Apple (NASDAQ:AAPL) has set a lofty target of growing its services business to about $50 billion by 2020. That effort will in part be driven by growing paid subscriptions, with Apple Music and iCloud storage being the company's most prominent first-party services at the moment. The Mac maker is now up to 40 million paid Music subscribers, which at $10 per month per subscriber would translate into a $4.8 billion business, before considering discounts like family plans, annual subscriptions, or subscriber growth going forward.
Too bad Apple Music isn't very profitable.
Thanks for the data, Spotify!
Macquarie Research analyst Ben Schachter put out a research note today pointing out that Apple Music is unlikely to contribute much to profitability, according to Tech Trader Daily. Spotify Technology's (NYSE:SPOT) recent direct listing has provided information analysts and investors can use as they evaluate how all the music streaming companies spend money. Specifically, the Swedish company's cost structure is dominated by royalty payments to record labels, which eat up approximately 80% of revenue and yield gross margin in the neighborhood of 20% (and that was after Spotify scored concessions while renegotiating its licensing agreements).
Schachter models Apple Music gross margin at 15%, a difference that could be explained by the fact that Apple pays out around twice as much as Spotify on a per-stream basis. In contrast, Apple's gross margin for the App Store is estimated at 90% in the analyst's view, since the company's infamous 30% cut on transactions is more than enough to cover the costs associated with running the App Store. Cloud storage has also become increasingly commoditized over time, so there's a good chance that iCloud storage is more profitable than Apple Music at $10 per month for the 2 terabyte plan in the U.S.
The analyst also addresses regulatory risk, pointing to Spotify's cited risk factor of relying on other platform operators that also compete in music streaming. The platform fees that tech giants charge undermine competitiveness. Spotify has been making this same argument for years, including lodging formal complaints with antitrust regulatory authorities around the world. For a while, Spotify effectively passed on the 30% fee to subscribers who signed up within the app, charging $13 per month for in-app subscriptions compared to the standard $10 per month fee. The company has since discontinued in-app subscriptions altogether, urging prospective customers to simply sign up outside of the App Store and use the free app to access the service.
Apple doesn't need music streaming profits
As the most profitable company on Earth, Apple is afforded a unique luxury: It doesn't need Apple Music to be profitable. As a pure play, the same can't be said of Spotify.
Apple Music provides Apple with a plethora of other strategic benefits, strengthening its overall ecosystem of services that bolster user loyalty and retention. The company has also long been a champion of the music industry -- particularly as it relates to economic sustainability -- a title that it's not ready to relinquish. Even if Apple Music's operating margin is breakeven, it's still well worth it.
Evan Niu, CFA owns shares of Apple. The Motley Fool owns shares of and recommends Apple. The Motley Fool has the following options: long January 2020 $150 calls on Apple and short January 2020 $155 calls on Apple. The Motley Fool has a disclosure policy.