Blockbuster Holiday Spending on Apple's App Store Bodes Well for Services Business

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As usual, Apple (NASDAQ: AAPL) products were among the most popular gifts over the holidays. For example, in the week leading up to Christmas (which included several days of Hannakuh), Apple comprised 44% of all device activations, according to Flurry Analytics. That's actually the same share of activations that Apple grabbed in 2016.

Naturally, one of the first things people do when receiving an Apple gadget as a gift is to go and start shopping for apps and other digital content. And shop they did.

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Hey, big spenders

Last week, Apple announced that the App Store enjoyed a "record-breaking" holiday season, with New Year's Day generating $300 million in purchases alone. For the week starting on Christmas Eve, customers spent a mind-boggling $890 million. For all of 2017, iOS developers earned $26.5 billion, according to marketing chief Phil Schiller. That's up 30% from 2016.

That would suggest that Apple's cut of App Store sales was about $11.35 billion, based on the historical 70-30 split. Apple's share should be slightly less, since it reduced its cut of paid subscriptions to 15% after the first year. While there are now 210 million paid subscriptions, many of those subscriptions were made within the past year and would still be subject to the higher 30% cut. The change was announced in mid-2016, so only a portion of those subscriptions would have reached the reduced 15% tier by now.

The App Store was redesigned in iOS 11 in order to focus on editorialized content discovery. So far, it seems to be working. Here's CFO Luca Maestri on the November earnings call:

Cumulatively, iOS developers have now earned $86 billion since the App Store launched in 2008, according to Apple.

Party like it's 2020

The App Store is one of the most important drivers of Apple's services business, which the company hopes will generate $50 billion in revenue in 2020. The strong growth in digital content sales is a good sign for those ambitions, particularly when it comes to paid subscriptions. Even though paid subscriptions hopefully reach the lower 15% tier, the reason why Apple has been highlighting paid subscriptions is that those generate recurring revenue.

Subscription-based businesses that sell software and services earn an awful lot of respect from investors due to their recurring nature and higher margins, and Apple's App Store specifically has very modest operating expenses since Apple does not have to license or create any of the content itself; Apple just has to manage and curate all of it.

In contrast, Apple Music (another key pillar of the services business that is also a paid subscription) is more complex operationally, because Apple has to negotiate with and maintain relationships with the record labels, pay royalties, and more in addition to managing and curating the content. Furthermore, there's all that original video content that Apple is buying and bundling with Apple Music.

If Apple collected over $11 billion in App Store revenue in 2017 (not including many of its other services offerings), while digital content purchases and subscriptions are growing at 30%, that 2020 target is starting to look awfully realistic.

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Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.