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By Tripp Mickle
This article is being republished as part of our daily reproduction of WSJ.com articles that also appeared in the U.S. print edition of The Wall Street Journal (January 11, 2019).
Apple Inc. has held out its fast-growing services unit as a bright spot in an outlook dimmed by soft demand for the iPhone. But the services business faces challenges of its own.
Chief Executive Tim Cook last week underscored that business's importance in his investor letter warning of slowing iPhone sales, singling out $10.8 billion in services sales for the quarter ended in December. It was the only revenue the company disclosed from its five business segments and another spotlight on a fast-growing business that includes App Store sales, streaming-music subscriptions and mobile payments.
But Apple still relies on the iPhone for two-thirds of sales, and growth in services are threatened by a recent slowdown in App Store sales, nascent antitrust concerns and services like Netflix Inc. moving to avoid Apple's payment system.
Apple also hasn't shown a willingness to make its services vastly available beyond its devices, nor proven it can keep pace with tech rivals like Facebook Inc. and Alphabet Inc.'s Google that constantly modify software and tap a trove of personal data to customize products.
It is the tech-company equivalent of asking a tiger to change its stripes, said Ben Bajarin, a technology analyst with Creative Strategies. "Growing the services business is going to take a very different playbook," he said.
The tech landscape is dotted with hardware companies that have turned to services for growth. For companies like International Business Machines Corp., Hewlett Packard and Dell Technologies Inc., the transition came as they faced slowdowns in their core business and wasn't always smooth.
Those companies pushed into business services. Apple is focused on consumers, whose tastes can change rapidly. Its success hinges on driving sales of apps and new offerings like video content and news subscriptions.
Services have become Apple's fastest-growing segment. In 2017, Mr. Cook set a goal of doubling the business to $50 billion by 2020, a feat Apple is on track for after revenue rose 33% last fiscal year to $39.75 billion. The business accounts for 15% of total sales, up from 11% in fiscal 2016.
Apple last week reclassified its quarterly results for last fiscal year because of new accounting standards, shifting some product revenue to its services business.
But Apple's services are tied to the amount of iPhones, iPads and Macs in people's hands -- and growth in those devices has begun to slow.
Apple said total active devices increased 8% last year to 1.4 billion, a deceleration from the more than 15% compounded annual growth rate between 2015 and 2018.
The slowdown is pronounced in China, where iPhone demand has waned because of a weakening economy, rising smartphone competition and increasing popularity of WeChat, an all-in-one app from Tencent Holdings Ltd. for messaging, payments and more.
WeChat lives on top of Apple's iOS software, reducing iOS' differences from Android. It also offers apps that lessen the App Store's appeal.
In China, App Store sales rose 14% last year, shrinking from more than 120% compounded annual growth rate between 2012 and 2018, according to Sensor Tower, which tracks app spending.
Still, Mr. Cook said services revenue in China hit a record during the December period. "We believe our business in China has a bright future," he said in his letter to investors.
Outside of China, Apple continues to enjoy strong device loyalty with an estimated 90% retention rate of existing iPhone owners, said Horace Dediu, an analyst at Asymco and former Nokia Corp. executive. The number of people paying for services remains a small percentage of the 1.4 billion active devices and stands to grow in the years ahead, he said.
Apple has a mixed history in services. While iTunes and the App Store have been hits, Maps was initially plagued by inaccuracies and Apple Pay struggled to gain traction.
The App Store's success has overshadowed shortcomings. It is the largest contributor to services with about 35% of sales, according to investment bank Jefferies LLC. Apple, which takes 30% of store sales, has more than tripled store revenue since 2014 to $44.49 billion, according to Sensor Tower.
The App Store's momentum, though, may be slowing. Aside from China, sales growth in the U.S. fell slightly last year, according to Sensor Tower.
"You've tapped those markets out, and the spending power of the typical smartphone user in growing markets like India is nowhere near the U.S.," said Randy Nelson, Sensor Tower's head of mobile insights.
Meanwhile, Apple awaits a Supreme Court decision in a case that determines if iPhone owners can sue Apple for antitrust damages for its alleged monopoly on the App Store. Should the justices decide the case has merit, Apple would face a challenge to its 30% cut of App Store sales.
Netflix and Fortnite creator Epic Games Inc. already are trying to avoid sharing revenue with Apple. Netflix plans to stop using Apple's billing system for new customers. Epic Games is setting up its own app store, taking only a 12% cut of sales.
Licensing revenue -- the largest driver of revenue growth last year -- also is expected to slow. Google pays Apple up to an estimated $9 billion to be the default search engine on Safari internet browsers, but Google expects such acquisition costs to moderate after jumping last year.
In the face of those challenges, Apple is broadening the reach of Apple Music and iTunes movies. Apple Music is now available on speakers powered by Amazon's Alexa, and an iTunes movies and TV shows app will be available this year on new Samsung televisions while new LG and Sony TVs will be able to stream video from Apple devices.
The deals show Apple is open to valuing music and video subscriptions over HomePod speaker and Apple TV sales, said Mr. Bajarin. "You can't guarantee everyone is on iPhones," he said.
Analysts speculate Apple could offer a single subscription to multiple services like video, news and music. "An all-you-can-eat option...would be a no-brainer proposition for" some Apple customers, said Katy Huberty of Morgan Stanley.
Write to Tripp Mickle at Tripp.Mickle@wsj.com
(END) Dow Jones Newswires
January 11, 2019 02:47 ET (07:47 GMT)
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