Apple’s addition of services to its world-class combination of hardware and software has been a success by almost any measure. We expect continued growth in the Services segment, fueled by increased adoption and the introduction of new services that may be hiding in plain sight on our devices.
Services revenue grew 16% y/y in FY20 to $53.7B, and we expect the segment to grow 15% y/y in FY21 to $62B. For context, Apple’s Services business is nearly the size of a Fortune 50 company, by revenue. Based on Apple’s recent press release highlighting Services, App Store growth (we estimate the App Store is 35-40% of Services revenue) is accelerating faster than our expectations. During the 2020 holiday period, App Store customer spend was up 27% y/y, an acceleration from 16% y/y in 2019.
We can also measure success by paid users. Spotify, which was founded in 2006, had 144 million premium subscribers as of Sep-20. At that time, Apple Music was just five years old and had grown to about 85m subscribers, based on our estimates. This illustrates the power of services built on top of default apps.
Apple went all-in on its Services business during a March 2019 event, in which it announced Apple TV+, News+, Apple Arcade, and Apple Card to the existing suite of Apple services (iCloud, Apple Music, Apple Pay, and App Store — a service of services). At that time, Tim Cook outlined a clear vision for the Services business: “To help our customers get the most out of the products and to enrich lives.” He added that services were intended to make their companion apps “more entertaining, more useful and more informative.”
Services that deliver more
The playbook is relatively simple: give customers an option to pay a monthly fee to get more from the apps they use every day. So, when does the company decide to augment an app with a service? What services might Apple launch next?
During the 2019 Services event, Cook outlined several key elements of an Apple service: ease of use, attention to detail, privacy and security, personalization, and family sharing. We see these more as selling points.
In our view, the true requirements for Apple to launch a new service are:
- Add unique value to the existing hardware + software offering
- Improve the Apple ecosystem with deeper integration
- Generate high-margin, recurring revenue
Apple Services create digital leverage for the company, simultaneously adding value for the customer, enhancing integration within its ecosystem, and generating high-margin revenue.
Fitness+, a case study
Apple’s new Fitness+ provides a clear case study of the company’s vision for its services. Fitness+ delivers 1) unique value to Watch users with digital workout content that 2) integrates directly with your Watch for on-screen biometric data, and 3) costs $9.99 per month. Although Peloton digital and other workout offerings have long existed within Apple’s ecosystem, Fitness+ goes beyond what these digital workout platforms can deliver through Apple’s GymKit API, and offers more than the base Fitness app.
In sum, Fitness+ adds unique value to the current hardware + software offering, tightens the integration of Apple’s products, including Apple Watch, Apple TV, iPad, iPhone, and AirPods, and generates incremental, high-margin, recurring revenue.
Apple’s default apps that don’t yet offer a companion service provide a route to explore possible future services. The company could build on its existing suite of services in the following ways:
We recently predicted that 2021 is the year Apple will take a page from Spotify’s playbook and bundle premium podcasts (Podcasts+) with Apple Music and Apple One, at no extra charge for paying subscribers. The company’s podcast platform is losing tier-one podcasts to exclusive deals on Spotify. The Podcasts app needs a paid tier, Podcasts+, in order to compete. It would add unique value to the suite of Apple audio services, tie tightly into most products in the Apple ecosystem, and drive incremental interest in Apple Music and Apple One, generating high-margin, recurring revenue.
Personal productivity remains a largely untapped opportunity within the Apple ecosystem. While Siri addresses some process automation, human intervention and coordination is often required. We’re investors in Invisible Technologies, a company that blends automation with human work — a virtual super-assistant — with staff in 35 countries. Read more in The New Yorker.
Invisible, as well as Calendly, are examples of personal productivity services Apple could incorporate in a service dubbed Mail+. Inbox management, scheduling, and many of the daily tasks we perform in the Mail app could be automated, adding sufficient value to our lives while commanding a monthly fee. Whether or not Apple could figure out how to integrate such a service across its ecosystem remains to be seen, and could be a deal-killer for such a concept.
We continue to believe that an Apple Car is on the product roadmap. Instead of considering Apple Car as a hardware product, we think it makes more sense to view it within the company’s entire hardware + software + services paradigm.
In a recent conversation with Horace Dediu, an expert on both Apple and mobility, he shared the idea that internet companies make money not by bringing you to a specific destination, but by suggesting the best destination based on your desired outcome. “The bigger opportunity would be redirecting people… The transportation world is all about getting you from A to B, but what about C?”
We’re bullish on Google’s Waymo project and expect the eventual integration between Waymo and Google Maps. Similarly, Apple Car and Apple Maps could work together in a new service, Maps+, to help deliver the future of transportation.
If Apple is comfortable launching a credit card, they could eventually add other financial services, such as investment accounts. The Stocks app is already a go-to app for many investors, and there’s more the company could do. First, Apple could replicate its success with Apple Card and offer low-fee, private, secure, simple brokerage accounts. The Stocks app would instantly deliver new and better value, tied directly to your account, including cost basis, market value, and gain/loss info. Apple could also offer trading services similar to Robinhood, and robo-advisory services like Wealthfront.
As we consider a health-centric service from Apple, we see a few key ingredients:
- For Tim Cook, health is a personal passion and mission. He’s said that Apple’s greatest contribution to mankind will be related to health and wellness.
- Apple’s device ecosystem (including Watch and iPhone) leverages sensors to capture more health data, more frequently, than perhaps any other consumer health platform.
- The company’s software ecosystem (including the Fitness and Health apps, GymKit, and HealthKit) captures health data from both first and third parties.
- Apple’s emphasis on privacy and security is a clear advantage as it enters sensitive markets like financial services and healthcare.
- The transition to digital health and telemedicine has been accelerated by the pandemic, with less regulation and more consumer interest.
- The healthcare opportunity is one among a small group of new markets that could move the revenue needle.
The ingredients exist for Apple to deliver unique value, enhance integration across its ecosystem, and generate high-margin revenue through a health-centric service offering. Exactly how that takes shape remains unclear.
Potential impact of regulation on Services
We remain optimistic about the segment’s long-term growth potential despite recent and the potential for additional refinements to the Services model that address regulatory concerns. As an example, in Nov. 2020, Apple halved the App Store take rate to 15% for developers with less than $1m in annual net sales. Additional changes could occur related to revenue generated from Google as the default search engine in Safari. As a reminder, Google is facing legal challenges regarding its broader traffic acquisition strategy, which could impact 2-3% of Apple’s overall revenue that comes from Google. The bottom line on regulation is this: any changes to the Services model would likely temper Services revenue growth in the near term. That said, following the first anniversary of any such changes, we expect Services growth rates should return to a mid-teens level.
Accelerating the digital transformation
The recent acceleration in Services growth is indicative of an acceleration in a much broader digital transformation. Apple is powering this transformation around the world, changing how we live, work, and play. New services will make Apple’s impact on our lives even deeper and broader, capturing value in new ways and driving the company toward a $3T market cap.
Gene details Loup’s prediction that AAPL will be the top-performing FAANG stock in 2021, along with ranking AMZN, GOOG, FB, and NFLX.