Categories

Counting stool legs

Feb 11, ’13 12:44 PM
Author Categories Financial

As Apple introduced a new set of revenue categories, the performance of its “minor” businesses has become clearer. The changes include re-statement of what used to be called “Software” revenues as part of iTunes. Apple Software includes sales of OS X, iWork and its pro tools. These products are now sold through the Mac App and since that is a part of iTunes its inclusion makes sense.

However, we have to understand that iTunes now is a blend of many business models. Some, like music, use a wholesale revenue recognition method and have very low to zero margins, others, like eBooks and Apps, are sold using an “agency” revenue model with potentially higher margins and some, like Software, are recognized at full value with very high margins.

When re-stated this way, iTunes becomes much more than a “break-even” business. My own estimate for its gross margin as currently reported is between 15% and 17% but it could be even higher. This allows the following picture to emerge:

Screen Shot 2013-02-11 at 2-11-12.06.08 PMThese graphs show contributions to Revenue and Gross Margins of the various reported product categories. Note that restatements for Accessories and iTunes only extend back to Q4 2010 and the older “Software” is still shown for earlier periods.

Note also that Accessories are now including some of the revenue that used to be reported as part of iPad and iPhone revenues. This was discussed in more detail here.

There are several observations we can make:

  1. iTunes now becomes a steadily and rapidly growing business. Growth over the previous two years averages well over 30% and is consistent across seasons.
  2. The absolute revenue number is substantial: $13.5 billion for 2012 (up from $10.2 billion in 2011).
  3. Assuming a gross margin of 15% to 17% yields contribution of $2 billion in margin in 2012 and $1.6 the year before.
  4. iTunes is now Apple’s fourth largest business, having overtaken the iPod in revenues two years ago
  5. iTunes growth relative to the Mac means that it could become the third largest business during this year.

When seen this way, as a percent of total, iTunes begins to look increasingly as a viable “leg stool” upon which Apple rests. Note that in the following charts the percent of total for iTunes holds steady while Mac and iPod decline.

Screen Shot 2013-02-11 at 2-11-12.24.44 PM

Adding the Accessories business (which includes Apple TV and is showing in Orange above) these “other” businesses are already bigger than the Mac. Of course, content, software, accessories and services depend on a healthy device business, but the size of these ancillaries are beginning to be substantial and Apple’s ecosystem may begin to be valued more than just as an incentive to buy the devices.

Indeed, if seen in isolation, iTunes+Accessories combined is a bigger business in terms of revenues than any of the other phone vendors except Samsung:

Screen Shot 2013-02-11 at 2-11-12.36.14 PM

 

  • Sa

    Horace. Can you label the second chart?

    • Tim Yoon

      Yes please that would be helpful.

    • http://gravitationalpull.net/wp/ ampressman

      Same colors as the first chart

    • http://www.asymco.com Horace Dediu

      The labels from the first charts apply.

  • Tim Yoon

    To me, the most impressive thing about this graph is how dependent apple still is on iPhone for gross margin. At one point I thought that ipad might reduce that situation as ipad was growing faster, but because apple can not get the same high margin for iPads this has not come to pass. These graph shows me that iTunes is still a very small leg. Apple is essentially standing on one leg – iPhone.

    • http://policydiary.com/ John S. Wilson

      one leg? No, that was in 2004 when the iPod was the majority of revenue and there was *nothing else* (aside from Mac sales, which were much lower than today). IPad is a 8-9 billion dollar a quarter business. And it will continue to grow.

      • JohnDoey

        One leg would be 1998–2001, when Apple’s only product was Mac OS 9 -based Macs. Then they go to 2 legs with Mac OS X -based Macs and iPods from 2002–2006.

        There was a brief moment of doubt in 1996, but the Mac never lost its hold on creative computing. Without the iPod, Apple still had a strong Mac business selling to audio and video producers, print and Web publishers, writers, artists, etc.

        And we could say that Mac OS X saved Apple as much as iPod. Mac OS X enabled the Intel transition, enabled the creation of iOS, and captured the majority of software developers from Windows, setting them up to be iOS developers.

        Not to mention that iPod only worked with the Mac for the first 2 years, utilizing FireWire during the USB1 era. So the later USB2/Windows iPods also owe a debt to the Mac.

      • twilightmoon

        OSX is NeXT so really NeXT saved Apple.

    • http://www.asymco.com Horace Dediu

      The iPad revenues were $10.6 billion last quarter. Google revenues (ex-Motorola) were $12 billion and Microsoft’s Windows and Windows Live were $5.9 billion. It won’t be long before iPad will be bigger than both Windows and Google.

    • Steve

      It’s funny how you say ‘standing on one leg’ as if it was something negative, or implying impending downfall. Even if one leg is larger than the others, the fact is that the other legs alone are still larger than many other companies. This is just how big apple has become. Yet someone can always spin it negatively.

      • JohnDoey

        The reason for the negative spin is that Apple competes with everybody else at once. Other phone or PC makers are part of a generic market that shares some things like Blu-Ray Disc or Android or Java. Apple provides a branded alternative to all of generic techs

        You can see after the iPhone 4 launch when some doubt was raised about the iPhone antenna that everybody else piled on.

        Also there is some element of just everybody attacking the king of the hill.

    • Space Gorilla

      Tim, I think you’ll find Asymco is not the place for your anti-Apple rhetoric.

      • http://www.noisetech-software.com/Home.html Steven Noyes

        Anti-Apple? I don’t see that comment as anti-apple but a valid observation. There is no denying the iPhone is a very long leg on the revenue stool. I was expecting the iPad to pick up a bit more of the slack a bit quicker than it is.

      • http://policydiary.com/ John S. Wilson

        A bit quicker than 10 billion in one quarter in under 4 years of operation? Seriously? That’s absurd.

      • Space Gorilla

        Perhaps I’m wrong but it does seem that Tim is simply spouting a talking point, about Apple being dependent on the iPhone, which is nonsense, and I think regular readers of Asymco appreciate the lack of nonsense.

      • Tim Yoon

        I am not an anti-apple person. I was surprised by Horace’s gross margin graph. Please look above. IPhone makes up a very large portion of the gross margin. This is just a statement of fact.

        The more interesting question is why iPhone has such margins when iPad does not. I suspect this is related to carrier subsidies. This leads to another question. Can Apple create another product line that has the same or better margins than iPhone? Or is iPhone anomalous?

      • Space Gorilla

        But you’re jumping from the iPhone margin to “Apple is essentially standing on one leg”, that’s a bit of a leap.

      • http://www.facebook.com/paul.eccles1 Paul Eccles

        I doubt it. iPhone margins are clearly anomalous, even by Apple’s standards. 30% margins for Mac, iPod, iPad etc is a great achievement. ~60% is staggering.

      • http://www.facebook.com/rambu.tan.161 Rambu Tan

        iPhone is a anomalous product only because the market, with the help of carriers, is willing to pay for it because 1. without really have a choice, 2. doesn’t really care about the margin it is paying, or 3. for the value that it provides.

