Apple Services Tracking To 20% Of Revenue In Five Years

Apple Services Through 2022. We have written about the need for Apple to reinvent itself in the next decade through services and AR. The Services reinvention is already underway, accounting for 11.6% of revenue in 2016, and closer to 18% of profits. Today we are rolling out our 2022 Services model, and estimate services revenue will account for 20% of Apple’s sales in five years, 30% of profits and growing at 15% annually. For comparison, we estimate Apple’s hardware sales will be growing at about 5% in 2022. This translates to $60B in 2022 Services revenue up from our estimate of $30B in 2017. This growth will in part be maintained by App Store revenue from Apple’s advancement of augmented reality (AR) that will be the company’s next major development platform. We expect AR will be a key feature in the upcoming iPhone X release (more on that here), which will slowly build developer enthusiasm for AR apps.

Beyond 2022. Apple should easily hit its stated goal that its Services business will become a Fortune 100 company sometime in 2017. Thinking about Services beyond 2022, we believe Services will have a steady 10% growth, and account for three quarters of Apple’s overall growth. This will be driven primarily by the App Store, Apple Music + Content, with all three areas strongly benefitting from the addition of AR.

App Store. By 2022, we expect App Store revenue to account for 44% of Services revenue and be growing at 14% annually, due to Apple’s continued leverage of revenue share with developers. Apple will continue to see App Store revenue account for a major portion of total Services revenue. The emphasis on AR capabilities in the iPhone X will be the next foundation for developers, creating an even playing field for creation and distribution of AR content. It’s worth noting that we don’t expect an acceleration of App Store growth from AR; rather, developers will view adoption of AR as fundamental to a mobile experience, and a necessity to maintain existing users and compete for new ones. Our App Store growth goes from 29% in 2017 to 14% in 2022.

Apple Music + Content. By 2022, we expect Apple Music + Content revenue to account for 23% of Services revenue, growing at 30% annually. We remain optimistic on the future of Apple Music. Despite a rough start, Apple has steadily built its music subscriber base to roughly 25m (as of Feb. 2017). By the end of 2017/early 2018, we expect Apple to begin offering additional video content as well, including its own original content (more on that here). While this pursuit adds Apple to an already tight freeway of content producers and providers like Netflix and Amazon, Apple’s combination of AR and VR related hardware and content could offer some differentiation.

Growth in this segment is ultimately dependent on Apple’s investment in the quantity and quality of its content, en route to its internal goal of 100 million Apple Music + Content subscribers by 2022. Apple is well on its way to achieving this target with roughly 25m music-only subscribers to date, while the preponderance of future subscriber adds will need to come from a hybrid music/content offering.

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Apple’s Progress With Apple Pay

Over the next 5-10 years, we believe augmented reality will emerge as the next dominant computing paradigm and that Google and Apple will provide the operating systems that power AR computing. The OS will need to incorporate core technologies including artificial intelligence, maps with points of interest, organized informational data, social data, a developer community, content, and payments. In what follows, we focus specifically on the payments element and report on the state of the union of Apple Pay.

Apple Pay State Of The Union:

  • 2,091 banks accept Apple Pay globally, up from 1,439 in July of 2016.
  • We estimate about 13% of active iPhones have activated Apple Pay.
  • We estimate 30% of new iPhones are activating Apple Pay.
  • 53% of retailers listed as “coming soon in browsers” have launched in the first 6 months.
  • 31% of retailers in the Internet Retailer 100 accept Apple Pay, up from 28% in Oct.
  • 44% of retailers in the Internet Retailer 100 have adopted Apple Pay at point of sale.
  • 40% of retailers in the Internet Retailer 100 have adopted Apple Pay in-app.
  • 13% of retailers in the Internet Retailer 100 have adopted Apple Pay in mobile browsers.
  • 9% of retailers in the Internet Retailer 100 have adopted Apple Pay in desktop browsers.
  • 22% of all possible points adoption leverage Apple Pay within the Internet Retailer 100.

