Apple's (NASDAQ:AAPL) services segment has been a hot topic recently, becoming increasingly central to the bull case for the stock. But why, exactly, is the segment so important to Apple's business? And why is it more crucial today than it was in the past?

The answers to these questions boil down to two things:

  1. Apple's iPhone business is no longer the catalyst it was in the past.
  2. The fast-growing services segment is growing as a percentage of total revenue and gross profit, making it critical to the company's growth prospects.

Here's a closer look at the segment -- and why it is key.

Apple senior vice president of software engineering Craig Federighi unveils iOS 13 at WWDC 2019.

Apple senior vice president of software engineering Craig Federighi unveils iOS 13. Image source: Apple.

What is Apple's services segment?

Apple's revenue comes primarily from two umbrella categories: products and services. Product revenue includes sales of iPhone, iPad, Mac, Apple Watch, AirPods, iPod Touch, Beats products, and accessories. The rest of revenue comes from services.

Apple's services revenue consists primarily of:

  • Digital content and services: Sales from the iTunes Store, the App Store, and Apple's digital book store, as well as subscriptions to Apple Music, Apple Arcade, Apple News+, and even the company's upcoming streaming TV service
  • iCloud: Sales of user subscriptions to iCloud storage and other iCloud services
  • AppleCare: Sales of the warranty programs and online support for purchased products
  • Apple Pay: The company's digital wallet and peer-to-peer payments technology
  • Apple Card: Apple's recently launched credit card

The tech giant has been doubling down on its services segment recently. Earlier this year, Apple announced a subscription-based news app, a streaming gaming service, a streaming TV service, and a credit card. All but Apple's new streaming TV service -- Apple TV+ -- have already launched. And the Apple TV+ official debut is just a few weeks away.

A key catalyst

It's no wonder Apple's services segment has come into the spotlight recently. Not only is it the company's second-largest segment, but it is growing rapidly. Of Apple's $259 billion in trailing-12-month revenue, $44 billion of it came from services. This compares to $146 billion from iPhone; $26 billion from Mac; $22 billion from wearables, home, and accessories; and $21 billion from iPad. Further, services revenue rose 18% year over year during this trailing-12-month period. This compares to 2% growth for Apple's consolidated top line over the same time frame.

But even these metrics understate the importance of Apple's services business. Thanks to the segment's lucrative economics, it has an outsize impact on the company's profitability. In fiscal Q3, for instance, services accounted for 21% of revenue. But since services had a gross profit margin of 64% during the quarter and the company's hardware sales had a 30% gross profit margin, services represented 36% of fiscal Q3 gross profit.

It's safe to say that Apple's services business has morphed into one of the company's most important catalysts -- if not the most important.