Apple Inc. (AAPL +1.25%) just reported the greatest quarterly profit in history, but that isn't impressing Mr. Market. The stock is sitting at 18-month lows after the company forecast in the same report that its revenue would decline for the first time since 2003 in the current quarter.
iPhones, the company's golden cash cow, have saturated the market for the time being, making continued growth for Apple difficult. In its last quarter, iPhone sales grew just 0.3% to 74.8 million as the period lapped the release of the popular iPhone 6 model that offered a bigger screen.
Apple faced the problem of stalling iPhone sales once before, but a deal with China Mobile unlocked a massive subscriber base and the larger screens also proved a hot seller, leading to a bumper year for the high-end smartphone. What to do now isn't as clear. Expanding sales in India presents one option, as iPhone sales grew 76% there in the last quarter, but the market is still much smaller than China. Another possibility is developing a smaller, cheaper phone to sell in emerging markets, but Apple has long resisted going downscale. Apple brings in 60% of smartphone revenue worldwide but only sells 20% of the units, so the opportunity to tap a lower-end market seems to be there. Reports indicate that the company may be preparing such a phone launch, but the risk remains that going downscale could hurt the brand halo. Even if it is successful, Apple would continue to face the challenge of finding new opportunities for iPhone growth as developed markets such as the U.S., Europe, and Japan are saturated.
The news isn't much better for its next biggest products, the iPad and the Mac. iPad unit sales declined by 25% in the last quarter, while Mac unit sales were down 4%. With its three biggest product category on the decline, Apple seems to be in trouble.
What's a $500 billion company to do?
A billion users and counting
One item that CEO Tim Cook was happy to glow about on the earnings call was that Apple's base of installed devices has now passed 1 billion. That's nearly one for every seven people on the planet, though surely many people own more than one Apple device.
That milestone may signal a transition in Apple's business model. Relying on device sales is no longer a viable strategy for stable growth as all three of its premier products are losing sales. Services, however, which include things like iTunes, AppleCare, and Apple Pay grew 26% in the quarter to over $6 billion. By this time next year, services will likely eclipse the iPad and Mac to be the company's second-biggest category.
Apple's "other products" category, which includes Apple Watch and Apple TV, also grew by 62% to $4.4 billion last quarter.
Selling those other products help build out the company's ecosystem, and make its products stickier, but it's the services segment that has the biggest potential for growth. Speaking of the installed base, Cook during the recent conference call said, "This is an unbelievable asset for us. Because our installed base has grown quickly, we have also seen an acceleration in the growth of our services business, another large and important source of recurring revenues."
Services like Apple Pay and Apple Music offer a steady, high-margin revenue stream without the need to develop blockbuster new products. That kind of business model is what makes companies like Alphabet Inc (GOOG +0.57%) (GOOGL +0.62%), and Facebook (FB +2.59%) so successful. Advertising offers an ever-replenishing revenue stream, and both companies own virtual monopolies over their respective industries -- Alphabet in search and Facebook in social media. It also means their revenue growth has been much smoother than Apple's, and it should continue that way.
Apple isn't about to become an advertising business, but it explains why the company has pushed innovations like Apple Pay and Apple Music so much, and why it's floated the idea of a television service. It desperately wants the recurring revenue from these kinds of services.
Apple has broken the bank with device sales. It will likely be some time before Apple or another company creates a product as profitable as the iPhone. Instead of developing a better smartphone or another gadget, Cook's greatest challenge now is to monetize those users with services that will give the company a steady, growing revenue stream. There are over a billion devices and their owners are willing to spend on a luxury brand, and many of them love Apple. Surely, the Mac maker can find a way to pry more money out of them.
