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How Apple, Inc.'s Reduced App Store Cut Will Boost Its Services Business

By Evan Niu, CFA - Jun 8, 2016 at 4:48PM

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The Mac maker wants to help developers start pushing subscriptions.

Image source: Apple.

Apple ( AAPL 3.55% ) knows full well just how important third-party content providers and developers are to its business. If Apple is a walled garden, then it's these stakeholders that build the walls.

That's why it's so meaningful that the company is now planning on making some important concessions in its relationships with developers. Specifically, Apple's famous 30% cut will be reduced in the context of subscriptions, according to a recent exclusive interview with marketing chief Phill Schiller by The Verge.

It's about time.

A pretty big carrot

According to the report, Apple's revenue-sharing model will shift and its cut for subscriptions will fall to 15%, allowing the developer or content provider to keep 85% after the first year. That's a big win for developers and content providers alike, since 30% has always been considered a tough pill to swallow when we're talking about long-term recurring revenue streams. Over time, it adds up -- fast.

This 30% cut has long been seen as a barrier for many developers and content providers, including dominant video streamer Netflix ( NFLX 2.10% ). For the longest time, you could not sign up directly for a Netflix subscription within the company's iOS mobile apps. At about $9 per month at the time (before the recent price increase), margins were already slim enough. For many smaller companies that lack scale, the 30% cut was simply economically unviable.

Late last year, Netflix had a change of heart and introduced in-app subscription purchases. I suspected at the time that Netflix had likely negotiated some type of pricing concession since it's a high-profile company, and there had previously been reports that Apple was testing lower rates for subscription content.

Apple will allow all categories of apps to sell subscriptions, including important categories like games.

Giving some back

It's hard to imagine that Apple's costs for operating the App Store are particularly meaningful, especially when you consider the global scale at which it operates. Sure, there are fixed costs around data centers and variable costs around employees that maintain it, but selling third-party content is very likely a high-margin business for Apple.

It stands to reason that it can then afford to give up some of that profit for the sake of benefiting developers, and the increased percentage that developers can now keep is a strong incentive to shift their own revenue models toward subscriptions. While we're talking about a 15-percentage-point increase in the developer's cut, that's more than a 20% increase relative to existing monetization levels -- and it's recurring, so that extra money compounds over time.

Meanwhile, Apple has been trying very hard to shift investor focus toward its large and growing services business, as a way to de-emphasize slowing iPhone unit sales. The company even introduced a new non-GAAP metric last quarter, called installed base related purchases. This new metric ignores the differing accounting methods associated with different types of content, and purely represents how much people are spending on their devices. The total was $9.9 billion last quarter.

While Apple will take a smaller cut of subscriptions, the full subscription value will be included in installed base related purchases, so providing strong incentives for developers to sell more subscriptions will help Apple's case. The Mac maker really wants you to know how big its service business really is.

And it's only going to get bigger.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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