By Jason Snell

August 2, 2024 1:01 PM PT

Existential thoughts about Apple’s reliance on Services revenue

Apple’s latest quarterly results were about as boring as you can get while still featuring $21.4 billion in profit and setting an all-time third-quarter record. Most categories were flat, with the exception of a one-time bump in iPad sales (amazing what actually introducing new products can do!) and the continued, relentless increase in Services revenue.

Another quarter, another record-setting total for Apple’s Services line—$24.2 billion in revenue. And yet, the more I looked at that number, the more I started to ask myself some fundamental questions about Apple’s business, today and in the future.

Service identity

Let’s start with defining what’s encompassed by the Services line, because it’s more than you think. When Apple talks publicly about its services, it really leans into the high visibility of services like Apple Music and Apple TV+. Emmy awards and Oscars are glamorous, and it’s great to be associated with beautiful, famous creative people.

But Apple’s Services line is powered by less glamorous businesses. The company’s cut of App Store revenue, AppleCare support subscriptions, Google’s payment for being the preferred search engine in Safari, Apple’s cut of Apple Pay transactions, and iCloud services are all a part of the category, and most of them contribute more to Services revenue than Reese Witherspoon and Adam Scott do.

Led by the Google deal, a lot of these services are incredibly profitable for Apple. Over the last three years, Apple has averaged a 72% profit margin on Services revenue. You can afford to lose a lot of money paying for TV+ content if you’re generating $20 billion a year in almost pure profit from Google payments.

Here’s what Apple CFO Luca Maestri said about Services in Thursday’s conference call with analysts:

We continue to have great momentum in Services as the growth of our installed base of active devices sets a strong foundation for the future expansion of our ecosystem, and we see increased customer engagement with our Services offerings. Both transacting accounts and paid accounts reached a new all-time high, with paid accounts growing double digits year over year. Also, paid subscriptions showed strong double digit growth. We have well over one billion paid subscriptions across the services on our platform, more than double the number that we had only four years ago. And we’re constantly focused on improving the breadth and quality of our services. From critically acclaimed new content on Apple TV+ to new games on Apple Arcade and the many latest features we previewed during WWDC for iCloud, Apple Pay, Apple Cash, Apple Music, and more.

Even if a quarter of the Services revenue is just payments from Google, and a further portion is Apple taking its cut from App Store transactions there’s still a lot more going on here. Apple is building an enormous business that’s based on Apple customers giving the company their credit cards and charging them regularly. And that business is incredibly profitable and is expected to continue growing at double-digit percentages.

What about products?

Most people still consider Apple a products company. The intersection of hardware and software has been Apple’s home address since the 1970s. And yet, a few years ago, Apple updated its marketing language and began to refer to Apple’s secret sauce as the combination of “hardware, software, and services.”

My reaction the first time I heard that was shock, but for years now Apple has been pointing out that it expects explosive growth from Services, and it hasn’t been wrong. Consider how large Apple’s Services business has become:

In the most recent financial quarter, Apple generated $24.4 billion in revenue from Services. The Mac, iPad, and wearables categories together generated just $22.3 billion. Only the iPhone is more important to Apple’s top line than Services.

But what about the bottom line? While Apple’s Services gross margin was 74% last quarter, products was only a measly 35%. (I’m kidding—35% margin on hardware is actually a really great number. It just can’t compare to Services, because hardware has some fundamental costs that services just don’t.)

Let’s look at total profits:

Last quarter, Apple made about $22 billion in profit from products and $18 billion from Services. It’s the closest those two lines have ever come to each other.

This is what was buzzing in the back of my head as I was going over all the numbers on Thursday. We’re not quite there yet, but it’s hard to imagine that there won’t be a quarter in the next year or so in which Apple reports more total profit on Services than on products.

When that happens, is Apple still a products company? Or has it crossed some invisible line?

Remember where you came from

Look, I don’t want to overplay this. Apple is still a hardware company, fundamentally. It continues to grow its installed base across all its products, and every time there’s a major new iPhone buying cycle—the arrival of Apple Intelligence will probably prompt another round of purchases, and there are rumored slim and foldable iPhones coming in the next few years—there’s a huge spike in revenue that Apple manages to convert into a new plateau of sales.

Wall Street wants to see growth, and Apple’s Services line gives the company’s executives something shiny to point at, even when hardware sales are growing very slowly.

But let’s make no mistake about where the strength of the Services business comes from: Apple’s hardware. Services work because Apple has succeeded at growing its installed base, selling more Macs and iPads and iPhones, getting users into the ecosystem so they can buy all the different hardware products on offer and tie them all together with Apple services.

Without good hardware and software, Apple’s services would be irrelevant. I hope everyone in a position of authority at Apple understands that. Services are a way to help make Apple’s hardware even more profitable than it already was. But services can never, ever take precedence over Apple’s hardware. If Apple ever begins to see its hardware as merely a vessel for selling more subscription services, the game will be over.

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