Wall Street has been thinking about Apple the wrong way. But that’s to be expected; so has Apple itself. In Apple’s 44 years as a company, its narrative has predominantly focused on its hardware business. Historically, public market investors have compared the company to other IT hardware businesses (e.g., IBM, HPQ, Dell, Lenovo). Recently, as the Apple iPhone has saturated the mobile market, comparisons have begun to shift to luxury goods businesses (e.g., LVMH, Hermes, Tiffany). Ten years ago, Apple might have been considered a fast-growing luxury or cycle-driven hardware business, but today, as we see it, Apple is neither. Apple is squarely an internet company.
What is an internet company? Simply, it’s a company that does the majority of its sales via the internet. With 82% of Apple’s current revenues derived from hardware sales, it is a common misconception that the company’s future will remain in that space. But we firmly believe the opposite. Based on the current state of the iOS ecosystem, a majority of Apple’s future business should and will take place on the internet.
Apple is already the company that laid the groundwork for mass internet use, especially in developed markets. The total number of internet users has more than tripled since the iPhone’s launch in 2007, growing from 1.3B to 4B+ today. Incredibly, >1B of today’s internet users are on an Apple device. This type of market penetration means that Apple is driving close to one-fourth of all internet users’ online experiences.
Beyond that, with its iOS App Store, licensing, AppleCare, Apple Music, and iCloud, Apple has more stable and diversified revenue streams than most other major internet platforms. In 2020, to focus mainly on Apple hardware sales is to ignore the potential of an iOS-based internet economy. This helps explain the rationale increase in Apple’s multiple from a 5 year average of ~15x P/E to 23x in recent weeks.
The next act for Apple is to provide value to its user base via software and services via the iOS ecosystem, which in turn will drive “higher revenue per active Apple user”. This is similar to how internet peers such as Facebook, Google and Tencent measure their revenue; revenue per active user is the core metric of any internet company. In our opinion, secondary metrics such as “Monthly Active User” and “Time Spent per User” are irrelevant for Apple. While Apple certainly has the opportunity to build out, for example, social components in its ecosystem (e.g., family sharing), iOS fundamentally functions differently than social platforms. For Apple, the focus is solely on improving experience across the iOS platform. As more of Apple’s growth moves from hardware to software and services, using “Revenue Per Active User” will become the north star.
Recent investor optimism at Apple has been driven by positive sentiment related to the sales of wearables and accessories (AirPods and Apple Watch). Even Apple starts each quarterly call with an emphasis on sales of these devices. But the value of Apple’s wearables should not be measured in terms of hardware sales. As accessories specifically designed to pair with the iOS ecosystem, AirPods and the Apple Watch have already increased the time users spend on iOS, and are possibly even increasing the revenue generated by iOS services. Even wearables should be judged by their true value to Apple: how effectively they lock customers into iOS and the Apple ecosystem (“attach rates”), and ultimately their incremental contribution to the “revenue per active user”. These devices also have the potential to acquire new users to the iOS ecosystem.
As an internet company, much of Apple’s future revenue potential will be realized by growth in services. If investors are to view and value Apple the way they should, Apple’s reporting of these various businesses needs to be more granular. We predict the following three services will have the biggest impact in shaping Apple’s future as an Internet company:
iOS App Store
Subscriptions (Entertainment and Gaming)
Payments & Financial Services
We are going to share how we believe Apple, in our opinion, should be presenting these three core sectors.
iOS App Store
The iOS App Store is the main driver of services revenue for Apple today. App Store revenue was estimated to be at least ~37% of Services Revenue (~$16B) in 2019. The App Store is already robust, maybe even more robust than Apple acknowledges. It is a powerful two-sided platform where developers build apps and iPhone users engage with them. As of 2018, Apple had 20M registered developers on their iOS platform, with numbers only growing. This, combined with Apple’s massive installed iOS base, has created a thoroughly thriving app ecosystem.
