The iPhone's stratospheric growth is over. Apple's future is in services - Wired.co.uk

Apple's Phil Schiller, senior vice president of worldwide marketing, reveals the iPhone XS

Apple revised its earnings for the last three quarters of 2018. It projected $89 billion, but is set to earn $84bn. That $5bn shortfall represented a five per cent drop. But, in its usual histrionic style, share prices took a greater dive, falling by 10 per cent after the announcement.

This raises a few questions. Why? How will Apple come back from this? And, if we want to be as dramatic as the stock market, are Apple’s days as the global smartphone superpower numbered?

The first point to note is that since the great drop on January 3, Apple’s stocks have recovered, if only slightly. And while the initial news may have seemed shocking to some iPhone buyers, it will not have shocked Apple. It foreshadowed all this last year.

In November, shortly after the release of the current generation of iPhones, Apple announced it would no longer release unit sales data for its hardware. This move means its quarterly reports will be judged on profit and revenue, with no direct reference to units sold.

Many have blamed Apple’s earnings shortfall on the high prices of the latest iPhones. But this exact strategy, of further maximising the profit and revenue for each piece of hardware sold, seems tailor-made for a market in which growth has decelerated, or stopped.

It does not take an MBA to understand this trend. Plot a graph of iPhone sales from 2007 to the end of 2018 and it will show huge growth up until 2016, and then an almost complete cessation of it thereafter. There were enough minor successes in the intervening years to earn Apple many positive-sounding headlines. But the stratospheric iPhone sales growth that seemed Apple’s default mode for years is history, and quite distant history at that, in tech terms.

Apple CEO Tim Cook blamed the recent shortfall on poorer-than-expected performance on China. On paper this may sound a sentiment worthy of the current US President, but Cook was, as ever, measured and considered with his words. “We did not foresee the magnitude of the economic deceleration, particularly in Greater China,” said Cook.

Indeed it did not. Nor could anyone. In November there was a staggering 71 per cent drop in sales tax revenue – effectively a shutdown on consumer spending in China. This has naturally had dramatic knock-on effects worldwide, and although Apple expected a slow down in China, an economic event such as this is almost impossible to predict.

"Apple is like the canary in the coal mine," offers Horace Dediu, analyst and founder of Asymco.com. "It is very accurate at making predictions and forecasts – always within 2 per cent for the last 10 years. So something really strange is going on."

The effect is not specific to Apple. In Q2 2018, Samsung’s Chinese sales dropped by 10 per cent. This didn’t seem anywhere near as dramatic at the time as Samsung phones have not been as traditionally popular in China as they are in the West. Conversely, China accounts for up to 18 per cent of Apple revenues.

However, Apple does seem to have somewhat increasing image problem in China. According to research by San Francisco based firm Prophet, which conducts annual reports on the country’s “favourite” brands, in 2017, Apple ranked fifth. In 2018, it dropped to 11th position.

Huawei moved from 12th position to fourth in the same interval. The impressive gains Huawei has made in the west with phones like the Huawei P20 Pro and Mate 20 Pro are, perhaps unsurprisingly, amplified at home.

It is not hard to find other reasons for this amplification in the news. Huawei phones are “banned” in the US owing to fears they would be used to collect data and steal information. Huawei CFO Meng Wanzhou was arrested in Vancouver, Canada in December 2018 at the request of the US. And these are just symptoms of the growing tensions and paranoia between China and the US.

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As much as global tech companies such as Apple may want to be left out of political disputes, particularly regarding the manner in which it is publicly aired on Twitter by president Trump and his allies, Apple is – to many – emblematic of the US. It hasn’t started any trade wars, but it is implicated, particularly when its key rival is home-grown Huawei.

However, perhaps focusing too much on the “China issue” may not be helpful if what we are interested in is elucidating Apple’s long-term strategy. “The problem in China is macroeconomic,” Dediu says, suggesting that Apple needs to carry on exploiting the strengths it has had for years: brand loyalty and a strong ecosystem, through services.

