The problem with Apple's service strategy – The Motley Fool

The iPhone powered Appleof (NASDAQ: AAPL) incredible growth over the last decade. But the smartphone market is no longer growing. Global smartphone shipments fell 4.9 percent in the fourth quarter of last year, and Apple's unit shipments dropped 11.5 percent, according to IDC. The price increase has been working for a while, but not anymore. Apple expects its total business figure will decline in the second quarter of its fiscal year, as growth other than that of the iPhone does not offset the weak sales of its flagship product.

As iPhone hardware is no longer growing, Apple is making a lot of noise about the services. The company has an installed base of approximately 1.4 billion devices, which represents a seemingly massive opportunity to sell subscriptions to Apple users. As part of its strategy, the technology giant unveiled four new services at an event, including a news subscription service, a personalized credit card, a mobile gaming subscription service, and a service. highly anticipated video streaming that targets the Netflix.

From what I can say, Apple's bullish reasoning is: "Yes, the iPhone sector is struggling, but growth in services can largely offset." Here is the problem I see with this line of reasoning.

The numbers are too big

First, a note on the service sector of Apple. The company generated a revenue of $ 37.2 billion in services in 2018, up 24% from the previous year. But more than half of these revenues come from non-services products, in the sense that consumers do not choose to pay for them.

The biggest contributor is the App Store, where Apple takes a reduction in sales and app subscriptions. The App Store is the only way to buy apps on iOS devices. Consumers do not have a choice. The second largest contributor is the payment license paid to Apple, especially from Google, which makes its search engine the default engine of the Safari web browser. Again, not really a service.

Services like Apple Music, iCloud and AppleCare – for which consumers choose to pay – each generate between $ 4 billion and $ 5 billion in annual revenue, according to UBS estimates. These are not small businesses, but they are small compared to the size of Apple. Apple's service revenue, which includes only what consumers choose to pay, is well below the figure.

Apple needs to significantly and rapidly expand this part of its service business to offset the drop in iPhone sales. It's a daunting challenge because the iPhone generates a lot of revenue. Offsetting, even with a slight decline in iPhone sales with new services, is a herculean task.

IPhone sales generated revenues of $ 166.7 billion in fiscal 2018. If annual iPhone revenue drops 10%, it's a $ 16.7 billion deficit society has to fill. The iPhone business figure fell 15% in the first fiscal quarter of Apple. A double digit decline for the year is not to be ruled out.

It will be difficult to fill such a big money pit with services:

Even if Apple manages to develop a Netflix-wide video streaming business, or a huge game subscription company, or a huge new business, profitability is another problem. Will some of these efforts be as profitable as selling the iPhone?

Netflix is ​​profitable, but only on an accounting basis. His cash flow is deeply negative because he pours money into the content. Apple will have to be just as aggressive with content spending to have a chance. Spotify is not profitable and Apple Music is probably not synonymous. Apple's news and gaming subscription services may have the best chance of generating profits, but they are unlikely to become big enough to move the needle.

I have no doubt that Apple will be able to increase its service revenues in the coming years. But if the discomfort of the iPhone is something other than a short-term phenomenon, the services will simply not be enough.