Two-sided platforms usually have indirect network effects that drive market share towards a “winner take-all” platform. However, as far as mobile app platforms are concerned, the market share is split between Apple iOS and Google Android. As of Q4 2019, iOS users were able to choose from 2.2M apps compared to Android’s 2.6M apps. But most users only download a handful of apps, many of which are cross-platform (i.e., apps are available on both platforms). Though Apple launched the iPhone sixteen months prior to Google’s Android launch, Apple lost the opportunity to “tip” the market towards its single platform because Google adopted an open strategy for its platform, in contrast to Apple’s vertically integrated approach. But we would argue that this is not a sign of equal market value across iOS and Android. For more on this topic you should read the excellent paper by Timothy Bresnahan and his team at Stanford.
So how does one measure the value of the App Store if not in volume of apps or developers alone? The only way to measure the success of the App Store is by measuring its payouts to its developers. Supply (developers) always goes to where demand (users) is to maximize its revenue earning potential. Apple claims it has paid developers $155B in total since the 2008 launch of the App Store with ~$39B paid in 2019 alone. Google on the other hand does not report this specific developer payout metric likely because it’s much lower.
Apple’s success in the app space is driven by the demographics of its user base. Apple’s largest geographies are developed markets and its user base skew higher income than Android’s (this is no surprise as the iPhone prices are quite high compared to the average Android device). This translates into more in-app purchases that drive gross revenue for the App Store and payout for Apple’s app developers. Per AppAnnie, iOS only accounted for 30% of worldwide app downloads in 2017, but 70% of worldwide app revenue.
It’s clear to us that Apple doesn’t fully appreciate what they have with the App Store. The 2019 Apple 10-K report only has 7 mentions of the word “developer” in it. Contrast this with Facebook, which mentions “developer” 58 times in their 10-K despite not even having an OS to build apps on. Ideally Apple should report on the metrics of Annual App Store Revenue per Active User and Annual Payout per Active Developer to solidify the value of what it has built.
Subscriptions (Entertainment and Gaming)
In addition to the iOS App Store, Apple has also launched a successful subscription offering. Apple Music launched only in mid-2015 and is expected to generate at least $5B of revenue in 2019. It quickly became the #2 global music streaming business next only to Spotify. According to the Wall Street Journal, Apple Music surpassed Spotify in US paid subscribers in 2019. This rapid success relative to incumbents shows the power and reach of the iOS ecosystem. And it suggests that there is potential for Apple to apply this proven model across other sectors.
Apple has the potential to grow its subscription offerings in a similar way that Amazon has grown Amazon Prime. If executed correctly, Apple, like Amazon, will drive higher customer loyalty and retention within a contained ecosystem. Over time, Apple would be wise to focus on bundling access to its various subscription services (Music, TV+, Arcade, News+, iCloud). Bundling products like Apple Music or TV+ along with hardware will only accelerate stickiness to the Apple ecosystem. Imagine a world where Apple lets you choose a subscription service of your choice (TV+, Music, Arcade, News+, iCloud) for a monthly fee alongside the purchase of an Apple hardware device (which itself could be purchased on subscription). Add this to existing social and family sharing capabilities of iOS coupled with iCloud storage and you will have the ultimate “Prime'' bundle for Apple.
The bundling of a free one-year Apple TV+ subscription with the iPhone 11 is a step in the right direction for Apple. As more online time spent shifts from desktop to mobile, it is especially important for Apple to tap into this utility. Streaming market leader Netflix estimates that it is still only 10% of TV screen time in the US. There is plenty of room for a major streaming player to come into the market and compete with Netflix, Disney+, or linear TV. While Apple TV+ has not yet presented itself as a formidable competitor, the success of Apple Music creates a roadmap to building a meaningful TV service alongside.
