Apple beyond the iPhone: All the roads lead to Services

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Last week Apple announced a new iPhone. As with previous iPhone reveals, many greeted the event with a collective yawn, convinced nothing is innovative enough. I will not discuss whether the product revealed was innovative or not, as this is rather subjective and depends on the definition of innovation. Instead, I’ll focus on what I think is more meaningful: the change in Apple's business strategies.

Is Apple a Services or a Hardware company?


Apple has always been a Hardware company and its primary business model has always been to sell premium hardware at high margins. The chart above from Chartr on Apple's 2019 revenues seems to confirm this. It shows that over 80% of Apple's revenues still come from the sale of hardware products ($214B vs. $46B from Services) with a sweet 55% of total revenues from the iPhone alone. However, the chart above doesn't tell the whole story. It doesn't say that Apple has doubled its revenues from Services in 3 years - revenues from Services were at $23B vs. $46B at the end of 2019. Nor does it say that Apple has a longstanding goal of increasing its Services revenue. These two things, though, don't confirm that Apple has transitioned from being a Hardware company. Let me explain.

Services and Hardware companies have completely different strategic priorities. Services companies want to maximize their addressable market (e.g. make the iPhone cheaper or more accessible through financing). Hardware companies on the other hand want to maximize their product differentiation (e.g. make their iPhone an order of magnitude better than the competitions' to justify premium prices).

When Apple announced its Services bundles last month, it didn't connect the offerings to its hardware. I called this out in a previous post and said that by doing so Apple is focused on pushing its music, streaming video, and gaming on its current users, and not on expanding the addressable market for Services. So from a strategic perspective, Apple was definitely not acting like a Services company. 

Apple introduces a budget iPhone

This leads to what is in my opinion the biggest news from last week's event: Apple cut prices. This was easy to miss because compared to last year, Apple has not reduced the prices of its flagship (iPhone 12 Pro @ $999), mid-tier (iPhone 12 @ $699), 1-year old (iPhone 11 @ $599) or 2-year old (iPhone XR @ $499) products. However, the most noticeable difference is that Apple has re-introduced the iPhone SE @$399, a product last seen a few years ago. 


It could be argued that the SE was introduced as a defensive move to reduce churn in China in these difficult economic times. This is because there is strong evidence that suggests that iPhone demand in China is very elastic: if the iPhone is cheaper, Apple sells more; if it's more expensive, Apple sells less. In China, Apple is less differentiated and is always at risk of losing customers to cheaper Android products.

However, I think the SE is an offensive move by Apple. Over the past few years, Apple has jacked up the prices of its flagship and mid-tier devices. Other Android manufacturers have followed suit and fell into Apple's trap. By re-introducing the SE at $399, Apple is effectively undercutting the prices of Android manufacturers. Hence, I expect the SE to enable Apple to eat into Android's market share in China. It also has big potential to be one of the most popular phones in emerging markets like India - SE is going to be assembled in India so it will be exempt from tariffs and import taxes.

Bottom line: I expect the SE will convert Android users to iPhone, thus expanding the addressable market for Apple's Services business. This is a major step to Apple truly becoming a Services company, at least in its strategic thinking: More phones sold, no matter their price point, means more Services revenue in the long run. This is a very big step for Apple and its profits margins - the Services margins are double those of physical products (64% vs. 32%). As an Apple investor, I think this is very innovative ;)

Disclaimer: This post is merely my own assessment and is not an investment recommendation. For professional advice, seek input from a licensed investment advisor.

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