Why Apple Needs to Get Beyond iPhone

(Bloomberg Gadfly) -- Apple Inc. says it's more resilient than a typical hardware company. This is more hype than reality, but I can't ignore the potential upside if Apple is serious about web video, digital music, and its other internet-centric software. 

Technology watchers know that Apple has been stressing how many people who own iPhones, Macs and iPads are also buying from its App Store, iTunes, iCloud data storage and other web-based services. Chief Executive Officer Tim Cook's vision is that these non-hardware services will ensure Apple's fortunes no longer rise or fall with the release of each shiny new iPhone. Earlier this year, he predicted Apple services business would double by 2020, from what at the time was about $25 billion in annual revenue. 

The big question, though, is whether Cook's vision of Apple as a predictable, internet-centric company is real, and whether the company can do much more to transform itself. It's fun to sketch out the possibilities, along with my doubts.

One idea that has made the rounds is Apple could charge a monthly fee to cover the cost of an iPhone and its warranty program -- Apple does this a bit already -- plus a subscription to Apple Music and perhaps more of the company's web offerings. The idea is even more interesting if Apple can include a web video service with exclusive programs.

Barclays analysts in August also floated the possibility of Apple selling a top-of-the-line iPhone that comes with a free one-year subscription to Apple Music and iCloud. More recently, Midia Research suggested Apple sell a discounted subscription to Apple Music for the company's forthcoming HomePod voice-activated speaker. 

The motivation behind these ideas is twofold: Apple can sweeten the appeal of a high-priced iPhone or speaker, and give people a chance to try -- and hopefully stick with -- Apple's internet services. These Apple hardware-plus-software ideas are intriguing, and I'm surprised Apple hasn't at least experimented with selling bundles like this. Maybe it will. 

And while I'm curious to see Apple product bundles, I have doubts about them. First, a lot of Apple software is subpar. That's been fine because the point of iTunes, iCloud and iMessage is that they work well with Apple’s devices. But if Apple wants its software to sell itself, then it needs to be better. 

Second, Apple investors love the idea of the company's services generating fatter profit margins than Apple's hardware. But that isn't necessarily so. Margins must be high for iCloud and the App Store, where Apple's costs are low. But the same isn't true for digital music and a potential Apple video service. 

Apple is likely paying more than half of music streaming revenue to record labels, and other groups take a cut. That means Apple Music's gross margins are likely worse than those on iPhones. Digital video isn't necessarily a high-margin business, either. Netflix had gross margins of 33.8 percent in the 12 months ended in September, compared with Apple at 38.5 percent, according to data compiled by Bloomberg.

Third, there are questions about whether Apple services revenue can keep growing if iPhone sales don't. An analysis this summer by Pacific Crest estimated Apple services -- excluding Apple Music and the App Store -- had generated a compound annual growth rate of 3 percent in the last three years. (The reported revenue growth rate in the latest fiscal year was 23 percent, which included a one-time adjustment of $600 million.)

Part of the relatively slow growth was due to a decline in iTunes downloads, but Pacific Crest also believed revenue from Apple's other services had grown more slowly than the number of people using iPhones, and that App Store sales had peaked. That suggests Apple may not be consistently successful at drawing more money from the one billion-plus company devices in active use. 

All that said, I want Apple to experiment with packages of its hardware and software. It's an appealing proposition for shoppers. But Apple's purported transformation into an internet company is more complicated than meets the eye.

A version of this column originally appeared in Bloomberg's Fully Charged technology newsletter. You can sign up here.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

Shira Ovide is a Bloomberg Gadfly columnist covering technology. She previously was a reporter for the Wall Street Journal.

  1. Perhaps not coincidentally, Apple gave this forecast at the same time it reported a slight dip in sales of iPhones, which remain the company's biggest source of revenue. 

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