Apple Arcade also gives us a glimpse into the future of Apple subscriptions. Apart from access to games, Apple offers access to 6 family members, cross-device compatibility, no ads, and no in-app purchases for a low monthly flat fee. Reviews on Reddit seem to indicate Apple Arcade’s value proposition has been well received, even if not yet prolific. It is a subscription system that plays to all of Apple’s strengths: it is social, shareable, and entirely embedded in the ecosystem that iOS users are already tapped into.
Apple is in a great place to build a very profitable subscription business within their ecosystem. What is even more interesting to us is that Apple is using its services to extend its platform by making them compatible with any non-iOS device. Apple Music, for example, already has an estimated 40M+ downloads from the Google Play Store since its launch. Though the cross-platform app has ways to go (the frequency of updates is reportedly much slower than on iOS, for example), it shows that the addressable market for Apple’s subscription offerings can extend beyond iOS users. Similarly, the Apple TV app is available on other streaming platforms like PC, Samsung Smart TV, Roku and Fire TV. Most other investors have not yet caught on, but we believe there is evidence here that the market for Apple’s services extends far beyond iPhone and iOS users.
Payments & Financial Services
Apple’s most under-appreciated assets are their payment products. Today, they receive very little attention from investors since Apple Pay and Apple Card only drive a small portion of the company’s total revenue. But the Apple Card + Apple Pay combination is a prime example of how technology will transform financial services and should not be overlooked.
Apple’s first major payments product was Apple Pay, which launched in September 2014. Though initial adoption was slow, today Apple Pay is available in 49 countries with 6,000 active issuers (e.g., banks, card providers) in the world. And, per Tim Cook, Apple Pay is now processing more transactions than PayPal while also growing 4x faster. In the September 2019 quarter, Apple processed over 3 billion transactions.
We view Apple Pay as one of Apple’s most strategic assets as an internet company. It is a multi-sided network that connects issuers, merchants, and consumers directly. As Apple builds out this network, it is poised to become the central digital wallet where its 1B+ iOS users transact both offline and online. This not only further entrenches customers into the Apple ecosystem, but also enables Apple to offer other adjacent financial services.
Apple Card is the first product Apple has built that is complementary to Apple Pay. It is a technology product designed to seamlessly work with the iOS ecosystem. Some investors have written off the Apple Card because its “rewards” and “perks” do not stack up relative to other high-value cards (e.g., the Chase Sapphire Reserve). But we disagree. Apple has hit the nail on the head in terms of the value proposition wanted by millennials by offering instant approval, fast check out, spending tools, instant financing, no fees and daily cash back. It is a service that caters exactly to the needs of the generation most likely to adopt it.
Research suggests millennials are budget-conscious, value-based and streamlined. Therefore the appeal of low-interest rate and spending tools (budget-conscious), no fees and daily cash back (value), and instant approval and integration into iOS payment flows (streamlined) will be strong for this next generation of consumers.
Consumers are demanding that financial services experiences match other consumer product experiences. We have personally seen this trend play out as neobanks have emerged globally.
Monzo (UK) has grown to 3.5M customers with a value proposition focused on transparency, low or fair fees, and budgeting/spending insights (Full disclosure: We are investors in Monzo)
Chime (US) has grown to 5.0M customers with a value proposition focused on transparency, no fees, and services that help you save
Nubank (Brazil) has grown to 20.0M customers by offering lower interest credit cards, low or fair fees, and financial control
And, much like the global neobanks, we hypothesize Apple will be able to take share from traditional financial services players over time. Apple will be able to meet many desires and expectations that are arising amongst consumers, such as:
No or transparent fees from financial services startups. Newer fintech startups (e.g., Monzo, Robinhood, Chime) have built their value proposition around this offering. Apple is following in their footsteps with their fee structure on Apple Card. Banks will not be able to respond effectively as their consumer banking business models are tied to fees related to overdrafts, wire transfers, and minimum account balances -- overdraft fees in 2017 alone totaled over 34 billion dollars. Wary consumers are happy to adapt newer and more transparent monetization models.
