Jack Narcotta, senior analyst at TBR, said that steadfast commitment by Apple executives to transform greater iPhone user engagement into service revenue growth is succeeding; Apple’s Service segment revenue climbed 18.9 percent year-to-year to $6 billion in calendar Q2 2016, and the Services segment has grown an average of 17 percent year-to-year each quarter since 2Q15. Apple’s excursions into services tethered to the iPhone, especially the App Store, iTunes and Apple Music, showcase its post-iPhone ambitions.
However, scale of the iPhone business ensures Apple’s success and challenges will be tied to the iPhone. The iPhone remains the barometer of Apple’s current financial health and an indicator of its future path. Overall, Apple’s overall revenue declined 14.6 percent year-to-year to $42.4 billion in calendar Q2 2016, in line with Apple’s forecast from April 2016. The second consecutive quarter of weaker iPhone unit shipments caused iPhone revenue to decline 23.3 percent to $24 billion, or56.8 percent of Apple’s total revenue in Q2 2016.
For Apple, TBR believes the greater task through 2017 will be in adapting to its new landscape of lower margins and reduced profits, even as those margins and profit volume surpass its competitors. Nearly all other Apple segments are poised for periods of decline, with demand for Mac PCs and the Watch (the largest component of Apple’s Other Product segment) weakening; the near $1,000 ASP of a fully-equipped iPad Pro will help lift iPad segment revenue incrementally despite fewer iPad units shipped.
The iPhone, and therefore Apple’s overall revenue, in longer in growth mode as iPhone users keep their older devices longer. As a result, Apple’s primary objective will be ensuring that recent declines do not dim customers’ perception of the company, dilute its brand strength or hinder greater adoption of iPhone-attached services by new and existing customers.
Services foster user engagement and loyalty, but do not fill the revenue gap from fewer device sales
With weaker demand for the iPhone virtually assuring overall revenue and profit declines, TBR believes rapid growth in Apple’s Service segment highlights a new leading direction for Apple post-iPhone. Sales and marketing strategies rolled out in conjunction with the iPhone 6s and 6s Plus in 2015 signaled a focus from the iPhone hardware to what iPhone users do, or what information and media they access, with the device. As users become ingrained in Apple’s ecosystem, they are more likely to make additional purchases of media, content, services and applications.
However, the smaller scale of the Services segment – in Q2 2016 the iPhone accounted for 56.8 percent of Apple’s total revenue, compared to 14.1 percent for Services – will make it difficult for Apple to fortify its margins and profits against declines in the iPhone business. TBR expects Apple’s revenue and margin declines will persist into 2017 in tandem with weaker iPhone demand, and Apple is forecasting revenue and gross profit declines of 9.7 percent and 14.6 percent, respectively, in calendar 3Q16. Apple’s focus will remain squarely on ensuring the iPhone remains a top priority as the profits generated by the iPhone allow Apple to continue bankroll its growing Services segment and foster recovery in additional hardware segments (Watch, iPad and iPad Pro), without overextending itself.
Apple will remain king of the devices market even as revenue and unit shipment declines persist
The success of the iPhone from 2007 through 2015 launched Apple to heights that the iterations, while successful in the context of an individual product launch, released since then have failed to achieve as the iPhone business gained massive scale. The rapid proliferation of the iPhone, one of the most successful product launches in history, accelerated the timeline for Apple to achieve market saturation. The iPhone’s 8-year run of success laid the foundation for the declines it has experienced in 2016 as its user base soared into the hundreds of millions.
Continued declines in the iPhone business do not indicate that Apple’s is primed to freefall towards operating losses, or relinquish its hold on the premium segment, the most coveted segment in the devices market. Even with its iPhone product mix shifting to include a greater number of lower-end devices such as the iPhone SE – iPhone ASP fell 9.8 percent year-to-year to $595 in Q2 2016 as the $400 SE proved popular with consumers in its first full quarter of availability – Apple’s profits and margins are the gold standard among device companies. Apple’s calculated operating expense spend and strict supply chain management help limit the impact of revenue declines on its margins and profits even as iPhone unit shipments fall year-to-year into H1 2017.