        Apple is rightly taking advantage of this anomaly and should continue to do it for as long as it is available for the taking.

      • Walt French

        @Rambu Tan wrote, “…the market… is willing to pay for [the iPhone] because 1. without really have a choice, 2. doesn’t really care about the margin it is paying, or 3. for the value that it provides.”

        And herein you have the recipe for essentially EVERY successful company: provide a product/service that competitors can’t touch. If not absolutely, at least enough so that you can capture as profit the difference between its value to consumers and the cost of the parts that goes into it.

      • KirkBurgess

        It would have to be a market where products that are regularly replaced are subsidised by a high priced recurring user contract.

        If you can figure out a current or new market that fits that description, you have an answer.

      • JohnDoey

        The reason iPhone has higher margins than iPad is that iPhone is a high-end phone and iPad is a low-end PC. Not only do high-end products have higher margins than low-end products, but notice that iPhone is the ONLY remaining high-end phone, while iPad is only one of hundreds of low-end PC’s. There is much more price pressure on iPad.

        Similarly, when Apple does a low-end phone, it will also have lower margins than the high-end iPhone.

        The PC that matches the iPhone is the Mac — high-end, high-margin. Lower unit sales because PC’s are 1/6th the size of phones.

      • http://www.asymco.com Horace Dediu

        A business should not be seen as a margin maximization problem. Too often that leads to niche markets and flight from better opportunities. Profits are a function of Accessible Markets, Market Share and Margin.

      • Walt French

        A simple function, at that: 5th-grade multiplication. Expand any measure independently by 10% and the business expands 10%. Expand one (say, margins) by 10% at the expense of cutting one by 10% (eg share), and you lose 1%.

        Easy peasey.

      • Walt French

        A bit touchy, are we? Apple DOES derive a lot of revenue from its most disruptive product? Gosh, they’re crying all the way to the bank.

        Of course, the fact that it has been such a fabulously successful disruptor forces some people to consider that somebody else could do the same, or that this whole “post-PC PC in your pocket” thing is just a fad. I don’t see how that’d happen, but I think it’s obligatory to contemplate if/how it could.

        So: thanks, Tim, even if I don’t actually take your point. To me, iPhone is merely the latest instantiation of Apple’s Innovation Creation machinery; there’ll be another to replace it, even if not on some people’s timetable for 5 monster hits per decade.

      • kgelner

        It’s a stupid observation since “one leg” is massive, and the many other legs exceed most businesses. It means that Apple “stands” on many legs, and uses the iPhone “leg” as a club to beat money out of other phone vendors.

      • JohnDoey

        iPad could not move any faster than it is.

        When iPhone shipped, smartphones and iPods were successful for 5 years before, but iPad is the very first successful tablet. iPad’s biggest problem is still convincing people it is a PC. Even after the Windows 8 homage to iPad, many people resist recognizing that iPad is a PC. Even with the burden of educating consumers, though, iPad outsells the biggest Windows PC maker all by itself.

        Remember also that the PC market is about 1/6th the size of the phone market. So multiply iPad sales by 6 to compare to iPhone.

    • handleym

      My guess is that there is truth to what you are saying, but not exactly in how you think.

      My belief is that the 5″+ phone phenomenon is a “poor people” phenomenon — if you can only afford ONE computing device, then it makes sense to get a phone that is as close to a laptop/tablet as is affordable+practical. You see evidence of this, for example, in the fact that it is outside the US that these monster phones are most popular.

      What does this mean for Apple?
      As I have said many times before, Apple’s strategy has been to sell not a single device which is poorly matched to the dictates of the human body, but rather a constellation of devices all in a human-optimized form factor, but which work well together. (I’d like to say “work seamlessly together” but sadly today iCould is far from that point…) This is a strategy that works well if your goal is make the best devices possible, and you are willing to leave some money on the table.

      But suppose you are not willing to leave that much money on the table (or, to put it differently) you want to be kind and allow poorer people to share in Apple goodness? It then makes sense to create compromise (and cheaper) devices which are less than ideal but which, as a single device can fulfill the role of two previous devices.
      You could view the iPad mini as the first step along that sort of path; with the REAL culmination of this path as a 5″+ iPhone.

      My point is: it’s perhaps artificial to view iPhone and iPad as competing business lines. Rather, a more natural analogy is to compare them as like MacBook Air vs iMac — if you’re wealthy enough, you’ll own both, and both will be the ideal tools for different jobs. But if you can’t afford both, you’ll compromise, and that compromise will probably be the MBA.
      Likewise, a large-screen iPhone will likely cannibalize some iPad (especially iPad mini) sales, especially among the poorer population (some in the US and the west, more so in the developing world). The release of a large-screen iPhone (along with the onward march of iPhone to ever more carriers in the developing world) could make the imbalance even stronger.

      BUT I see this not as weakness, but as an intermediate stage. Over the next few years, the effective price of the iPad and iPad mini will fall. (By which I mean that the Apple price may stay flat, but ever larger numbers of second hand iPads will flow out through eBay and Amazon to serve the poorer in the US and then further afield.) And so gradually, and in hand as iCloud evolves, the ultimate Apple vision of a personal cloud of appropriately-sized devices will move downmarket.
      Apple still makes money (from iTunes and maybe some accessories) even from those second hand sales, which also allow Apple to keep the first-sale price higher, and the iPad sales should be seen as simply lagging iPhone to some extent — reflecting not a poor product, but a poorer customer base which has to decide carefully where to spend its first ever Apple-purchase dollars.

      • JohnDoey

        Apple is serving low-budget customers, though. An iPad mini for $329 completely outclasses all other $329 PC’s. People who paid $189 for an iPod touch got basically a full iPhone when in Wi-Fi. $5 iMovie and GarageBand and iPhoto apps — $10 Keynote, Pages, Numbers.

        What is missing is a low-end prepay phone from Apple. When that comes, they will have a complete lineup of low-end and high-end devices.

        The 5-inch phones are because bigger is cheaper in phones, and the salespeople say “bigger is better.” Consumers fall for this once.

      • Walt French

        Well put.

        But part of Apple recommending a product is an endorsement of sorts, so I think they have to be careful with their messaging to developed-world consumers when they start sending conflicting messages to developing-world prospects.

    • Jeff G

      98% of Google revenues are from a single leg, advertising. What does that tell us? Not much.

      What does IPhone as a largest Apple revenue leg tell us? Since iPod used to be biggest leg… It tells us they know how to innovate and create new legs. IPad and iTunes for example.

      • Walt French

        Upvoted, but I think Google’s “stick to the knitting” of charging businesses for being the tour guide that drives customers to their shops is VERY helpful in knowing what they’ll do in the consumer-facing world where competitors such as Apple serve customers who are willing to pay for sites & services without distractions from 3rd parties who Google thinks might tempt you.

        Take Siri: I can ask her for “Zuni’s phone number” without seeing ads for other restaurants or going thru the effort of scrolling past a bunch of them. Google is pretty good for the function, but it’s seems they almost grudgingly help you dial the number because otherwise you wouldn’t use them and you wouldn’t see all the sites such as TripAdvisor that want to be “helpful” by delaying you from your purpose.