Apple Pay adoption trend since Oct, 2016. In March 2017, we counted 31 of the Internet Retail 100 accepted Apple Pay in some form.  In October 2016, while at Piper Jaffray, we counted 28 of the Internet Retail 100 accepted Apple Pay in some form, including point of sale, mobile and desktop (excluding in app).

A better way to measure Apple Pay adoption. We looked at the Internet Retailer top 100 online sites to gauge adoption of Apple Pay. Next, we created an Apple Pay adoption score that looks at current retailer adoption as a percentage of potential adoption. There are 4 ways a retailer can adopt Apple Pay, including point of sale, in app, mobile and desktop browsers. This equates to maximum of 316 Apple Pay adoption points within the Internet Retail 100, considering that only 62 offer point of sale and 54 offer an app. We found 22% Apple Pay adoption in March 2017, or 71 of 316 possible points of adoption. Since this is the first time we have measured the adoption score, we don’t have a comparative score.

Point of sale. Apple Pay has 44% adoption at point of sale within the Internet Retailer 100. 62 of the top 100 online retailers offer point of sale; among them, 27 accept Apple Pay in store. Apple Pay launched at retail and in-app in the fall of 2014. Apple added Apple Pay for mobile and desktop browsers in the fall of 2016. In other words, the company has had over 2 years to build adoption at point of sale. Apple Pay at point of sale works with a broader tap and pay network; most locations that accept Apple Pay also accept other tap and pay offerings including Google Wallet and Samsung Pay. Since this our first measurement, we don’t have a comparative number. Bottom line: adoption of Apple Pay at point of sale is growing nicely, in-line with growth among other digital payment players, including Google and Samsung wallet.

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AirPods Are More Important Than The Apple Watch

At this point, it might not even be that crazy to say it, but we think AirPods are going to be a bigger product for Apple than the Watch. After using AirPods for the past month, the Loup Ventures team is addicted. The seamlessness in connecting and disconnecting with our phones and enabling Siri has meaningfully improved the way we work and consume content. AirPods are a classic example of Apple not doing something first, but doing it better. And they look cool. We think there are three reasons that AirPods are more important than the Apple Watch.

AI-First World
Google has been talking about designing products for an AI-first world for about a year now. In our view, an AI-first world is about more natural interfaces for our screen-less future. Speech is an important component of the next interface. Siri, Alexa, Google Assistant, and Cortana are making rapid improvements in terms of voice commands they understand and what they can help us with.

We view AirPods as a natural extension of Siri that will encourage people to rely more on the voice assistant. As voice assistants become capable of having deeper two-way conversations to convey more information to users, AirPods could replace a meaningful amount of interaction with the phone itself. By contrast, using Siri on the Apple Watch is less natural because it requires you to hold it up to your face. Additionally, the screen is so small that interaction with it and information conveyed by it is not that much richer than an AI voice-based interface.

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The Five Senses of Computing

The trend in computing towards more natural user interfaces is unmistakable. Graphical user interfaces have long been dominant, but machines driven by more intuitive inputs, like touch and voice, are now mainstream. Today, audio, motion, and even our thoughts, are the basis for the most innovative computer-user interaction models powered by advanced sensor technology. Each computing paradigm maps to one or more of the five human senses; exploring each sense gives us an indication of the direction in which technology is heading.

Sight – Graphical User Interface

The introduction of the graphical user interface (GUI) drove a step function change in computers as productivity tools, because users could rely heavily on sight, our dominant sense. The GUI was then carried forward and built on with the advent of touchscreen devices. The next frontier for visual user interfaces lies in virtual reality and augmented reality. Innovations within these themes will further carry forward the GUI paradigm. VR and AR rely heavily on sight, but combine it more artfully with other inputs like audio, motion, and touch to create immersive interfaces.

Touch – Touchscreen Devices

PCs leveraged basic touch as a foundational input via the keyboard and the mouse. The iPhone then ushered in a computing era dominated by touch, rejecting the stylus in favor of, as Steve Jobs put it, “the best pointing device in the world” – our fingers.  Haptics have pushed touchscreen technology further, making it more sensory, but phones and tablets fall well short of truly immersive computing. Bret Victor summarized the shortcomings of touchscreen devices in his 2011 piece, A Brief Rant on the Future of Interaction Design, which holds up well to this day.

