Apple’s management is starting to tell a new type of story. Understanding this story is key to understanding their growth strategy. Listening to management and fitting what I heard into what I’m seeing globally in consumer markets, I believe Apple’s growth thesis is built on the following assumptions.
The Apple Experience as a Service
Apple is trying to paint the picture that they are not just a pure-play hardware company. At first blush, this sounds like a tough argument to make. However, it is essential they make it. Having studied the history of this industry, we can predict time and time again a market shift from value lying in hardware, then shifting to software, then finally moving to services. This is why a company like Google or Amazon, who started off as services companies, are valued the way they are. Wall St. doesn’t love hardware companies (see Fitbit and GoPro) but they do love software and services companies.
Apple makes most of their money in hardware but building the services narrative is central. This is exactly what they are doing by making the following points:
1) Our installed base is large and growing
2) Our customers spend a lot of money in our ecosystem
3) Our customers never (or rarely) leave us
Every one of these themes was part of an overarching story Tim Cook told on the earnings call and they are all true.
The services story compounds. Some time ago, a very smart executive told me the most brilliant thing Apple did was sell you a piece of hardware, the iPhone, and get you to spend $1 a day (on an app). That was early in the adoption cycle of iPhones when apps were all the rage. Now, Apple is looking to get you to spend a predictable monthly amount on everything from cloud services, like iCloud photo sync and storage, Apple music for $10, and eventually a TV service at $X per month, along with anything else.
So, look at the services story this way. Between subscribing to hardware and services, Apple can potentially offer a consumer the full Apple experience for $X per month. Let’s just say, beyond the hardware margin, Apple succeeds in having their base adopt Apple Music for $10, Apple TV for $20 per month or $50 per month for family (I’m just making these numbers up to make a point), and cloud storage and all data in sync for $5 per month. If they get 100m people, or less than 20% of their user base, to buy into this, well, You can do the math but that is significant revenue from services. And it seems modeling that at a family or individual level is not that much of a stretch given what we know about Apple’s customer base spend in the ecosystem.
One other area I have been thinking about is Apple’s services opportunity to enterprises. As iPhones, Macs, and iPads continue to increase in share of enterprise sales, perhaps partnering deeper with IBM or developing new business services can lead to revenue from the enterprise world as well.
Well Positioned as Consumer Mature
Another key thesis I believe Apple has about their products is related to markets as they mature. Apple has seen, as have I with our research, that as consumers become more mature in their technology needs, greater and greater percentages of people not only strongly consider Apple’s products but do in fact buy them. This is why the Mac keeps outperforming the continually negative PC market. As consumers PC needs mature, Apple is attracting more customers looking for greater value, product quality, customer service, longer life, lower total cost of ownership, and more.
This was framed by Tim Cook when he made a point about China LTE device penetration to be about 20%. A buyer of an LTE device is a more “mature” customer who is about to buy their second or likely third smartphone. This buyer will be more aware of what they want and what they don’t want and thus, Apple believes will be more likely to consider an iPhone. At 20% LTE device penetration, his point is there will continue to be a huge opportunity to compete for these customers.
Now China is a unique market. Even with the currency issues and foreign exchange, Apple sold more iPhones in mainland China than in any other December quarter. And even by the end of January, I still see continued momentum on the ground for sales in China. Other markets are much more difficult. While consumers in China are more tolerant of iPhone price increases due to foreign exchange, other markets are not.
Reading between the lines, what I gather is Apple believes they are well-positioned when global markets recover. iPhones and other Apple products will still not be the cheapest but, as India (a market Apple said was up 76% to approximately 800,000 to 900,000 unit sales for the quarter) further develops and their customer base matures and starts upgrading devices, Apple believes they will be competitive.
It is worth pointing out Apple is competing for replacement customers, not first-time smartphone owners. The thesis here is, as the customer matures and looks to upgrade their Android device for the full Apple experience, Apple will be competitive. This is where continued innovation in the ecosystem and hardware, software, and services layer to truly differentiate their experience from anything you get on competing platforms is crucial.
Modeling the growth of net new additions to the Apple ecosystem will be tougher than before. More importantly, predicting when macroeconomic issues resolve will be even more difficult. Even the best economists in the world are continually wrong in their predictions.
At a fundamental level, both these growth points are related. Apple is trying to be the first fully integrated hardware, software, and services player in consumer tech. From a growth standpoint, we and Apple’s investors, need to figure out if we believe the services growth story and that Apple can gain meaningful share from Android.
Lastly, while my main points on hardware are related to the iPhone, since that is the short term emphasis, the rest of Apple’s hardware should be viewed in this light as well. The Apple Watch is not only going to become a serious revenue contributor but also a deeper lock-in, attractive to a switcher, etc. Apple TV, Mac, iPad, and anything else becomes not just a hardware sale but a portal to a rich services ecosystem. All the pieces are there.