    • simon

      > Apple is essentially standing on one leg – iPhone.

      Interestingly I haven’t heard the same argument against Samsung even though the same is true. Really, look it up. Most of Samsung’s profit is from selling phones.

      • JohnDoey

        Motorola also has one leg, but it is broken in 52 places and they have been laying flat on their back for years now.

        LG has one leg: selling displays to hardware makers. Their phones are a charity.

        So anyone knocking the iPhone business in any way is just not making sense.

      • simon

        > LG has one leg: selling displays to hardware makers. Their phones are a charity.

        Not really true. LG Display and LG Electronics are two separate companies with separately traded stocks.

      • SSShu

        Samsung as a whole?

      • simon

        Samsung Electronics as a whole.

      • http://www.asymco.com Horace Dediu

        You can find the answer here: http://www.asymco.com/2012/12/03/samsung-electronics-product-line-revenues-and-operating-income-in-context/

        This data has been updated and will be published shortly.

    • JohnDoey

      The reason for that is that iPhone is a high-end phone and iPad is a low-end PC. There is more margin in high-end products than in low-end products. However, iPad margins are the envy of the low-end PC market, so Apple’s margins are still beating their competitors by far.

    • http://www.asymco.com Horace Dediu

      Are you suggesting that Apple would be better off if the iPhone business was smaller? I have in the past suggested that it makes sense to see each business individually and, in so doing, for example, the iPad appears to be a bigger business than Windows, which I take to be a sign of health.

    • http://www.facebook.com/rambu.tan.161 Rambu Tan

      Apple is standing on one leg only because that leg wants to grow & keep growing faster than the other legs. But that doesn’t mean the other legs are small & weak. I think while Apple would like to have all legs to be equally big & strong, they’re happy with that one big leg as long as the others are strong & growing.

    • SSShu

      Maybe you should’ve used the word Pillar(s) instead.
      But i understand you POV – though I look at it from another angle. I dont think it’s entirely Apple’s fault – the market decides what it wants.
      At the moment the iPhone seems to be the one thats in high demand – and i dont see any reason for Apple to slow down the iPhone’s momentum just so the graphs would line up a lot nicely.

  • Jim Zellmer

    iTunes on Window was decisive in expanding the ecosystem, not to mention selling buckets of iPods. Presumably other platforms will receive similar attention….

    • Kizedek

      Presumably other platforms would receive similar attention from their own creators.

      iOS *is* the platform that iPod and iTunes never was (until the iPod Touch). So what platform or platforms now need attention from Apple [if that was your implication]?

      Building iTunes for Windows did indeed help establish the iPod, but the reason was that the iPod required a computer to sync with. Now iPhones and iPads no longer do. If you wish to synch them with a computer, you may — on either Windows or Mac OS as you wish, as always.

      Apple should no more extend iTunes to Android than license OS X to Dell.

    • JohnDoey

      What other platforms?

      Windows+iTunes used to be Apple’s low-end PC. Now, Apple has iPads that run their own iTunes app.

      Non-Apple phones can play music purchased from iTunes on Mac/Windows.

      Going forward, if there are new iTunes apps, they will likely descend from the iTunes app on iOS, not Mac OS.

      • Jim Zellmer

        It depends on the “strategy tax”, or, perhaps how asymmetric the ecosystem strategy is. Horace has noted the growth in the cloud aspect fo Apple’s ecosystem. Perhaps an emerging product segment featuring new input paradigms might benefit from iTunes on Android. Ideology should be revisited from time to time.

  • http://twitter.com/MarbellaCapital John Wang

    This means if AAPL were to be valued like NFLX (624PE), it can stop selling hardware altogether and still have a mcap of $1.25 trillion ($2 billion x 624)… But seriously, Horace, how do you get to your estimate of 15-17% margins?

    • http://www.asymco.com Horace Dediu

      In the last quarter before folding-in Software, iTunes generated about 2.3 billion and Software generated 892 million. If you assume 1% gross margin on iTunes and 60% margin on software you get about 18% on the combined. I think this is quite conservative as iTunes without software could get as much as 10%.

    • Shawn Dehkhodaei

      Well, since AMZN is considered a “peer” or competitor to Apple, then I’d rather have Wall Street douchebags price AAPL with the same PE ratio as AMZN !!! In that case the stock would be in the $100,000 + range. Seems fair, no ??

  • beidaren

    i was reading the new book by former AT&T CEO and GM CEO ED Whitacre, In the book, He disclosed a few interesting things about original iPhone deal with AT&T. the most interesting one is this:

    “The original deal Stan cut also gave AT&T a percentage of revenues from iTunes, now called the App Store. There were a number of conditions around revenue-sharing—music and movies were exempt…”

    if true, that’s news.

    • steven75

      That doesn’t make any sense. The original iPhone launched without an App Store so there wasn’t any revenue to share.

      Also it’s widely known (due to China Mobile holding out for precisely this) that Apple doesn’t share revenue with any carriers, nor should they IMO. It would be like gas stations sharing a percentage of their revenue with car manufacturers. There’s no reason for them or Apple to entertain such a thing.

      • beidaren

        i’m quoting from the book just published. ED Whitacare was the CEO when the original deal was struck. i have no reason to doubt him.

        “Stan later said he wished he’d taken Steve’s cue on another thing: that ten-year exclusive. As noted above, Stan got Apple to agree to a five-year arrangement: an initial three-year exclusive, with the right to renew for an additional two years so long as both sides agreed. But on a positive note, AT&T got millions of new customers and a pretty good lift in its brand image, so we weren’t exactly complaining. The original deal Stan cut also gave AT&T a percentage of revenues from iTunes, now called the App Store. There were a number of conditions around revenue-sharing—music and movies were exempt, for example—but the overarching positive was that AT&T was well positioned to take advantage of the applications boom that”

        Excerpt From: Edward Whitacre & Leslie Cauley. “American Turnaround.” Grand Central Publishing, 2013-01-22. iBooks.
        This material may be protected by copyright.

        Check out this book on the iBookstore: https://itunes.apple.com/us/book/american-turnaround/id525507851?mt=11

      • orthorim

        Sure why would he make this up. But there were no apps and NO plans to ever allow apps on the iPhone when the iPhone first came out in 2007. Which would be the time the deal was struck.

        And as stupid the details of this deal were, without it today there would be no smart phones. There would be
        – No affordable mobile internet (that was jealously guarded in 2007, and unlimited plans were unheard-of world-wide; you had to pay by the Kilobyte for GPRS speeds, or use 3G for video calling at $5/minute in Europe, which, unsurprisingly, nobody did)
        – No apps. Carriers at the time and even later thought that they would be the exclusive owners of any app stores. This was a huge deal.

        Also in the initial deal, Apple shared in AT&T’s monthly revenue from iPhone users, too. Later it turned out that that wasn’t good for Apple, it was an idiotic idea.