Simple and fast transactions in both online and offline settings. The look and appeal of the “plastic” will be immaterial in a few years. As mobile payment adoption accelerates, there will be no difference between a metal, plastic, or digital card. All that will matter is consumer experience. Apple Pay is a mobile payments platform focused on making transacting both online and offline easy; it checks every box here.
Instant access to services. Consumers don’t want to wait 2-7 days to open a bank account or get approved for a loan. Consumers want instant experiences. Neobanks, like Monzo, realize this and enable customers to open checking accounts / savings accounts and get loans instantly. Apple can also do this. Beyond just setting up an Apple Card, Apple Pay enables Apple to track or monitor consumer spending, enabling Apple to play a significant role in consumer lending in the future.
As previously discussed, Apple also has the unique ability to increase the adoption rate for the Apple Card by bundling the purchase of an iPhone on a monthly installment Apple Pay plan with no interest. This would not only help grow Apple Card adoption rates, but may even allow existing millennial users to feel they can afford to replace their iPhones more often.
Lastly, Apple is uniquely positioned to solve the distribution challenge in fintech. In our experience, acquisition costs can become prohibitively expensive for fintech startups if you don’t have a unique value proposition (e.g., Robinhood offering no fee trading) or a network built into the product (e.g., Venmo, SquareCash, Monzo). Apple, on the other hand, can leverage its user base and its trusted brand to rollout the Apple Card. I believe that Apple Card is positioned to accelerate innovation in banking and financial services in the same way the iPhone accelerated growth in smart-phones sales and internet ubiquity.
With the investments in App Store, Subscriptions and Payments, it is clear that Apple is building the foundation for a large internet services business built on top of its installed base of 1.4M devices globally. Therefore the only missing piece in the puzzle for Apple to be a truly global internet platform is whether Apple can break into mass market.
Can Apple go mainstream?
We believe Apple stands a better chance today than it ever has to go mainstream. But Apple’s commitment to mass market expansion remains ambiguous. The common perception amongst investors is that the high price point of the iPhone will necessarily continue to exclude a large portion of the global market, leaving a massive void in the developing world for Android to fill. There are signs, however, that Apple is attempting to become more price competitive. When one accounts for the trade-in value of the iPhone, for example, purchasing a new mobile device with Apple can in fact be cheaper than direct Android competitors. With a trade-in, the net cost of an iPhone X is nearly $100 less than the net cost of its contemporary 128GB Pixel 3 XL. More recently, when Apple launched the iPhone 11, it refrained from increasing the iPhone price for the first time in recent memory, and even reduced prices of older iPhone models more than usual. All of this suggests that Apple is positioned to expand its global mobile market share. But as Apple has not clearly indicated mass market as a key strategy, it’s unclear where its intentions lie.
There are investors who believe price premium and high-end branding are important for Apple to maintain over the longer term for profitability. But as we’ve seen, the real value for Apple in the future will be in figuring out how to expand the reach of the iOS ecosystem as far and wide as it is able. Apple would be smart to lean all the way into this. Internet platforms have the tendency to be winner take all. Microsoft has a 78% market share of desktop OS, Amazon effectively has monopolistic share in e-commerce, and Facebook is the network on which nearly every social aspect of the internet is built. Apple has the potential to become the global giant for all core internet services (like utilities, entertainment, and payments). But as long as Apple maintains a “device-first” vertical integration focus, it will not be able to tip the global market.
In 2020, it should not be a matter of whether Apple can go mainstream. To reach the full, massive potential of its platform, Apple should and must go to mass market. The future of Apple lies in its internet services. The more global citizens with access to the iOS ecosystem, the stronger Apple’s economic future will be.
Thanks to Chloe Gordon, Ram Parameswaran, Sonal Chokshi and Simon Lu for reading multiple drafts of this essay