It's difficult to say if last quarter's iPhone revenue reflects a supply problem or a demand problem; it could be a little of both. Either way, it's cause for concern. Not only did Apple (AAPL 0.02%) report lower year-over-year iPhone sales, but total iPhone revenue of $65.8 billion also fell short of analysts' expectations of $68.3 billion. That shortfall prompted a rare companywide earnings miss.
It's not necessarily the end of the world, though. Apple has been preparing for "peak iPhone" for some time now. If that's where we are -- and it very well could be -- then the company already has a powerful profit engine humming.
Profits trump sales
If you're reading this, you likely know how important the iPhone is to Apple. Even with last quarter's relatively weak showing, iPhone sales alone accounted for 56% of the company's total top line.
The iPhone doesn't make up a proportional piece of Apple's profits, however. Services revenue makes up a surprisingly big piece of its income pie, and this digital business's bottom line is getting ever bigger.
You won't directly find this detail in Apple's quarterly reports. Rather, you have to do a little math to come up with the numbers. Subtracting the cost of services revenue from services revenue itself, however, leaves you with the gross profit specifically attributable to the company's services business. The number-crunching reveals that Apple still makes more total profit with its products like the iPhone, the iPad, and Macs. Services, however, now makes up nearly one-third of Apple's total bottom line. And its net impact is growing.
Data source: Apple. Chart by author.
It seems unlikely Apple's services business -- the sale of apps and digital media like movies, shows, and music -- will become Apple's biggest business in the foreseeable future, if ever. The preceding chart does make clear, however, that the company has a plan to survive and even thrive once the iPhone has reached its maximum annual revenue potential.
And that time may well be at hand.
The smartphone market was already shrinking
As was noted, last quarter's tepid iPhone sales could reflect supply chain problems. CEO Tim Cook also used the phrase "challenging macroeconomic environment" several times during Thursday's earnings call.
But it would be short-sighted to ignore the possibility that at least some of the iPhone's slowdown can be chalked up to sheer saturation.
That's one of the takeaways from IDC's recent look at the 2022 smartphone market, anyway. The market research outfit estimates that every major smartphone maker suffered a serious drop in unit shipments in the fourth quarter as well as for the entirety of last year, and it wasn't primarily a supply problem. IDC research director Nabila Popal noted within the report that "weakened demand and high inventory caused vendors to cut back drastically on shipments," adding, "Heavy sales and promotions during the quarter helped deplete existing inventory rather than drive shipment growth." IDC's Anthony Scarsella goes on to say, "We continue to witness consumer demand dwindle as refresh rates climb past 40 months in most major markets."
IDC isn't the only outfit seeing a waning growth for the smartphone market, either. Canalys foresees "flat to marginal growth" for the smartphone business this year. Rival phone-maker Samsung believes the worldwide smartphone business will outright contract again this year.
That's not a tough prediction to believe, either, in light of deteriorating smartphone sales since 2016's fourth-quarter peak of 431 million units.
Data source: IDC. Chart by author.
Connect the dots. Smartphone sales were poised to shrink here regardless of the economic backdrop simply by maintaining the current trend.
To its credit, Apple's iPhone briefly snapped out of the 2016 funk in 2020, overcoming all of the challenges linked to the pandemic at the time. Even so, it's clear that even the iPhone isn't immune to headwinds other than logistical and supply chain headaches, as most pandemic-prompted supply-and-demand problems have been reasonably well addressed since late 2020.
Apple's going to be fine... just different
Don't misunderstand. Apple is neither in dire straits, nor is it set to rule the digital content and services world. It would love to continue growing iPhone sales, but even if it doesn't, there's still money to be made with the amount of units it will sell. At the same time, Apple is doing quite well -- and turning a good profit -- with services, yet that area may never be the company's biggest breadwinner.
It just doesn't matter. The point here is, Apple doesn't have to be the smartphone juggernaut it used to be to produce strong results. Services can take up much of that slack.
It is taking up much of that slack, in fact, and there's no reason to think it won't continue doing so. Its services arm just reached record quarterly revenue of $20.8 billion, with total digital subscriptions managed through Apple's iOS growing from 900 million to 935 million last quarter alone. Yet that's still less than half of the 2 billion Apple devices currently in use worldwide. That's a lot of opportunity to add more paying services customers, starting with its own user base.
