Neil Cybart Neil Cybart

Eddy Cue Hints at Big 2023 for Apple, App Store Revenue Growth Slows (Daily Update)

Hello everyone. We kick things off with my thoughts on Eddy Cue, Apple’s SVP of Services, looking back at Apple’s Services business in 2022. Cue made an interesting comment about Apple in 2023. We then look at a key financial metric Apple disclosed regarding the App Store. With this data point in hand, we derive estimates for the amount of overall App Store revenue in 2022 and the amount of revenue Apple reports in its quarterly financial statements.

Let’s jump right in.

Eddy Cue Hints at Big 2023 for Apple

Going back to the mid-2010s, Apple has used the new year to publish a recap of how the App Store performed the prior year. As Apple released additional services over the years, the recap has grown into something of an Apple Services year in review.

This year's release contained plenty of statistics, although very few of them could be used for financial modeling purposes. Typically, the releases included a few select quotes from Eddy Cue and Phil Schiller.

Apple did something different this year. Cue, Apple's SVP of Services and part of Tim Cook's inner circle, penned the opening section of the press release.

Here's Cue:

“2022 was a groundbreaking year for entertainment. At some point over the past year, you probably discovered a new app, a new song, a new TV show or movie, or game. An experience that made you laugh, taught you something new, or helped you see the world in a new way — and moved you to share it with others.

At Apple, we have the privilege of partnering with creators of all kinds, while building products and services that enable even more creativity. Our mission has always been to enrich people’s lives and to leave the world better than we found it, and we know that takes more than technical skill. It requires leading with our values in everything we do. We believe that our products and services should be made for everyone. We believe that privacy is a fundamental human right, and that our highest obligation to our customers is security. We believe that a culture where everybody belongs can drive innovation, and that we must stand up for the change we want to see in the world.”

Cue made the case that Apple Services aren’t just revenue-generating side hustles that Apple is doing to please Wall Street analysts.

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Above Avalon Membership

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The Above Avalon Daily Update Recap (3Q21 Edition)

I publish exclusive daily updates all about Apple throughout the week. The updates contain my perspective and analysis on Apple’s business, product and financial strategy, and competitive relationships with a range of companies. The updates have become widely read and influential in the world of Apple and tech and are ideally suited to executives, investors, project managers, and hobbyists. When combined with the periodic articles and podcast episodes, which are accessible to everyone, the updates provide the full Above Avalon experience throughout the week.

During the third quarter of 2021 (July to September), 48 Above Avalon daily updates were published, chronicling both noteworthy industry and Apple-specific stories as well as my Apple research. The major themes discussed during the quarter included:

  • Developments in the App Store regulatory space (South Korea, Japan, Epic Games Vs. Apple trial).

  • Apple TV / paid video streaming industry developments. 

  • Apple unveiling its Child Sexual Abuse Material (CSAM) detection plan and the resulting fallout.

  • Project Titan leadership changes and developments in the EV space.

The Above Avalon Daily Update Recap (3Q21 Edition) goes over these major themes and the corresponding daily updates.

(To access the following updates, become a member and then request access to the daily updates archive found in Slack.)

Developments in the App Store Regulatory Space (South Korea, Japan, Epic Games Vs. Apple trial)

After years of discussion and debate regarding Apple’s handling of the App Store, there was notable movement on the App Store legal and regulatory fronts. During 3Q, Apple notched two App Store victories in U.S. courts, South Korea rushed an anti-App Store bill through, and Apple began to loosen its grip on some of the more controversial App Store guidelines.

Apple TV / Paid Video Streaming Industry Developments

The paid video streaming industry continues to intrigue as it expands and evolves. There were a number of noteworthy events and developments during 3Q including Netflix’s move into gaming, a “Ted Lasso” bonanza, and the Netflix vs. Disney dynamic. I also went over my estimate for the number of Apple TV+ subscribers.

