Opinion: Do services really have the kind of revenue potential Apple would like us to believe?

Apple has always been seen as a hardware company – from the original Apple Computer through to the Apple Watch. Ask anyone to describe what the company does and they’ll all talk about those sleek, stylish, easy-to-use gadgets.

Some people will even jump straight to calling Apple the iPhone-maker, other products seen as also-rans. Which, in financial terms, is not unreasonable: the iPhone accounts for 65% of the company’s revenues. So it’s no surprise that the market is unsure how to respond at a time when the company’s main product is experiencing declining sales. That uncertainty is being exacerbated by suggestions that the iPhone 7 may be rather similar to the iPhone 6 and 6s.

I’ve talked before about my view of Apple’s long-term prospects, but that piece focused on hardware, touching only briefly on an area Apple has been increasingly talking-up: services …

That shift in emphasis first became apparent in June 2015, when Apple quietly changed its description of the company. Here’s how Apple described itself at the start of that month:

Apple designs Macs, the best personal computers in the world, along with OS X, iLife, iWork and professional software. Apple leads the digital music revolution with its iPods and iTunes online store. Apple has reinvented the mobile phone with its revolutionary iPhone and App Store, and is defining the future of mobile media and computing devices with iPad.

And here (with my emphasis) is how it was describing itself by the end of the month:

Apple revolutionised personal technology with the introduction of the Macintosh in 1984. Today, Apple leads the world in innovation with iPhone, iPad, Mac, Apple Watch and Apple TV. Apple’s four software platforms — iOS, OS X, watchOS and tvOS — provide seamless experiences across all Apple devices and empower people with breakthrough services including the App Store, Apple Music, Apple Pay and iCloud. Apple’s 100,000 employees are dedicated to making the best products on earth, and to leaving the world better than we found it.

Apple Music, Apple Pay and iCloud were all now considered sufficiently important to make it into the one-paragraph summary the company uses to close every press release.

By the start of this year, Apple also started emphasising services in its earnings calls. In the January call, CFO Luca Maestri talked about services at some length, specifically pointing out the long-term business potential.

We have built a huge installed base around four platforms, iOS, Mac OS, watchOS and tvOS. We have tremendously satisfied and loyal customers who are engaged with our services at a fast-growing rate. All of this provides us with an unparalleled foundation for the future of Apple business.

In the most recent call, CEO Tim Cook picked up the baton.

The services business is powered by our huge installed base of active devices, which crossed one billion units earlier this year. Those billion-plus active devices are a source of recurring revenue that is growing independent of the unit shipments we report every three months.

The question is: was this real optimism about the potential of services to rival the company’s revenue streams from hardware, or just a way to put a positive spin on a quarter in which hardware sales fell across the board?

There’s no question that a positive message was needed. iPhone revenue fell 18%, iPad revenue by 19% and even Mac revenue – an area in which Apple is outperforming the rest of the market – fell by 9%.

But there’s also no doubt that there’s substance behind the spin: services revenue climbed 20% year-on-year in Q2 to reach $6B – at a time when hardware sales were down. To put that number into perspective, that makes services Apple’s second biggest revenue source, ahead of both iPad ($4.4B) and Mac ($5.1B). It now makes up 11.8% of Apple’s total annual revenues.

This may be one reason that Berkshire Hathaway decided to get in on the action: while hardware sales can be fickle, at the mercy of new technological developments and consumer fashion tastes, revenue from services tends to be significantly more stable.

And that billion device market is real: it’s active devices. Ones real customers are using, not including those sitting in desk drawers. In principle, at least, every single one of those billion devices represents a sales opportunity for one or more of Apple’s services, as IDC research director told CNBC.

Focusing on services is the best strategy and the increase is quite remarkable. They are starting to fully explore the 1 billion users in its customer base and it is one of the best customer bases a company can have.

The power of the ecosystem is also a strong reason to be optimistic about services. The more Apple devices you own, the greater the likelihood that you’ll purchase Apple services. On a trivial level, that 5GB of free iCloud storage might be ok when you own a 16GB iPhone, but space will quickly get tight when you buy a higher-tier iPhone and supplement it with an iPad.

But at a deeper level, the more invested you are in the Apple world, the more sense it makes to remain within that world when it comes to services. If you want to create a document on your Mac, edit it on your iPad and view it on your iPhone, iCloud is the most seamless way to do that. If all your own music is stored in iTunes and you want to buy a subscription to a streaming music service, Apple Music is the obvious choice.

Apple Pay, too, has huge potential yet. The rollout of contactless payment terminals is better established in some countries than others, with coverage still rather spotty in Apple’s home market, so not everyone with an iPhone or Apple Watch has yet started using it. Once contactless terminals are ubiquitous, as they already are in London, Apple Pay becomes an extremely attractive proposition.

And there’s more to come. Apple’s plans to launch its own web TV service may have hit a few roadblocks, but I’d say the chances of it coming together at some point remain high. Either way, it’s a given that Apple isn’t done inventing services any more than it is inventing hardware. The revenue opportunities will continue to grow.

None of this means Apple will get an easy ride, of course. There are areas in which Apple faces an uphill battle to persuade some customers to sacrifice the investment they already have in rival services, like Spotify. This is especially true in China, where existing mobile payment services make it tough for Apple Pay to compete.

There’s also the fact that Apple hasn’t always been very good at services – and still isn’t, in some ways. Deleting music from iTunes, for example, or the all-too-frequent iCloud outages. But in one sense, this represents an opportunity for Apple: if it can get its act together, many of us who currently use rival services may make the switch.

For example, I love iCloud in theory – but in practice syncing can take more time than I’d like. That’s the reason that I pay Apple for just 50GB of iCloud Storage while I pay Dropbox for 1TB. Dropbox is my primary online workspace, with iCloud filling in the gaps. As someone with all-Apple hardware, I’d switch to iCloud in a heartbeat if it could match Dropbox for performance and reliability.

Put all of this together – a segment that is already the second biggest revenue stream after iPhones, huge growth potential from existing services and new services likely in the pipeline – and my answer to the question I posed in the headline has to be yes. In a rare exception to Betteridge’s Law, I do indeed think that services have the potential Apple would like us to believe.

What’s your own view? Please take our poll, and share your thoughts in the comments.

Images: Apple, Digital Trends, Enterprise Innovation, Apple