Apple's sweet talk about its $10.8 billion services business was totally undermined by Netflix
- Apple's stock crashed after it lowered its revenue forecast, blaming the Chinese economy and slowing iPhone sales.
- As a sweetener for Wall Street, CEO Tim Cook pointed to the $10.8 billion Apple makes from "services" such as the App Store, iCloud subscriptions, and Apple Music.
- Apple has long touted services as its new growth business.
- This would be more convincing if Netflix hadn't just undermined Apple by skirting the iTunes billing process.
Spare a thought for Apple and its raging New Year's hangover.
The company's stock price plummeted in after-hours and pre-market trading on Wednesday, as the company revised its revenue estimate for its first fiscal quarter down to $84 billion. Apple had previously told investors to expect revenue between $89 billion and $93 billion.
As Wall Street adjusted to the new reality of peak iPhone, Cook was handwaving: Look at our burgeoning services business! Lots of revenue!
Services, Cook wrote on Wednesday, "generated over $10.8 billion in revenue during the quarter, growing to a new quarterly record in every geographic segment, and we are on track to achieve our goal of doubling the size of this business from 2016 to 2020."
This is an important narrative for Apple, which has been trying to distract Wall Street from peak iPhone since about 2016, when it began talking up its "non-iPhone revenue." The idea is that Apple won't earn money forever from high-margin hardware like the iPhone, and instead can earn sustainable revenue by getting existing users to pay for services like the App Store, Apple Music, iCloud storage, and AppleCare.
This would be more convincing if it wasn't for Netflix
This isn't reassuring Wall Street just yet, and here's why.
Apple doesn't break down its services revenue, instead lumping various software revenue streams under the one umbrella. We don't know, for example, how much revenue iCloud subscriptions bring in versus Apple Music subscriptions.
We can calculate, though, that a decent chunk of the money comes from the App Store.
Apple splits app revenue with developers, skimming up to 30% off app subscriptions, purchases, and one-off payments.
The company said developers earned $26.5 billion from apps in 2017. Assuming this is after Apple sliced off its 30%, this suggests the company earned around $11.35 billion from the App Store for the full year 2017. Apple said it earned $29.9 billion from services in 2017, so that suggests App Store accounted for nearly 38% of services revenue that year.
This is a nice earner for Apple as long as developers keep playing ball. This isn't just about skimming 30% off flash-in-the-pan mobile games, but earning continuous revenue from subscriptions to beloved services such as Netflix and Spotify, which cost up to $170 a year.
Except developers are not playing ball.
Netflix has just altered its signup process so that iOS users won't be billed for their subscriptions through iTunes. That lets the streaming service dodge the 30% fee (or 15% after a year) that Apple charges and keep all the subscription money for itself. Netflix happens to be the app that currently earns the most money for Apple in the US.
Spotify has been fighting iTunes billing for years, asking lapsed subscribers to update their subscription directly through its website. In 2016, the company said Apple's fee was actively harming its business.
Amazon likewise dodges iTunes billing on Kindle ebook purchases, by forcing people to buy ebooks through its website rather than through the Kindle iOS app.
It's a case of bad timing for Cook that Netflix decided to pull its iTunes billing stunt just days before Apple announced lowered revenue and tried to point to services as the new growth business.
It isn't clear how Apple will respond to Netflix, or prevent other developers from taking the same route. The company may make an aggressive move and block the Netflix app, although it's difficult to see how that doesn't raise competition questions given Apple is currently building its own Netflix competitor.
Alternatively, Apple may cave and drop its fees further. But that would put the services growth narrative at further risk - and no amount of handwaving could help.