Apple Unveiling Its Child Sexual Abuse Material (CSAM) Detection Plan and the Resulting Fallout

In August, Apple lit a firestorm of a debate by announcing a plan to combat child sexual abuse. The plan ended up drawing into question a number of philosophical questions as to Apple’s role in society and the company’s reason for being.

Project Titan leadership changes

Apple’e electric car project continued to move forward with a major leadership change as Apple Watch software chief Kevin Lynch replaced Doug Field as Titan head.

A few additional updates published between July to September stood out to me.

Above Avalon membership is required to read the preceding daily updates. There are two membership options available: $20/month or $200/year. The annual option amounts to a $40 discount. Payment is hosted and secured by MoonClerk and Stripe. Apple Pay is accepted. You can update your payment information and membership status at any time on this page.

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Above Avalon Year in Review (2020)

Heading into 2020, the big question facing Apple was found with growth. Apple had reached a billion users. Would Apple be able to reach two billion users in the 2020s by continuing to do what it had been doing or would more in the way of strategy shifts be needed?

As it did with every company, the pandemic turned 2020 into a steady stream of unexpected challenges for Apple. The company needed to figure out a way to continue product development on a global scale with little to no employee travel. Apple retail needed to be completely rethought as social distancing initiatives ruled out the usual crowded Apple stores. Apple events (both WWDC and product unveilings) needed to go virtual.

According to my estimate, Apple saw approximately $20 billion of delayed demand in FY2020 as a result of the pandemic. Approximately 15 million iPhone upgrades were delayed while wearables sales faced pressure due to retail stores being closed. Partially offsetting those headwinds, iPad and Mac results have been stellar as consumers upgrade older machines and look for larger displays to support working at home and distance learning.

Articles

In 2020, I published 15 Above Avalon articles. In looking through the articles, which are accessible to all, there was one overarching theme: Apple’s improving competitiveness in comparison to that of its peers and the steps the company is taking to position itself for continued ecosystem growth in the 2020s.

Here are some of my favorite articles published in 2020 (in no particular order):

  • Apple Is Pulling Away from the Competition. Relying on an obsession with the user experience, Apple is removing oxygen from every market that it plays in. At the same time, the tech landscape is riddled with increasingly bad bets, indifference, and a lack of vision. Apple is pulling away from the competition to a degree that we haven’t ever seen before.

  • The Secret to Apple's Ecosystem. Apple’s ecosystem remains misunderstood. There is still much unknown as to what makes the ecosystem tick. From what does Apple’s ecosystem derive its power? Why do loyalty and satisfaction rates increase as customers move deeper into the ecosystem? Apple’s ecosystem ends up being about more than just a collection of devices or services. Apple has been quietly building something much larger, and it’s still flying under the radar.

  • A Billion iPhone Users. A billion people now have iPhones. According to my estimate, Apple surpassed the billion iPhone users milestone last month. Apple’s top priorities for the iPhone include finding ways to keep the device at the center of people’s lives while at the same time recognizing the paradigm shift ushered in by wearables.

  • Apple’s $460 Billion Stock Buyback. Share buybacks came under fire earlier this year. Some companies that were recent buyers of their shares found themselves in financial distress and seeking bailouts due to economic fallout from the pandemic. A very good argument can be made that Apple has become the poster child of responsible share repurchases. The company has relied on its stellar free cash flow to fund share repurchases over the years.

  • Apple Watch and a Paradigm Shift in Computing. Despite being only four years old, the Apple Watch has fundamentally changed the way we use technology. Many tech analysts and pundits continue to look at the Apple Watch as nothing more than an iPhone accessory - an extension of the smartphone that will never have the means or capability of being revolutionary. Such a view is misplaced as it ignores how the Apple Watch has already ushered in a paradigm shift in computing.

The five most popular Above Avalon articles in 2020, as measured by page views, were identical to my favorites list.

Podcast Episodes

There were 16 episodes of the Above Avalon podcast recorded and published in 2020, totaling seven hours. The podcast episodes that correspond to my favorite articles are found below:

Charts

The following charts found in Above Avalon articles were among my favorite published in 2020.