        The iPhone is a story of how a gadget succeeded despite a number of hare-brained marketing mistakes right in the beginning… remember it cost $500 subsidized and Apple got a cut of revenues…

      • JohnDoey

        There were clearly plans in 2007 to launch native apps on iPhone. The SDK that launched in early 2008 was much more than 1 year of work.

        It is more correct to say that native iPhone apps were on hold in 2007, pending an improved security model, which ultimately Apple came up with: audits, multitasking limits, App Store exclusivity.

      • http://twitter.com/WalterMilliken Walter Milliken

        I can’t say what Apple was thinking at the launch, but they were definitely internally developing native applications for the iPhone, so the SDK had to exist for that purpose, even if it weren’t originally intended for 3rd-party use. A year to clean it up and partition it more for security, I think is plausible, though probably required an aggressive schedule.

      • Walt French

        @orthorim wrote, “But there were no apps and NO plans to ever allow apps on the iPhone when the iPhone first came out in 2007.”

        I’d just love a quote proving that Apple didn’t always intend to have an app store, but wanted to work out the terms before disclosing it. Methinks people are over-interpreting one of Jobs’s famous misdirections.

      • http://www.asymco.com Horace Dediu

        There is a lot of circumstantial evidence that the iPhone was built around apps. It may have been done in defiance of Jobs but it was done nonetheless. Consider that all the apps that shipped with the original iPhone were, well, apps. Also consider that once jailbroken, apps could be written with ease even though there was no public SDK or documentation (i.e. the API was there). The entire platform existed for the benefit of Apple’s own software engineers to build apps. Creating an ecosystem was a matter of tearing down barriers rather than building access bridges.

      • http://twitter.com/WalterMilliken Walter Milliken

        I think a lot of that was due to the reuse of the Mac OS and its APIs in iOS, so I wouldn’t give this argument *too* much credit. iOS wasn’t built de novo, and it made a lot of sense for Apple to simply re-use a lot of libraries that were already in good shape. A lot of what they did was streamline and re-engineer for better power consumption.

        I think the key challenges in creating the public iOS SDK were around security and power consumption; things that Apple didn’t need to worry about in their own first-party apps.

        It made a lot of security sense for Apple to not allow native third party code on the device. Basically they only needed to harden the HTML/Javascript interpreter and use best practices in their own code to minimize potential exploits (which, of course, wasn’t 100% successful).

        It seems to me (and I’ve been involved in security work) that a lot of Apple’s design decisions in iOS revolve around limiting the potential for security problems — something that definitely would have killed them early on, if there had been a highly visible security failure.

        I don’t know if they originally intended to ever allow third-party native apps or not. But I don’t think the early iOS would have looked much different either way, given that they decided to build it on top of a fork of Mac OS X.

      • KirkBurgess

        The App Store didn’t exist, but you could still buy music, movies & TV shows on your iPhone. And ringtones were a normal source of revenue for operators at that point, not sure when ringtone sales started on iTunes.

      • orthorim

        Music, movies (and presumably TV) was excluded so that deal was clearly about ringtones.

    • orthorim

      When the iPhone came out there were no apps. So sharing iTunes revenue “without movies and music” would come down to … ringtones?

      • beidaren

        Perhaps.
        I find it most interesting that apple even allowed any type of revenue sharing.
        Yes, it is widely speculated that apple doesn’t share rev. But we’ve seen no hard evidence. Ed Whitacre’s account is the only real evidence I’ve seen countering the wide spread belief.

    • Walt French

      Indeed; that would include apps.

      I’d seen the claim that Google effectively rebates all Play revenue to the phone’s carrier (at least for Verizon and at least for purchases made from the phone). I didn’t realize a possible precedent.

      Would there be evidence of when Apple actually started working on the app store? It seemed pretty robust when rolled out just a few months after Jobs told developers they could do HTML apps, so maybe their platform was wonderful or maybe Apple knew they’d have one, well before developers knew.

  • http://twitter.com/hermione1 hermione1

    what’s a bit surprising to me is the nokia line – and it’s upward trend. Any comments on what’s driving that?

    • http://www.facebook.com/paul.eccles1 Paul Eccles

      Well it’s a modest increase, still down for the year, mostly flat really. Remember they took huge knocks prior to this. This is probably due to increased sales for Lumias following the WP8 launch.

    • JohnDoey

      They had zero smartphones last year and 1 smartphone this year.

  • M

    There is substantial and growing rift between earnings and free cash flow. I’m of the opinion that iTunes/AppStore are one significant contributor to this. iTunes gift cards are everywhere. Charles Schwab is giving away $200 iTunes gift cards for clients bringing $50 K. The thing about gift cards is,.. They are rarely spent instantly and often are never spent at all,… So there is always some incoming cash that falls into a black hole. It is not “earnings” because it is still owed,.. But so long as the total number of gift cards sold continues to grow and some percentage are never actually redeemed entirely,.. This contributes to free cash flow,… which at this point is expanding faster than earnings.

    I don’t think this is the only contributor but it is “one”.

    • KirkBurgess

      iTunes gift cards pale in comparison to the amount of cash for deferred tax that is set aside each quarter on yet to be repatriated overseas earnings.

  • stevesup

    Horace, is this going a way toward making the case that Apple doesn’t need a next big thing? Fine. But I wonder if there isn’t an elephant in the room: The CE tech sector is in total disruption: What’s to stop prices falling to $100 and software (tunes, books, apps, games, shows) dropping to $1. At that point, who will make any profit at all? (Except Google with its ads. I’d throw Google off iOS devices today.) Or is this a unicorn in the room?

    • handleym

      WHATEVER Apple ships next will not SEEM to be the next big thing. That’s just sheer numbers. Phones have reached the status of “essential” for most of the world’s population, Apple is selling well to the rich part of that population, and appears to be making strides to move its sales downmarket. Unless Apple can invent either
      – a must-have subscription service that’s appealing to most of the world’s population and brings in around $100 gross a year (to APPLE, not to content providers or whatever) OR
      – a must-have new piece of hardware that’s appealing to most of the world’s population and brings in $200 gross a sale OR

      – a must-have new piece of hardware that’s appealing to the world’s wealthy and brings in $2000 gross a sale,
      there will be nothing again on the scale of the iPhone.

      This may have implications for Apple’s future growth at double digit figures, but it doesn’t mean Apple can’t continue to grow.
      There are a variety of lower sales (cheaper, not as must-have) that users are clamoring for Apple to release.

      Smart watch is the obvious immediate one. The Smart stylus (as opposed to the dumb stylus of Palm/Newton/S-Pen) is another I have described. Smart glasses at some point. These are all possible iPod-at-its-peak sized markets.