More fully integrating our sense of touch will be critical for the user interfaces of the future. We think that haptic suits are a step we will take on the journey to full immersion, but the best way to trick the user into believing he or she is actually feeling something in VR is to manipulate the neurochemistry of the brain. This early field is known as neurohaptics.

Hearing – Digital Assistants & Hearables

Computers have been capable of understanding a limited human spoken vocabulary since the 1960s. By the 1990s, dictation software was available to the masses. Aside from limited audio feedback and rudimentary speech-to-text transcription, computers did not start widely leveraging sound as an interface until digital assistants began to be integrated into phones.

As digital assistants continue to improve, more and more users are integrating them into their daily routines. In our Robot Fear Index, we found that 43% of Americans had used a digital assistant in the last three months. However, our study of Amazon Echo vs. Google Home showed that Google Home answered just 39.1% of queries correctly vs. the Echo at 34.4%. Clearly we’re early in the transition to audio as a dominant input for computing.

Hearables, like Apple’s AirPods, represent the next step forward for audio as a user interface.

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AirPods: The First Mass Market Hearable

Apple’s AirPods are a step towards the future of computing. Starting with the move from the keyboard and mouse to the touchscreen, computing continues to move towards more intuitive user interfaces. Audio and motion capture are the basis for most innovative computer hardware today, including wearables. And we think that voice-controlled wearables, like AirPods, show a lot of promise. We call them hearables.

In order to look forward to the impact of AirPods on the future of computing, it helps to first look back at how sound has evolved as an interface. Computers have been capable of understanding a limited human vocabulary since the 1960s. By the 1990s, dictation software was available to the masses. Aside from limited audio feedback and rudimentary speech-to-text transcription, computers have not leveraged sound as an input or as an interface until natural language processing matured in the early 2000s.

As digital assistants continue to improve, more and more users are integrating them into their daily routines, and AirPods make that even more convenient. In our Robot Fear Index, we found that 43% of Americans had used a digital assistant in the last three months. However, our study of Amazon Echo vs. Google Home using 800 different everyday queries showed that Google Home answered just 39.1% of the queries correctly vs. the Echo at 34.4%. We’re early in the transition to audio as a dominant input for computing.

Hearables, like Apple’s AirPods, represent a giant leap forward for audio as a user interface. Now, Siri is always available and your phone stays in your pocket. In fact, using AirPods necessarily means using your phone less frequently – or at least pulling it out of your purse or your pocket less frequently. AirPods can handle information requests, dictation, media control, and phone calls; meanwhile, quick glances at the Apple Watch on your wrist will suffice for most notifications. All of this means that your phone stays in your pocket. As Jason Calacanis declared just yesterday, “AirPods are the new smartphone.” And we believe audio as a UI is a key enabler of AR technology. AirPods may not be perfect, but they’ll get better, smarter, and easier to use. They are just the beginning for hearables and a new wave of computing.

We surveyed 55 AirPods users to better understand the state of the early hearables market. We were surprised that AirPods received a net promoter score (NPS) of -2, which means that the number of detractors, passives, and promoters were split roughly in thirds, with slightly more detractors than promoters.

While an NPS of -2 could actually represent relative outperformance within the bluetooth headphones category, AirPods clearly have some kinks to work out if hearables are going to perform more of our daily computing. Among detractors and passives, half identified the ear fit as the opportunity for improvement, not the software or functionality. So, we remain convinced that AirPods and other hearables will play a big role in shaping the future of how we interface with our devices and with each other.

Disclaimer: We actively write about the themes in which we invest: artificial intelligence, robotics, virtual reality, and augmented reality. From time to time, we will write about companies that are in our portfolio.  Content on this site including opinions on specific themes in technology, market estimates, and estimates and commentary regarding publicly traded or private companies is not intended for use in making investment decisions. We hold no obligation to update any of our projections. We express no warranties about any estimates or opinions we make.