Number of Users

While Apple new user growth rates have slowed, the company is still bringing tens of millions of users into the fold. Due to Apple’s views regarding innovation and its focus on the user experience, once someone enters the Apple ecosystem, odds are good that customer will remain in the ecosystem.

Apple Installed Base (Number of Users)

Apple Non-iPhone Revenue Growth

Apple finds itself in an ecosystem expansion phase. Hundreds of millions of people with only one Apple device, an iPhone, are embarking on a search for more Apple experiences. We see this with non-iPhone revenue growing by double digits in the back half of 2020 on a TTM basis, which is higher than growth rates seen in the mid-2010s.

Apple Non-iPhone Revenue Growth Projection

The Apple Innovation Feedback Loop

With Apple Silicon, Apple took lessons learned from personal devices such as Apple Watches, iPhones, and iPads to help push less personal devices, like the Mac, forward.

 
 

Daily Updates

In 2020, I published 196 Above Avalon Daily Updates that were available exclusively to Above Avalon members. With each update coming in at approximately 2,000 words, 196 updates are equivalent to seven books. This continues to be an industry-leading number when it comes to the amount of Apple business and strategy analysis published.

When looking over the topics discussed in this year’s daily updates, a few sub themes become apparent:

Apple and the Pandemic

When the pandemic began during the first half of the year, there was much unknown as to how a company like Apple would be impacted. It eventually became clear that Apple and its peers were positioned to do OK during the pandemic although new ways of thinking would be needed to navigate working from home and travel restrictions.

The Paid Video Streaming Battle

With Disney+ and Apple TV+ launching in late 2019 and HBO Max and Peacock launching this past May and July, respectively, 2020 turned out to be the legitimate start of the paid video streaming battle. As the true new kid on the block, Apple learned quite a bit about being more than just a distributor of other people’s content.

Pushback Against the App Store

Apple is pulling away from the competition, and the App Store is considered the best (and last) chance for competitors to reshape the mobile industry to their liking. A series of legal and PR battles were waged against the App Store by a handful of smaller app developers and larger Apple competitors.

When looking at my daily updates published in 2020, selecting a handful of favorites out of 196 updates was not an easy task. The following updates stood out to me (in no particular order):

  • Apple’s Organizational Structure, Apple’s Leadership Structure, An Autonomous Apple. We first go over my thoughts on Apple’s functional organizational structure and the difference between a functional and multidivisional structure. The discussion then turns to Apple leadership and the ideas of “discretionary leadership” and “experts leading experts.” The update concludes with a revisiting of my Above Avalon article, “Jony Ive, Jeff Williams, and a Larger Apple” and a discussion of how Apple has been able to become a larger design company. (Oct 26, 2020)

  • Nike Earnings, The Similarity Between Nike and Apple, A Stronger Apple and Nike Partnership. We kick off this update with my thoughts on Nike’s earnings. After going over three structural tailwinds facing Nike, we discuss why I think Nike is pulling away from the competition. The discussion then turns to how Nike is the company most like Apple. The update concludes with a look at how Apple and Nike are both interested in health. We go over the competitive dynamic between the two companies and why it’s premature to conclude that Apple and Nike will become fierce competitors in the future. (Sept 24, 2020)

  • iPhone Momentum Building in Europe, Apple's Good Timing with iPhone SE, Selling Utility on the Wrist. We begin this update with my thoughts on the iPhone gaining momentum in Europe. The discussion includes new iPhone sales share data and what looks to be some kind of inflection point in the region. We also discuss the possible factors behind the inflection point. The update then turns to how Apple ended up launching the updated iPhone SE at just the right time. We then take a closer look at wearables competition on the wrist. In particular, we go over Fitbit’s latest earnings and compare fitness tracker and smartwatch demand. The discussion concludes with why Amazon Halo faces an uphill battle for wrist real estate. (Sep 3, 2020)

