Apple's Breakthrough Product: Services

By Tripp Mickle Features Dow Jones Newswires

When Apple Inc. last year began breaking out revenue from app sales, music subscriptions and payment transactions, the accounting change seemed opportunistic. Sales of iPhones were declining and services provided a growing business to showcase.

Continue Reading Below

The change now appears more than justified.

On Tuesday, Apple said services -- the App Store, iTunes, Apple Pay, iCloud and more -- generated more than $27.8 billion in revenue for the 12 months ended July 1, making it the equivalent of a Fortune 100 company and larger than Facebook Inc.'s total revenue in 2016.

The company hit the milestone a full quarter before predicted by Chief Executive Tim Cook, as rising subscriptions to Apple Music, Netflix Inc. and other services lifted services revenue 22% in the June quarter to $7.27 billion. The iPhone is still Apple's chief moneymaker, but services combined with better-than-expected iPad and Mac sales reduced Apple's total revenue from the iPhone to 55% in the quarter from 57% a year ago.

"The business is really impressive when you think about it in terms of scale compared to other publicly traded companies out there," said Jeff Dillon, chief executive of Jackson, Mich.-based Dillon & Associates, which counts Apple among its largest holdings. "There's a long runway to go there."

Apple's total revenue rose 7.2% in the quarter to $45.41 billion, while profit was up 12% to $8.72 billion. The company's stock rose 5% in late-morning trading.

Continue Reading Below

Apple grew services revenue while facing a host of challenges, including shuttered movie sales in China, shrinking iTunes market share in the U.S., and a music-streaming service that's a distant No. 2 player in paid subscriptions to Spotify AB.

The company remains guarded about which sources are driving services revenue. Apple annually reports total payments to app developers and in June said Apple Music subscriptions hit 27 million. But it hasn't broken out revenue from AppleCare, Apple Pay, iTunes, iCloud storage or any of the other pieces that contribute to the business.

The growth in services is driven by the size and quality of Apple's user base. Apple now has more than 1 billion devices in use world-wide. Its pricier iPhones, iPads and Macs are typically bought by more affluent consumers who load them up with apps or pay extra to store photos in the cloud. The App Store generates nearly twice the revenue of Alphabet Inc.'s Google Play, according to App Annie, a tracking service.

Apple to some extent is drafting off broader consumer trends. An increasing number of customers are shifting from cable subscriptions to streaming-subscriptions services such as Netflix, HBO Now and Hulu, and many sign up through the App Store, giving Apple a 15% cut of the subscription.

Apple said its number of subscriptions rose 12% in the past 90 days to 185 million. In a call with analysts, Chief Financial Officer Luca Maestri credited some of the growth to making App Store purchases easier by adding more payment options, such as Alibaba Group Holding Ltd.'s Alipay in China.

The services business hasn't been without headaches. In China, the government shut down Apple's movie and book sales because they violated local media guidelines. Apple also has faced criticism globally for removing apps in China such as the New York Times earlier this year, and others that allowed users to evade the country's censorship laws.

Apple's streaming-music service continues to lag behind Spotify, which in June reported more than twice as many paid subscribers at 60 million. Movie rentals and sales on its iTunes service in the U.S. have been pressured by Comcast Corp. and Amazon.com Inc., reducing its market share to about 20% from more than 50% in 2012.

The iPhone maker is trying to differentiate to gain Apple Music subscribers and video viewers by branching out into original content. It released the reality show "Planet of the Apps" in June and will add "Carpool Karaoke" next week. It recently hired two top Hollywood television executives to spearhead a push into original programming.

"We'll see how this area goes, but it's still an area of great interest, " Mr. Cook said on the call.

The services growth over the past decade is impressive considering late CEO Steve Jobs didn't want an app store. The iPhone launched without one, and Mr. Jobs primarily wanted to offer only Apple services, but employees and outsiders prevailed in getting him to change his mind, former employees said.

The bulk of services revenue now comes from apps. In January, the company said customers spent $28.5 billion in 2016, with Apple collecting about $8.5 billion based on its 30% share of app sales.

Write to Tripp Mickle at Tripp.Mickle@wsj.com

(END) Dow Jones Newswires

August 02, 2017 11:59 ET (15:59 GMT)