Apple Q2: Services buys time, what next?

Continued stress between the US and China and the slow transition to Apple Intelligence may be limiting Apple’s business growth, but there’s no legitimate way to deny the strategic success of CEO Tim Cook’s decision to build Apple’s services business (a decision he likely had in mind during the Beats purchase in 2014). The money it is making with services gives the company strength with which to weather these storms.

Think about it like this. Yes, Apple’s iPhone sales in China fell, and yes, regions in which Apple Intelligence is available saw iPhone sales outpace those in which it is not, but services increased 14% year-on-year, generating $26.3 billion in revenue — around 21% of Apple’s total revenue during the most recently revealed quarter. That’s why it means so much that Cook said, “In services, we achieved an all-time revenue record, and in the past year we’ve seen nearly $100 billion in revenue from our services business.”

That’s double Cook’s original ambition for services.

The cost of doing business

What makes those dollars even more valuable to Apple is the number of them it gets to keep: While the company generates a 39.31% margin on hardware revenues after costs, it books an astonishing 75% margin on services. In other words, for every 10 dollars of services income Apple creates, it keeps around $7.50.

Other details from Apple’s most recent financial results:

Revenue: $124.3 billion (+4% YoY)

EPS: $2.40 (+10% YoY)

Gross margin: 46.9% (but much higher for services)

Net income: $36.3 billion

Product revenue: $98 billion (+2% YoY)

Services revenue: $26.3 billion (+14% YoY)

Morgan Stanley analyst Erik Woodring today shared his estimate that the average revenue per user Apple is generating with services has now reached around $72 per user, up $5 on the last quarter. 

Apple’s management also confirmed that the iPhone 16 is outperforming the iPhone 15 range. The company said there’s been a record increase in iPhone upgrades during the quarter, presumably as its customers ensure they have the correct devices to run Apple Intelligence.

Services, services, services

Apple has managed its services pivot across the last few years. This configuration is a huge lesson to any business in that it shows the value of diversification. While Apple’s attempt to diversify its own business with services benefited hugely from the company’s incredibly positive customer satisfaction levels, any business should seek out related opportunities if it hopes to maintain growth in challenging circumstances.

“Services continues to see strong momentum, and the growth of our installed base of active devices gives us great opportunities for the future,” said Apple CFO Kevan Parekh. “We also see increased customer engagement with our services offerings. Both transacting and paid accounts reached new all-time highs, with paid accounts growing double digits year over year. Paid subscriptions also grew double digits.”

Services income also requires hardware sales, and not every Apple service will be generating anything like these numbers. The accretive nature of this part of the business is a little like the small fish that lives on a larger whale — you can’t have one without the other.

But in Apple’s ocean, Parekh’s revelation that the company has “over 1,000,000,000 paid subscriptions across services on our platforms” shows there’s plenty of fish in its ocean. Even as competition authorities force more competition into those waters, it’s a solid bet that Apple will continue to generate good business from the services segment.

Not playing games

Kicking the raw data Apple provided on its consolidated balance sheet around, you’ll see that services revenue after direct sales-related costs delivered almost half of Apple’s overall net income during the quarter. And if hardware revenue tracks overall hardware margins at 39.1%, then services at 75% is generating more actual net income than any Apple product other than the iPhone. Apple Fitness, indeed. Apple Arcade is not just playing games.

Ultimately, however, Apple’s services income is doing the job it should be doing and generating a lucrative slice of high-margin income that protects the company against product sales-driven challenges. It is also acting as a bulwark as the company engages in the transition to Apple Intelligence.

But while the company has done an excellent job crafting business resilience and bought itself time with the initial introduction of its own system-wide AI, it still needs a follow-up punch to consolidate its gains. Is Apple really going to rely on international language rollouts of Apple Intelligence, or does it plan new models for WWDC? How does it intend to augment services with additional offers its customers can’t resist? 

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