“Services grew at 27 per cent in the last quarter, the second highest growth rate after 31 per cent earlier in the year,” says Deidu. “Apple is ahead of its schedule of doubling over four years. App revenues alone are now higher than worldwide box office revenues for the entire movie industry. I don’t know if they need to do much to accelerate what is already growing faster than anticipated, and the fastest growing business in technology.”

Apple services revenue, which aggregates the figures from the App Store, Apple Music, iCloud subs and others, totalled nearly $10bn in Q4 2018. It takes 30 per cent commission from App Store sales on subs over a year old. This may sound a lot but it matches the rate of game platform Steam (although the more money a publisher makes, the smaller the percentage Steam takes), and is based on the largely sound concept that this rate is lower than traditional retail.

The ideal Apple customer is gradually hooked onto more hardware and, increasingly, services through positive experience. It’s a tale as old as iPhones. But a recent development shows that Apple's other strength, aside from loyalty and the integration of hardware and software, is control.

Did you know that if you subscribed to Netflix through the iPhone or iPad app, Apple took a 30 per cent cut every month for the first year? It did. Things like this have buoyed the growth of Apple’s services revenue. However, on January 2, Netflix removed that option to make more people subscribe direct.

Again, the Apple formula for long-term profitability is control. And this is why the long-rumoured Apple movie streaming service is anything but vapourware. Some believe this service may see a launch in Q1 2019, and Netflix’s decision may even be a pre-emptive move.

No-one expects an Apple streaming service to arrive and decimate Netflix. It didn't happen with Apple Music. As of May 2018, Apple Music had 50 million paying subscribers worldwide. As of June 2018, Spotify had 83m. Apple’s growth is impressive, but it is still not the market leader.

Apple’s movies and music services could cross-pollinate, though. Apple Music costs the same as Spotify. “Apple Flix” may cost the same as Netflix. But would you be tempted to switch if offered a couple of pounds’ discount for a dual subscription? Apple would need to invest tens of billions of dollars into original programming over the next few years to compete. But it's perhaps not fatal to be late to this particular game.

Apple has not had a clear strategy when it comes to content, and has ]traditionally been wary of the risk factor of producing it. But the subscription model of Netflix et al sees this risk mitigated. Of course, it's been a land grab for talent, and Amazon and Netflix have got their first. Apple will no doubt stumble occasionally as its figures this new world out, however, it should be underlined that possible revenues will be nothing compared to apps.

"The whole of Hollywood is like the pimple on the arse of apps," says Dediu. "Follow the dollars and the app economy is a huge thing. Fornite is making millions of dollars selling virtual outfits and trinkets – more than top grossing films – and in this sense Apple is still in the top position in terms of revenue."

Also, despite valuing its customers' privacy above the other major tech companies, Apple still collects and monetises user data in similar ways as Amazon or Google, feeding it to an ad network to earn billions of dollars a year. “Apple has all the data it needs and none of the data it does not need to serve customers,” says Dediu. "Privacy ethos is a consideration that a customer’s data is useful insofar as it helps the customer. It’s contrary to the assumption that data should be used in the service of someone other than the customer.”

This claim has not proved entirely true. Digital assistants provide a legitimate use for uncomfortably personal data, and this is partly why Siri seems so much less intelligent than Google Assistant. Siri is virtually a stranger compared to the stalker that is Google Assistant.

It also helps explain why Apple hasn’t pivoted to the smart home more enthusiastically to offset an iPhone lull. Where’s the money in this area if not in collecting data, when rivals can effectively subsidise prices with that same data collection? And we should frankly hope Apple does not change its policy as it digs deeper into the health-monitoring potential of consumer tech.

Anonymised Apple Watch data may be great for gigantic, if slightly vague, headline-grabbing trials to gauge the behavioural habits of nations. But to “free” up the use of that data in an insurance-based healthcare system, which the UK seems increasingly at risk of becoming in the longer term, is a scary prospect.

Unless Apple discovers the “next iPhone” area of tech that will recreate the kind of growth of its 2007-2016 period, the days of stratospheric year-on-year profit rises are on pause – but only for now. And we should be thankful its current main strategies are still to entertain and inspire, if often just with shiny expensive items, without anything too much more sinister working in the background.