Apple Used to Be an Inventor. Now It’s Mainly a Landlord.

(Bloomberg Opinion) -- For years, analysts and journalists watching Apple Inc. have talked up the growing importance of services, as opposed to hardware sales, to the company's top line. But it's only now that Apple's business model truly appears to be shifting toward collecting rent from the company's ecosystem and increasingly relying on gadget sales to perpetuate this rent rather than drive growth. Apple's decision to stop reporting iPhone unit sales underscores the shift.

Services have been steadily growing in importance for Apple since 2016, while the share of revenue provided by the flagship gadget, the iPhone, has gone up and down depending on the popularity of different models.

Apple, of course, is still predominantly a hardware company. It's increasingly clear, however, that the iPhone is no longer a reliable growth generator. In a recent research paper, Goldman Sachs estimated that the user base of iOS, Apple's mobile operating system, will drop to single digits by 2020 from 13 percent in 2017. Apple has only extracted revenue increases from the iPhone lately because it raised the prices steeply; in the fourth fiscal quarter, which ends in September at Apple, the average selling price of an iPhone reached $793, compared with just $619 in the same quarter two years ago.

The reason Apple can raise the prices, though, also explains the growing importance of services. Apple is milking its essentially captive audience. I hesitate to call it “loyal” – these are, essentially, people who look with trepidation at the idea of moving years of photos and other data to a different system. My wife gnashed her teeth when she got one of the new, wildly overpriced iPhones – but she just can't imagine switching to Android.

As far as services go, only two steady contributors of revenue streams keep swelling without Apple having to charge subscription fees. One is the money paid by Google parent Alphabet for searches made through Apple products such as the Safari browser and Siri. Obviously, further developing these products and increasing the user base boost this stream, which Goldman Sachs estimates at $6.5 billion in 2017 and $9.4 billion in 2018, a full 24 percent of Apple's total service revenue. 

The other source of revenue that Apple doesn't directly extract from end consumers comes from paid apps and in-app purchases in the App Store. There, outside developers do all the work, but Apple's revenue keeps going up both in absolute numbers and on a per-user basis. Only the strongest developers, such as Spotify, have the market power to charge subscribers directly rather than pay Apple a cut.

There's a lot of potential for Apple to squeeze a higher rent directly out of its captive user base. Goldman Sachs estimates that only 10 percent of Apple's user base pay for iCloud Storage; in terms of price and service quality, iCloud has been a poor competitor to services provided by Google and some smaller companies such as Dropbox, but that only means Apple can increase revenue from it exponentially if it bothered to compete more aggressively, as it does with another key service, Apple Music. Even that streaming service has relatively low penetration, though, with only about 35 million users last year. Goldman Sachs predicts that number will grow to 83 million by 2020.

Goldman's proposal for Apple is to create a services bundle similar to Amazon Prime; for $30 a month or so, subscribers would get access to music, video, 200 GB of storage and phone repair. The investment bank calculates that with just 50 million subscribers, such a bundle could add $18 billion in services revenue in 2019.

But Apple also has plenty of space to add new services; for example, it's one of a very small number of companies that could try to serve as an aggregator for the numerous media that have been introducing paywalls and subscription fees lately. It already has the billing system required, and it has the user base to enabled it to price a meta-subscription attractively. It's already talking to big newspapers about adding their copy to Texture, the digital magazine distributor it bought in March. 

Rent extraction from a user base that finds it hard to go away may sound a bit like extortion. But it's more honest and upfront than extracting data from users in ways they often don't understand and then making money off the data, as Facebook does. That honesty is in itself a competitive advantage for Apple as it gradually reimagines itself as more of a services company. Now, the challenge is to grow the services offering fast enough to make up for potential iPhone revenue losses; gadget prices cannot keep going up forever without hurting the top line, and in the end, a phone is just a phone. We only need it to gain access to all the nice digital stuff out there. 

To contact the editor responsible for this story: Therese Raphael at traphael4@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Leonid Bershidsky is a Bloomberg Opinion columnist covering European politics and business. He was the founding editor of the Russian business daily Vedomosti and founded the opinion website Slon.ru.

©2018 Bloomberg L.P.