Apple’s revenue composition, accounting for ~19.4% of the revenues Apple has collected so far in 2022, up 810 bps from 2016.

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Ben Thompson, someone who has been writing about Apple for near enough a decade, possibly longer, felt unconvinced about this new narrative in 2016; remarking that “Apple’s services revenue numbers are impressive, but it is very clear that the company remains a differentiated hardware company”. It is typical of a premium hardware business to focus on product quality and be unrelenting on cost. Conversely, it is the intention of a services business to focus on increasing the number of subscribers. These two goals appear to be in competition with one another. Apple has long juggled both of these contesting factors but has historically placed more emphasis on the former. Put differently, they have been a hardware business first, and a services business second. In this memo that I share today, Thompson revisits a plethora of his older articles discussing Apple’s product launches and competitive position, and fathoms an updated conclusion on Apple’s services narrative based on the actions that the company took in their latest September product release.

On a somewhat related sidenote, I wanted to shout out Liberty for his perspective on Apple in a recent edition of Liberty’s Highlights.

  • “What I want to focus on is the dance that happens on every iPhone release: A bunch of people will complain that there’s no innovation and it’s the same as last year, while others will be overjoyed at the new goodies and improvements. I think the dichotomy is largely caused by expectations and what you’re looking for. If what you want is a mind-blowing demo on stage for a totally new product or feature that nobody had ever thought about, you’re going to be disappointed often, because even back in the Steve Jobs era, there were years between big category-defining moments (from iMacs to iPod, to iPhone, to iPad...), and that was at a time when both computers and mobile devices were a lot less mature than they are now, so changing more quickly. Apple has always been more about iteration than anything else, really. Sure, once in a while they make a big splash by entering a category with a big leap forward over the rest of the field, but it’s the relentless refinement for years after that which makes them hard to compete with. Especially since almost nobody buys a new iPhone or Mac every year, so the absolute improvement after 2-3-4 years is pretty huge.” Liberty

A common critique of Apple is that “they don’t innovate anymore”, and this grates me somewhat because it demonstrates a lack of understanding with regard to the business life cycle and the nuances of innovation; a word which has lost much of its meaning today. Radical innovation, that which is truly paradigm shifting, is like lightning. It comes around seldom, and when it does it strikes hard and fast before disappearing. Incremental innovation then takes the reigns and moves the world along one piece at a time. This is particularly true in more mature markets; as voiced by Jim McKelvey:

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Quote from The Innovation Stack

Just 15 years ago, few knew what a seamlessly internet-enabled smartphone was, let alone an iPhone. Today, we are essentially cyborgs with supercomputers (and high-quality cameras) strapped to our palms; capable of things that would be thought unimaginable at the turn of the century. 15 years is such an incredibly short space of time, and it amazes me how few people appreciate that. You could argue that following the iPad in 2010, there has been no radical innovation, sure. But the incremental innovation that has taken place in between has still been phenomenal in my book. This is not me suggesting Apple is still as dominant 30 years down the line. Rather, the notion that Apple is past its peak is strenuously exaggerated.

  • “Very few people just buy an iPhone: they upgrade to a higher-priced model, they spend money in the App Store and on subscriptions, and they buy an Apple Watch and AirPods that work seamlessly with their phone. The end result is that Apple isn’t making $550 per customer, to go back to the iPhone 5C, or $650 in the case of the 5S: they’re making upwards of $2000 — $1,000+ for a top-of-the-line iPhone, $400+ for a Watch, $200+ for AirPods, and all of that App Store revenue (and this doesn’t even include what is likely a thriving accessories business, AppleCare, or the Google search deal).” - Ben Thompson
Invested Thought's avatar
Loved reading this. I've never thought about how the replacement cycle magnifies the upgrade in the mind of the consumer since you're going from a 2-3 year old device to a new one, but it's so true!
Conor Mac's avatar
@investedthought Yea, works in practice too. I have a 12 right now, but not super compelled to upgrade to a 14. When I had a 10, the leap from 10 to 12 was pretty huge imo.

My partner went from an 8Plus to a 13 Pro Max and it was like night and day.
StockOpine's avatar
Fantastic piece Conor. Especially, the explanations on what innovation is.
Conor Mac's avatar
@stockopine innovation was my masters subject. Not that this really means anything, but it helped me appreciate just how special radical innovation is.
StockOpine's avatar
@investmenttalk it definitely means something especially when you perform stock analysis. You have an edge on that which others may not.

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