  • Valuing Big Tech on Free Cash Flow, AAPL vs. Free Cash Flow, AAPL vs. Low Interest Rates. This update begins with my thoughts on the idea that Wall Street has changed the way it is valuing Apple - one away from focusing on P/E ratios (price-to-earnings) and more towards free cash flow valuation. After going over the free cash flow yields for the tech giants, we look specifically at Apple’s declining free cash flow yield and what it tells us about how the market is approaching the company. The update concludes with a discussion of interest rates, inflation, and the U.S. Fed looking to embrace elevated inflation before seeing the need for higher rates. There are various AAPL-related implications associated with that development. (Aug 25, 2020)

  • Apple Acquires NextVR, Apple Glasses in 2022?, A Wearables Platform for the Face. We begin this update with my thoughts on Apple acquiring NextVR. The discussion includes the reasons why I think Apple acquired NextVR and how the company can play a role in Apple’s product strategy. The update then turns to new rumors about Apple Glasses launch dates. Simply put, the Apple AR / VR rumor mill is getting out of hand. We go over two factors that I think are driving the varied rumors regarding Apple Glasses. The discussion concludes with a different way of thinking about AR / VR and Apple. (May 18, 2020)

  • Warren Buffett’s Annual Letter, The Power of Apple Retained Earnings, Imploding Demand for Fitbit. We kick off this update by examining Warren Buffett’s annual letter to Berkshire Hathaway shareholders. Berkshire Hathaway is Apple’s largest individual shareholder. Accordingly, there is value in keeping on top of Berkshire and Warren Buffett (Berkshire’s CEO and Chairman of the Board). The discussion then turns to retained earnings and why Apple’s retained earnings are such a powerful tool. We conclude with a look at Fitbit’s awful 4Q19 earnings and why the company represents such a problem for Google. (Feb 24, 2020)

Here are the five most popular daily updates published in 2020 based on page views:

  1. iPhone Sales Share Rises During Pandemic, It’s All About Smartphone Upgrading, A $5,000 Swiss Smartwatch (Jun 3, 2020)

  2. Connecting the Dots in Apple vs. FBI (Pensacola Edition), Tesla Demand Is Exceeding Expectations, Tesla Market Cap Higher Than GM and Ford Combined (Jan 16, 2020)

  3. Google Pixel Shakeup, Consumer Spending During the Pandemic, Surface Sales vs. iPad and Mac Sales (May 14, 2020)

  4. Apple vs. Hey (Jun 17, 2020)

  5. The App Store’s Impact on Apple Financials, Facebook Launches Paid Online Events, 4Q20 Microsoft Surface Results (Aug 18, 2020)

Just 11% of the daily updates published in 2020 are highlighted above. The full archive consisting of all 196 daily updates is available here. Membership is required to access the updates.

Daily Podcast (Launched in 2020)

In 2020, Above Avalon Daily Updates became available in audio for the first time via a private podcast called Above Avalon Daily. Reception to the daily podcast continues to exceed my expectations with very positive listener feedback. The podcast has allowed members to consume the daily updates in new and different ways while around the house, on a walk, or in the car. More information on the daily podcast, including a few sample episodes, is found here. Above Avalon Daily was launched in August, and 66 episodes were published in 2020, totaling nearly 17 hours of audio. Once a member signs up for the daily podcast, all prior episodes become available for listening in podcast players that support private podcasts.

Here’s to 2021

Without question, 2020 ended up being the busiest year for Apple since Above Avalon was launched in 2014. There was no shortage of newsworthy stories, and all indicators point to the fast pace continuing into 2021. A big thank you goes out to Above Avalon readers, listeners, and members for making 2020 another successful year for Above Avalon.

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Neil Cybart Neil Cybart

Above Avalon Podcast Episode 173: Let's Talk App Store

As Apple pulls away from the competition, the App Store is considered the best (and last) chance for competitors to reshape the mobile industry to their liking. In episode 173, Neil examines how competitors are waging a guerrilla war against Apple and the App Store. The discussion then turns to Neil unveiling a new podcast called Above Avalon Daily.