      (There are doubtless crazy schemes one can envisage that could, in some wild fantasy, lead to Apple maintaining it’s growth rate. IMHO ALL of them would require Apple to give up substantial control of the final product, and would pollute the brand while not actually raising that much money. I’d rather see Apple grow at 8% a year for the future than engage in these and hit disaster. Examples:
      – team up with Home Depot or whomever for home automation
      – team up with GE or whomever for medical equipment
      – team up with Tesla or whomever for next-gen auto

      Each of these has obvious superficial attractions. And Google is going to get into at least one of them…
      It’s a hard problem: how does Apple achieve what it did with iPhone, managing to keep control out of the hands of the carriers, while working with partners it needs ever more if it were to go into these fields? I honestly don’t know. And if anyone does then
      [a] you know more than the rest of us the future trajectory of Apple’s stock price
      [b] go get a job at Apple and you can name your salary!
      )

      • stevesup

        I’d say buy Tesla and make “the best for the rest” iPlug vehicle.

      • orthorim

        I don’t think Tesla’s for sale and I don’t think its founder would settle for anything less than becoming CEO of Apple… hmm there’s a thought… 😉

      • stevesup

        Hmmm indeed.

      • orthorim

        Apple buys Tesla, makes Elon Musk CEO, and proceeds to develop an iSpaceShip to go to Mars. Who’d have thought?!

      • KirkBurgess

        I think Apple would be far to boring for Elon Musk – but I would LOVE to see what he would do with $150 billion dollars in cash…

      • JohnDoey

        There is not just one phone market. Apple has dominated high-end phones, but has yet to enter low-end phones.

        In 2005, people said, “how is Apple going to top the iPod?” The answer was iPod nano — a cheaper iPod for the more casual music listener. The same has yet to happen with iPhone.

        But there are plenty of other markets to conquer. Today’s cars have bolt-on computers just like 2006 smartphones, and they have Internal Combustion Engines that are obsolete. An electric car is an iPod with wheels. A Tesla battery pack contains hundreds of iPhone batteries. The inside of a car is 100% human interface.

        Any device that doesn’t have a computer or which only has a bolt-on computer is fair game for Apple to redesign around modern computing.

      • ankleskater

        This sounds like the perspective of someone looking at Apple from the outside.

      • ankleskater

        I doubt Apple is plotting its strategy around “what is our next iPod Nano?”. Arguably, if one insists of using this limited analogy, the iPad is the follow-up to the iPhone much as the iPod Nano was a follow-up to the iPod. Not all follow-ups have to be cheaper and smaller.

      • Walt French

        Nano was a successful derrière-garde effort to hold off the potential disruption from ultra-cheap MP3 players. It gave Apple the time to get iPhone out the door, which we all remember was positioned as “a wide-screen iPod, …”

        Myself, I kinda doubt that Apple has an image of the device that’ll disrupt today’s smartphone market. (It’d be awesome to watch it unfold; I just doubt it’s up their sleeves.) So just as Microsoft is doing Surface to hold off the Tablet Hordes (aka, “iPad users”) from the Windows fortress, Apple may offer a lower-cost iPhone. But I think their DNA is urging them to invent the iPhone killer, not a low-cost version.

      • KirkBurgess

        I think the Apple answer to the low cost smartphone is the iWatch, which actually could be a wrist mounted iPhone rather than simply a iPhone accessory.

        Think about it, would you rather have a not so great $200 android smartphone. Or have a superlight 2.5″ screen connected to your wrist running iOS for $200?

        I’m guessing there will be lots who would still prefer the $200 android phone, but I think the amount who would opt for the iOS device could still be a large fraction. And this is a large fraction of a couple of billion consumers, rather than the much smaller pool whom can afford the $400+ needed to enter the current iPhone club.

      • http://twitter.com/WalterMilliken Walter Milliken

        The standalone wristwatch phone is currently a technical problem without a solution, there simply isn’t room for enough power for the cell radio. (I’m assuming you don’t want to strap something roughly the size of the iPhone to your wrist, at least.)

        There’s a reason why the iPhone is mostly battery, and it’s not all for screen backlight, the cell radio is a good part of the power budget, and virtually all of it in standby mode. I fully expect any wrist-wearable device anytime in the next few years is going to be Bluetooth-based at best for radio connectivity. I.e. short-range to a larger hub device like an iPhone, computer, or router.

        This may change if someone comes up with a new miracle battery, but I haven’t seen anything on the horizon yet (though we keep hearing about supercapacitors…) And even if the energy density did get there, you’d then be wearing a small (potential) bomb on your wrist… (Note the current Boeing problem.) Making the battery smaller will also reduce the margin for error in things like internal shorts; making them safe will be a *serious* issue.

        Communication over distance takes power, with larger distances requiring more power, and Apple’s brilliant design team can’t change that, unfortunately.

      • KirkBurgess

        If anyone can solve the issue of battery miniaturisation, its apple with a decade of making iPod nanos & shuffles.

        To me an obvious solution exists in the form of the wrist strap.

      • http://twitter.com/WalterMilliken Walter Milliken

        Interesting notion, but that’s still a lot of mass to pack in *somewhere*. The other solution would be to reduce battery lifetime significantly, but I don’t think that would be wise unless they can make the wireless charging trick work at a distance. They do have some technology there, this might be the place to use it.

        But the cell radios emit something like 1W of power, and Apple’s iPhone battery holds something like 5Wh (1440mAh * 3.7v if I remember right), enough to power the radio continuously for about 5 hours, assuming perfect efficiency and no other power use. (It’s more complicated than that, since the radio doesn’t actually transmit constantly even in use, of course.) If we assume about half the power actually is devoted to the display and CPU, we’d get a requirement for something on the order of 2.5Wh of battery in a wrist device, for equal cell use, and assuming much less power use for screen and CPU (which might be plausible). That’s still a very large battery to fit somewhere. I’d be dubious about even a quarter the size fitting reasonably.

      • http://twitter.com/matthewwanderer matthew

        The “low cost iPhone” question floating widely might not be called for from the right perspective. Looking at the iPod evolution might provide insight into how the iPhone (and the iPad) will evolve. Apple never touted the iPod shuffle or nano or mini as “low cost” iPods. They simply designed and marketed new price points into the iPod line when the time was right to do so. This took years to actually happen, and I would argue it had to do with component costs that would allow for a given price point at a level of quality Apple requires from all of its products.

        In this regard, however, the iPhone waters are muddied a bit further because of the carrier relationships; no other Apple product is priced by way of subsidy, of course. People calling for a “low cost” iPhone are really asking for an iPhone that can be sold in markets where consumers can’t justify or afford an iPhone with or, particularly, without a contract. The latter is the nut to be cracked, as we already have “$0” iPhones, the free iPhone is just subsidized, and the iPhone 4 and 4s might still require a “heavy” subsidy in relative terms in countries like China and India.

        I’m very interested in how Apple will solve this problem. Apple doesn’t do “cheap” so I assume they’re waiting for the component costs to drop sufficiently on an iPhone that meets Apple’s minimum standards for quality as mentioned above. In doing so, they’re playing a game of chicken with Android, IMHO, but I think Apple’s set up to do well once they finally get the formula right for the iPhone equivalent of the “low cost” iPod.

      • KirkBurgess

        Assuming that nothing will ever be as big an opportunity as mobile is short sighted.

