With its highly anticipated introduction in 2007, the iPhone was the revolutionary hardware device that catapulted Apple (AAPL +0.01%) to global fame. This smartphone, which is arguably one of the most successful products in history for any business, made the tech giant a global cultural icon.
Even today, the iPhone is Apple's biggest moneymaker, generating $69.7 billion of revenue in the latest fiscal quarter (Q1 2024 ended Dec. 30), or 58% of the company's total. There's no question that the business is still well-known for this product, as well as other devices like the MacBook, iPad, AirPods, and Watch.
However, the sale of hardware pales in comparison to another burgeoning segment when it comes to profitability.
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Creating Apple's powerful ecosystem
Representing 19% of Apple's revenue in the latest fiscal quarter, services posted sales growth of 11.3% on a year-over-year basis, faster than the products division, where sales were essentially flat. Services consist of various things, like advertising, AppleCare, iCloud, App Store, Arcade, Fitness+, Music, News+, TV+. Card, and Pay.
Not only has this segment expanded at a rapid clip in recent years, but it also carries a stellar gross margin of 72.8%, much higher than the hardware devices. This is due to these offerings being digital in nature, thus having low marginal costs.
Besides driving growth and improved profitability for the enterprise, services support Apple's entire ecosystem strategy. On their own, the installed global base of 2.2 billion active hardware devices would be just like other consumer electronics products on the market, lacking pricing power and being commoditized.
However, Apple's software and subscriptions make the products much more valuable. They drive stickiness and customer loyalty.
Warren Buffett once suggested that if a person was offered $10,000 on the condition that they could never use an iPhone again, they'd likely decline that offer. This demonstrates the importance of software and services.
But at a current price-to-earnings ratio of 28.4, some investors might take a pause before buying Apple stock.
