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)
Copyright (c) 2019 Dow Jones & Company, Inc.