        I doubt back in 2000 many would have said that smartphones would be the worlds most profitable tech market a decade later (and that apple would command 75% of the profits).

        I can already think of a huge market of $10,000+ a piece units that would be desired in every household and workplace, that would require a great marriage of hardware, software & cloud – but this market doesn’t quite exist yet as the technology isn’t quite there – but I fully expect it to be a huge market by 2020

      • Robd

        That has to be a house robot?

      • KirkBurgess

        Bingo!

        Siri would be the perfect interface of course.

      • http://twitter.com/matthewwanderer matthew

        “Smart glasses at some point.”

        I still think we’re talking about “smart contact lenses” in order for this category to be massively adopted.

        The notion that some huge portion of the non-spectical wearing population will suddenly feel the need to drastically change their aesthetic by wearing glasses is a non-starter for products like Google Glasses, IMVHO.

    • http://policydiary.com/ John S. Wilson

      That’s not a plausible scenario, at all. Why would hardware prices fall to $100? And for what exactly — tablets, phones, all pcs? I mean, under what scenario do you envision that could ever happen? And no, you can’t throw Google off of iOS because many iOS users use Google services.

      • stevesup

        If we tracked prices over the last five years on hardware and software for all mobile segments, tablets and phones, where the big money will shift to, they would vector right at the $100/$1 scenario. So what’s to stop that happening?

      • JohnDoey

        There are Google apps for iOS because Google makes more money on iPhone users than Android users.

        Google is the default search on iOS because it is the best in the world. The mapping data that Google was offering Apple for the iOS Maps app was not the best in the world — Google artificially limited it — and so it was replaced.

        Google is an advertising company — not an Apple competitor. Samsung is an Apple competitor. Yes, Google ripped off Apple in an attempt to commoditized the hardware market, but they were only successful outside of Apple. Apple’s hardware has not been commoditized.

      • stevesup

        “not an Apple competitor.” I wonder what Larry Page would say to that. I can think of a dozen ways that Google competes with Apple or intends to do so, beginning with its Android OS.

      • http://www.asymco.com Horace Dediu

        Commoditization is inevitable when products over-serve. It has never failed to happen. In order to create value and profits either new products or categories need to be created or new jobs need to be found for existing products.

      • KirkBurgess

        Do you think its possible for an ecosystem (itunes media, app store, accessories, 500 million credit card numbers) to become commoditised also? Shifting the basis of competition from the phone hardware & OS to the ecosystem may slow commoditisation I think.

      • http://www.asymco.com Horace Dediu

        The answer rests on whether the ecosystem is “good enough”. Can iTunes be improved? Are the means to improve it within the abilities and motivations of Apple? I can imagine many ways in which iTunes content and iCloud and Siri are not good enough and I believe that Apple is motivated to improve them.

      • KirkBurgess

        I agree with that. So can devices that have exclusive access to a non-commoditised ecosystem, be commoditised themselves?

      • http://www.asymco.com Horace Dediu

        That’s not quite the right question. It’s the same as the razor/razor-blade integration. The razor is a commodity but the blades make it valuable and if they are both under the same ownership (and have a proprietary interface) then the benefits accrue to the owner. In the case of the PC, because it’s modular, the software and microprocessor remained valuable long past the point where the computer itself was commoditized. Apple avoided this fate for the Mac by keeping the system integrated.

    • orthorim

      In phones there is not and probably never will be a “race to the bottom” – especially not in high end phones.

      I think this PC-era thinking which has currently hurt Apple stock deserves a closer look. On the one hand, phones are status symbols like cars; luxury cars are doing very well, and have not been replaced by the TATA Nano. They never will be, either, even though there is a market for super cheap cars.

      Luxury phones will continue to sell as long as people have money which is to say basically forever. I can afford to spend $600 on a phone, and I will; because it’s the one device I use most, and I rely on most during a given day. I am not going to settle for less just to save a few $100.

      The advent of cheap Android phones is a huge threat to Nokia and all dumb phones – these will simply cease to exist in a few year’s time. But it’s no threat at all to iPhone, which is in a completely different market. iPhone would be threatened if Samsung came out with a phone that is *more* desirable than an iPhone. This has not happened and cheap Android phones at any rate would not have anything to do with it. It’s not about price, it’s about how desirable the product is. An almost-ran that’s cheaper isn’t going to cut it.

      At the same time, look where the PC market ended up; look what going for cheaper and cheaper has produced: A crap product that nobody wants to use. And industry that has stagnated for a decade, with no innovation, no improvements in usability. PCs are the dinosaurs in today’s age – and they got there by engaging in a race to the bottom. Everyone wants to get away from this failed technology, its complications and its inability to comfortably meet people’s needs.

      The race to the bottom is overrated.

      • stevesup

        Hope you are right.

      • JohnDoey

        Look at the Mac. It is almost 30 years old and never raced to the bottom.

        The Mac is the only remaining high-end PC, same as iPhone is the only remaining high-end phone. They are depended upon daily by millions of people for whom they MAKE money. My Apple devices MAKE money compared to the alternatives.

        There is no alternative to an iPhone running iMovie or GarageBand. There is no other phone that runs PC class apps like that. Android only has baby Java apps and it has more viruses than apps. Apple is the ONLY virus-free vendor.

        Also, you have to understand, video orbits QuickTime. Most music production relies on CoreAudio and CoreMIDI. Web development is Mac-based. Apple is completely and utterly essential in those industries.

      • SSShu

        Well TBH – Apple seems to always be the exception to the rule. Might not be a good idea to use them as a trending guide.

        The doomsday scenario that i fear relies on a simple notion – that people (generally) always want to have the ” ‘best’ stuff for cheaper”….. and that Apple doesnt have to be in the equation/participate for it to happen.

        I think it is still possible for people to jump from one phone to another picking the ones with the ‘best bang for buck’ – riding the market all the way to the bottom…..

        JohnDoey
        >>Apple is winning through better design and technology

        I agree – but the market is a fickle beast. Take into account what Apple has done so far – and also take into account how Samsung has managed to… can i possibly say – buy their way – into the market? (I am of course – oversimplifying a metric tonne of stuff). Perhaps …. quality is in the eye of the beholder?

      • http://twitter.com/matthewwanderer matthew

        “I agree – but the market is a fickle beast. ”

        This is true, but I think Apple’s iPhone is more robust than your comment suggests. If nothing else, Apple’s best poised to benefit from any fickleness that might exist: For example, last Quarter, iPhone market share in the US grew from 45% to 51%.

        I’ve speculated previously that this result has much to do with Apple’s most significant competitive advantage: the Apple customer experience.

        Some consumers, of course, will _try_ a competitor, but because these competitors do not have Apple’s obsession with (this was seeded by Jobs himself) nor a track record of building customer satisfaction like Apple’s (see Apple’s JD Power top satisfaction rating for the last decade-plus), and Apple’s competitors do not have anything close to Apple’s Retail Store presence (where service, replacements and delight can be had by the customer in mere minutes), Apple’s said competitors do not enjoy Apple’s customer retention numbers.

