Apple's (NASDAQ: AAPL ) been on a roll lately, giving investors a 1-year return of nearly 50% with the stock hovering near all-time split-adjusted highs on a per share basis. With this momentum, you'd assume Apple's firing on all cylinders with its products. Unfortunately, that isn't true -- Apple's $2.5 billion business, its iPod line, is struggling.
And while some have called for Apple to discontinue the product amid a disappointing near-50% revenue drop, I think that's a poor strategy. Here's why they should keep its precursor to the iPhone and iPad.
1: Apple needs revenue growth
After an amazingly high-growth period, Apple's (NASDAQ: AAPL ) growth has slowed considerably over the past four quarters when compared to the four prior. The chart below gives some context:
As you can see, revenue growth is only up 5.1% during this period. For perspective, Apple averaged top-line growth of 41.2% from fiscal year 2009 to fiscal year 2013 by growing from $42.9 billion to $170.9 billion. The last four fiscal quarters have had their share of strong performances from its iPhone and iTunes/Software/Services lines, and poor performances from its iPad and aforementioned iPod lines.
However, no product has struggled as much as the iPod. By dropping from $4.6 billion to less than $2.5 billion, Apple's iPod provided a headwind of sorts for overall revenue growth. For perspective, if Apple would have repeated its revenue performance over the last four fiscal quarters in its iPod line as the four prior, overall revenue growth would have been 6.4% instead of 5.1%.
And yes, this is a small part of Apple's revenue haul, but when one considers Apple's top-line is approaching $200 billion, having all products contributing to growth helps.
2. Apple's iPod is a "gateway product"
A common argument against the iPod is that Apple is still capturing that revenue, just through other products -- generally the iPhone. This "cannibalization" argument has the added benefit of higher-margins, considering Apple's iPhone is commonly considered its highest-margin product.
And on the surface it makes sense, Apple's entry-level iPhone -- its iPhone 5c -- is only $99 with a 2-year contract whereas a similar iPod touch is $150. However, Apple's iPod should also be thought of as a "gateway product" designed to lock users into its ecosystem and brand.
And Apple could use another tool to effectively compete with Google's Android abroad where carrier subsidies are less prevalent. Remember that all countries don't provide carrier subsidies. Worldwide, Google's Android has an 80% market share. Ecosystems are sticky; once apps, music, and movies are purchased on one operating system, it is harder for users to abandon that system. If Apple could "hook" users with its low cost iPod shuffle or iPod nano products, then higher-margin purchases will follow.
3. It bolsters Apple's highest-growth business and could make another line a $10 billion line
Getting users into Apple's ecosystem not only helps revenue from the devices sold, but it also has the added benefit of potentially adding revenue through Apple's highest-growth business: its iTunes/Software/Services business. Growing at a near 16% clip, that line more than tripled Apple's growth during that period.
Alas, there are headwinds for the category. A recent Deloitte study found that users are downloading fewer apps, pointing to a saturated market. In addition, Billboard reported digital downloads of music were down for the first time ever in 2013. If those two pillars are declining, one way that Apple would continue its high growth in its iTunes/Software/Services business is to bring more overall users to its ecosystem -- the iPod provides a low-cost way to do so.
In addition, Apple's Beats acquisition could bring increased demand for Apple's iPod through the complimentary nature of these products. This could provide growth for another product -- Apple's accessories line -- that could become Apple's next $10 billion business.
It seems almost funny when analysts are clamoring for a company to abandon a $2.5 billion business. For perspective, Apple's smallest product line provided more revenue than Twitter and GoPro did their last fiscal year combined. Right now, it is rumored that a smartwatch, a phablet, and a payment system are in the works -- and that's great, Apple fans have desired a new revenue driver for years now.
However, Apple has an opportunity to grow revenue, introduce new users into its ecosystem, and support other product lines by keeping its iPod. Personally, I'd love to see a recommitment to the line with a Beats headphone bundle for the holiday season.
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