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By Jason Snell

Reassuring words about Apple’s approach to Services

The last couple of quarters, Apple has made an effort to highlight their growing Services revenue line, which includes the App Store, Apple Music, and iCloud. In January, the company provided an unusual supplement to their results, half of which highlighted how Services revenue was growing strong. CFO Luca Maestri spent quite a long time talking about Services during the post-release conference call with analysts, too:

The vast majority of the services we provide to our customers, for instance apps, movies, and TV shows, are tied to our installed base to devices, rather than to current quarter sales. For some of these services, such as content, we recognize revenue based on transaction value. For some other services, such as the App Store, we share a portion of the value of each transaction with the app developer, and only recognize revenue on the portion we keep.

My thought at the time was that Apple was interested in highlighting Services because it was the one part of its business that was showing major growth, at a time when iPhone sales were flat year-over-year and about to go down for the first time ever. I’m not saying it was intended as a distraction, but it definitely seemed like an attempt to give the answer when someone asked where Apple’s future growth might come from.

That’s fair. But I was also a little concerned about what it might have said about Apple’s future product strategy. Apple’s a company that’s all about selling people a premium product that delights them. Relentlessly grinding your installed base for extra cash is not an Apple move. My concern at seeing Apple highlight Services to the degree it did was the possibility that Apple would begin to see its growth path in terms of nickel-and-diming the users of its existing billion devices.

Take iCloud storage, for instance. The existing 5GB of cloud storage that’s granted to users for free is insufficient for most users for backup, especially if they have more than one device. I don’t dispute Apple’s need to charge for storage, but a reasonable amount of storage should be supplied for free as a thank-you for purchasing a new Apple device. The 5GB limit causes people to be prompted with scary “failed to backup” errors that immediately turn into a conversion attempt to a larger, paid iCloud storage account. It’s one of the places where it feels like Apple is prioritizing revenue over the user experience. I don’t want to imagine a world where that’s the norm, and my iPhone becomes a device that constantly asks me to pony up for another extra feature because the product wasn’t good enough to begin with.

I was relieved, then, to see that analyst Steve Milanovich of UBS had some of the same concerns that I did. On the post-release call with analysts, Milanovich asked Tim Cook point blank about this issue: “How do you view services? You’ve obviously highlighted it the last two quarters. Do you view it going forward as a primary driver of earnings? Or do you view it [as] more creating ecosystems that support the high margins on hardware, as opposed to independently driving earnings.”

Here’s Cook’s response:

The most important thing for us, Steve, is that we want to have a great customer experience. So overwhelmingly the thing that drives us are to embark on services that help that and become a part of the ecosystem. The reality is that in doing so, we have developed a very large and profitable business in the services area. And so we felt, last quarter and working up to that, that we should sort of pull back the curtain so that our investors could see that services business, both in terms of the scale of it and the growth of it. As we said earlier, the purchase value of the installed-based services grew by 27 percent during the quarter, which was an acceleration over the previous quarter. And the value of it was just shy of $10 billion. And so, it’s huge, and we felt it was important to spell that out.

This is exactly what I wanted to hear. It allows Apple to signal loud and clear that while they want to trumpet Services revenue as a growth area, it is an area that grows as a result of Apple’s hardware and the customer experience. Cook’s first two sentences make that clear.

As the platform owner, Apple has the advantage of deeply integrating its services with iOS in ways that competitors can’t. I don’t begrudge them their ability to make money off of additional services, so long as it doesn’t get in the way of a fundamentally good user experience. I feel a bit more optimistic about that after this week.

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