        Retention rates are rarely mentioned in AAPL-related press. It’s the elephant in the room, IMHO.

        Without all these advantages, I am assuming that Apple’s iPhone will not suffer the “slowing demand” predicted in the tech and financial press. In fact, as more Android users begin to actually _use_ these smartphones as smartphones (Web stats suggest the vast majority use their Android as though it were a feature phone) the attrition rates will grow due to the lower customer (service) experience and Apple will benefit directly from this.

      • Walt French

        Or in Horace’s language, Macs are winning in serving “new jobs to be done.” I’d say a solid, easy-to-operate laptop is miles removed from the beige or black desktop PCs. Somebody maybe remembers from the quarterly call that laptops are some very significant part of Macdom these days.

    • JohnDoey

      What stops Apple’s prices from falling that low is their uniquely desirable product.

      Android phones already cost $100. Android apps already don’t sell at $1. Apple doesn’t have that problem.

      My Apple products all pay for themselves within a year, but I use the iOS devices for 2 years and Macs for 3. They are already really, really cheap.

      Also, notice that the $10 Keynote for iPad replaces PowerPoint, which costs 10 times as much. The $5 iMovie is also only a fraction of the cost of a video editor for any other low-end PC. So Apple’s prices are already cheap. They aren’t in any danger of crashing.

  • WFA67

    What I am looking forward to is more passive/self-sustaining income, e.g. subscriptions of some sort. (A la carte TV programming?) And/or investment income from cash re-positioned to dividend paying securities.

    • http://twitter.com/WalterMilliken Walter Milliken

      If Apple were looking in this direction, I think the most obvious choice isn’t content — there are plenty of competitors in that industry, and they’re all monopolies for their particular bits of content, a rather ugly situation. Users might want a la carte content, but the people who own the content know very well that they don’t want to let them have it, because it destroys their pricing model.

      On the other hand, the payment transaction market is easily accessible to Apple, and money isn’t a monopoly good (except maybe of governments). Also, people don’t much like banks…. Apple becoming the next Mastercard/Visa might be a good idea if they wanted a recurring revenue stream. And they’re already about 2/3 of the way there. On the other hand, there are plenty of regulatory problems with this path, so I don’t know if Apple wants to open that can of worms.

    • http://www.asymco.com Horace Dediu

      Apple’s devices have always been self-sustaining. Have you looked at satisfaction and repeat purchase data? Regarding investments, Apple (or any other company) is going to give cash back to shareholders before it decides to become their investment manager.

  • poke

    Apple has a whole bunch of viable businesses, any one of which would be a major story in the industry if they were separate companies (iTunes, iPhone, iPad, Mac, iOS), so maybe the market is punishing them for being integrated?

    • kiran bhanushali

      break it open to “maximize shareholder value”?

  • http://twitter.com/kariemil Kári Emil

    Nitpick: RIM is now called BlackBerry.

  • jimbotomy

    I find it interesting to look at these graphs and consider the strategic decisions of Amazon and Google with regards to mobile and tablets. They both are, from what I can tell, operating on near zero margins to their equivalent of Apple’s iPhone and iPad businesses, in the hope of going after the much smaller duller yellow bar. Bezos in particular has said he wants Amazon to make money when a person uses the device, while Google’s Android strategy has always been in that direction.

    Right now that dull yellow bar represents the best those two companies could hope for, given how much more vibrant the iOS ecosystem seems to be than the Android or Amazoned-Android system. Is there something I’m missing there?

    • JohnDoey

      Google is about $20 billion in the hole on Android. That is less than zero margins.

    • Carlos

      It’s important to remember that Google makes its money from advertising. Android, and to some degree Google iOS apps, are Google’s insurance policy that they will have access to display banner ads and search ads on a mobile platform.

      • twilightmoon

        Apple is actually stealing their mobile lunch with iAd and I would not be surprised if we see Apple with more mobile ad revenue than Google a few years down the line and perhaps even see Googles total ad revenue in decline as more of the world shifts to mobile.

    • http://twitter.com/amol_pk Amol Kasbekar

      Apple is indirectly reliant on carriers for these device margins. Apple has the brand name leverage for now but i wonder how long Verizon or At&t will continue this. For e.g. in India iPhones have low presence since the carriers are not willing to subsidize the costs. As device costs go down or Apple is forced to make cheaper ipad and iphones device margins will decline. If that happens margins from iTunes start to become more important than device margins. That IMO is essentially the Bezos strategy.

      • http://policydiary.com/ John S. Wilson

        Carriers in major countries are realizing they can’t afford to not carry the iPhone. It was clear to Sprint and TMobile, and it’s becoming very clear to others as well.

  • http://twitter.com/moebastaki Muhammad Bastaki

    What is fascinating is that the volatility of the iTunes business looks far less than what the rest of Apples businesses have (Mac, iPod, iPhone and iPad). It seems too be a good measure of the platforms “Stickiness”. Since people are spending money on paid/free content thats exclusively available to them on their Apple products, we might get a good sense of how viable Apples other businesses are by analyzing the iTunes business.

    • twilightmoon

      Interesting point.

      • http://twitter.com/moebastaki Muhammad Bastaki

        So instead of thinking of iTunes as one of the legs to the stools. One should rather think of it as the seat of the stool. iTunes is not independent. It is dependent on the 4 legs (Mac, iPod, iPhone and iPad). These legs are shipping each quarter and are hence exposed to elements like supply constrain and product demand at a given moment. iTunes is not supply constrained. It is a service available for the entire apple customer base. At any moment in time.

      • Tim Yoon

        Very nice analogy.

      • http://twitter.com/matthewwanderer matthew

        @Muhammad, great observations. Given how much lower margins are on iTunes content, your “seat” analogy resonates.

        How would/will the rumored/forthcoming Apple TV change your views in this regard? I imagine Apple’s content partners and content library will expand significantly as part of the strategy.

      • http://twitter.com/moebastaki Muhammad Bastaki

        The basis of its existence should remain consistent. iTunes is a service, a service for the entire apple customer base. It brings content holders to content seekers. Music, Apps, Movies, Podcast, iTunes U, Ringtones, Books they are all included.

        Regarding the expansion of its library. Please correct me if I am wrong but, iTunes would probably be a global leader in terms of library size.

  • Rick Starr

    Couple things: that last chart purports to be Apple vs. the cell phone industry. Yet there’s no line for Samsung. Quite an omission, no?

    I don’t know that Apple’s software margins are 60% or anything close. They may be for Microsoft, but that’s distributed over hundreds of millions of PCs, while Mac is over tens of millions. In a high leverage business that makes quite a difference at the profit line. Is writing OS for Mac significantly cheaper than writing Windows for PCs?

    I wouldn’t be surprised that the first AT&T contract allowed for some revenue sharing. Back then the cell companies had their own (crappy) stores selling ringtones, GPS, rudimentary access to email, and yes, music. Not surprising that they would try to protect at least some of that.

    There is not a lot of margin in the music part of iTunes (although there is some), and it seems the same would be true of apps, which also pass 70% of revenue to developers. And I refuse to believe that iBooks is anything significant. They might make a good buck on movies, which are higher dollar, but it seems that’s about it.

    • jawbroken

      “Indeed, if seen in isolation, iTunes+Accessories combined is a bigger business in terms of revenues than any of the other phone vendors except Samsung”

      Hence the chart.

    • http://www.asymco.com Horace Dediu

      The paragraph preceding the chart explains the omission of Samsung. Regarding the margins on Apple software, the graph shows gross margins, not operating margins. Gross margins are sales minus cost of sales. Cost of sales excludes fixed costs like R&D and counts only variable costs like manufacturing and distribution. The variable costs of online distribution of software are far less than 20%.

  • http://alexandersmith.co/ Benjamin Alexander

    Looks like two three-legged stools to me.

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  • Henry

    This post is very interesting.

    It doesn’t seem like there is anything preventing Apple from focusing on non-device sales – specifically, non-hardware sales like content and ads – to generate huge amounts of income.

    Apple controls the platform for the majority of moderate and high-income people of the world – i.e., where the money is. This platform is somewhat sticky, which may limit commoditization of the content.

    It seems there is huge potential to sell stuff through this platform – ads, content, subscriptions, whatever. It doesn’t take much sales per user – say, a few hundred dollars per year – to add another $100B to Apple’s top line. Since content, ads, etc. are inherently low variable cost (profit margins increase with scale), there is potential for very high margins here, too.

    Just because Apple has primarily been a device company up until now doesn’t mean it can’t have an enormous service business in the future. In fact, perhaps someday we’ll look back on the 2010-2014 period as just an intermediate step on Apple’s path to a well rounded business that uses content not just to sell devices, but also as an ends in themselves.

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  • http://twitter.com/boioglu Adrian Boioglu

    Hello Horace,

    I shared your last graph and I’ve been asked why there’s no Samsung present on that list. Could you please help me with an answer?

    Thank you

    • KirkBurgess

      From the article directly above the graph:

      “Indeed, if seen in isolation, iTunes+Accessories combined is a bigger business in terms of revenues than any of the other phone vendors except Samsung:”

    • http://www.asymco.com Horace Dediu

      By definition, the comparison is with companies other than Samsung.

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  • Phil

    Great review. I believe your 15-17% iTunes margin estimate is already under-stated. The top grossing world-wide App (Supercell’s Clash of Clans) currently Grosses >$500k/day USD on iTunes [consistently at this level for past four+ months]; Apple takes 30% of this revenue stream [$50M/yr annualized rr from one game!] all with little-to-no-cost (api server for installs, payments server cost, a few persons to review each app update “submission”, App store devs & app store “managers” for each country). The model (freemium games on iTunes) is infinitely scale-able & will drive incredible margin growth in quarters to come. Definitely a stool leg (see Asian companies such as DeNA, GREE, etc.).

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  • Michael Dance

    Horace, When you talk about “Assuming a gross margin of 15% to 17% yields contribution of $2 billion in margin in 2012” I wonder how that compares to Amazon’s PBT for 2012 of $544m and net loss of $39m. I assume the other costs for iTunes (if any) were fairly low.

    • http://twitter.com/asymco Horace Dediu

      Stay tuned for a comparison of Amazon with the other “usual suspects”

  • greg

    Good analysis of the stool model as it is spot on. Some thoughts:

    1) Most consumers own more than one leg of the stool
    2) They are solidly locked into the Apple ecosystem (they are Apple repeat customers that will be difficult to move to another platform and likely to try new products)
    3) When you adopt the system you are more likely to buy another product that supports the seat (iTunes)
    4) The model supports that additional stool legs are forthcoming
    5) Current users will adopt those legs
    6) It will take something very disruptive to topple this model as iTunes will remain a viable revenue stream for years to come

    7) Apple has enough financial resources to put multiple (new product) legs in the pipeline with a solid chance that a game changer will replace weaker legs.

    This model is a MOAT and the SEAT also supports the legs. I like my Apple products most because of the SEAT and as someone else stated the value of iTunes is the real sleeper. Even if something new comes out NOT APPLE Apple users may be slow to adopt giving Apple time to react and perfect the idea.

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  • alex

    Horace,

    I just saw your article and I’m wondering why you say that the margins of the iTunes line are 15-17% and the music business is accounted as a wholesale business. I’ve been looking at the revenue recognition part of the 2012 10-K and this is what I’ve found:

    “For the sale of most third-party products, the Company recognizes revenue based on the gross amount billed to customers because the Company establishes its own pricing for such products, retains related inventory risk for physical products, is the primary obligor to the customer and assumes the credit risk for amounts billed to its customers. For third-party applications sold through the App Store and Mac App Store and certain digital content sold through the iTunes Store, the Company does not determine the selling price of the products and is not the primary obligor to the customer. Therefore, the Company accounts for such sales on a net basis by recognizing in net sales only the commission it retains from each sale. The portion of the gross amount billed to customers that is remitted by the Company to third-party app developers and certain digital content owners is not reflected in the Company’s Consolidated Statements of Operations.”

    Of course you can argue what they mean by “certain digital content” but to me if you are recognizing in net sales “only the commission it retains from each sale”, the gross margin of that must be much closer to 80% than to 15%, at least in apps.

    Do you have evidence that says otherwise?

    Thank you for your time

    • http://www.asymco.com Horace Dediu

      With music Apple sets the price and therefore is the “obligor to the customer”. It books all music revenue in full. For Apps Apple uses the agency model where the developer is the “obligor to the consumer” and they only book 30% of the sale (their handling fees.) The margin on music and apps is nearly zero as they pay out almost everything they receive. The margin of 15% is for iTunes + Software, Services.

      • alex

        What is the fee that apple charges per song? If it is close to the 30% like apps, then I don’t see why its gross margin wouldn’t be clearly above 0%. In apps, if all they book is the fee, why would their gross margin be close to 0% instead of close to 100%?, what marginal costs does apple have in selling an extra developer’s app?

      • http://www.asymco.com Horace Dediu

        Because in both cases gross margin has to account for the cost of transaction and fulfillment. Cost of sales include credit card fees, bandwidth fees and depreciation on capital infrastructure assets. There might also be referral fees as well. Also let’s not forget that the bandwidth fees (and capital costs) must be allocated over all app installations including those which are priced at zero. The 30% transaction fee for paid apps and in-app purchases has to sustain the fulfillment costs of all apps. Another way to look at it is by estimating operating expenses and assuming break-even on both stores (as the company claims.) If operating expenses are small then it follows that all costs are variable. Other than app curation, I can’t think of any significant operating (i.e. overhead) costs that can be attached to the stores.

      • alex

        I didn’t know the company had claim that its stores were operating at break-even, that changes everything, when did they make that claim?

      • http://www.asymco.com Horace Dediu

        http://www.theregister.co.uk/2010/01/26/app_store/ The claim was made many times with respect to the iTunes music store and a few times regarding the App Store. Search transcripts of commentary during earnings calls.
        Sent from my iPad