To listen to episode 173, go here. 

The complete Above Avalon podcast episode archive is available here. 

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Neil Cybart Neil Cybart

Attacking the App Store

Apple competitors have turned to guerrilla warfare tactics to wage a battle against Apple and the App Store. Based on what is being written and said about the App Store, one would think we have an entered a tech dystopia in which 27 million iOS developers and a billion Apple users are being taken advantage of by Tim Cook and his allegiance to Wall Street.

What had been valid criticism aimed at the App Store has descended into calls to burn everything down and replace it with anti-consumer and anti-developer alternatives. The writing is on the wall. Apple is pulling away from the competition, and the App Store is considered the best (and last) chance for competitors to reshape the mobile industry to their liking.

App Store

We have never seen anything like the App Store, a curated marketplace where a billion users can access 1.7 million apps. Apple established an easy, safe, private, and convenient way for consumers to personalize nearly 1.3 billion iPhones and iPads with third-party applications. Approximately 500 million people visit the App Store each week - a remarkable figure that speaks to how the App Store continues to connect with consumers on a global basis. In FY2019, App Store revenue was an estimated $53 billion. Apple’s share of that revenue came out to an estimated $14 billion. (Apple generates much less when it comes to App Store profit.)

Some have tried to say that there was a viable, safe, cost efficient, and overall compelling form of software distribution to the mass market prior to the existence of the App Store. There’s one problem with such a claim: The mass market didn’t consume software prior to the App Store. In 2008, the year the App Store launched, only 20% of people even had access to the internet.

There are a number of reasons why the iPhone installed base is eight times larger than the Mac installed base, and the App Store is high on the list.

Evolving Criticism

The App Store is not perfect. A small, but vocal, segment of the iOS developer community (now 27 million strong) has spent years raising concerns and issues regarding the App Store, and in particular, app review and the way Apple enforces App Store guidelines.

However, over the past 18 months, App Store criticism began to take on a dramatically different look and feel as multi-nationals entered the fray. In just the past few months, Facebook, Microsoft, Airbnb, and Epic Games have raised concerns about the App Store.

Spotify was one of the early App Store opponents. The company took what now looks like a delicate approach to raising specific issues with the App Store and what it deemed to be anticompetitive behavior on Apple’s part. While the company was grasping at straws with most of its claims, a few concerns had merit.

Microsoft decided to go behind Apple’s back to secretly get U.S. lawmakers to investigate the App Store on monopolistic grounds. Airbnb ran to the New York Times to air its grievance about wanting a special deal from Apple so it didn’t need to follow long-standing App Store guidelines.

However, it was Epic Games’ attack against Apple that marked a turning point in App Store criticism. Epic relied on a different kind of strategy:

  1. Breaking App Store guidelines willingly and blatantly. We have never seen a company actually take pride in breaking App Store guidelines. Epic made sure everyone knew it was breaking App Store rules by offering a virtual currency as an in-app purchase without going through Apple payment.

  2. Leveraging users and press to its advantage. Instead of making the battle be between two companies, Epic weaponized its user and fan base in an attempt to wage an uprising against Apple. In this pursuit, Epic also tried to use the press more than any other company that came before it in going after the App Store.

These corporations are ultimately after the same goal – to weaken Apple’s ironclad grip over the App Store. While many independent developers are simply focused on finding financial sustainability for their families, the multi-nationals are more interested in pulling iOS from under Apple’s control in order to gain power at the expense of Apple.

Why the App Store?

Apple is pulling away from the competition like never before. A revised product strategy (pull to push), and a broader consumer technology landscape that is swinging and missing on bet after bet, are the two primary factors behind Apple’s momentum. However, the App Store plays a vital role in setting Apple devices apart from the competition.

Accordingly, the App Store may seem like an unusual target for Apple competitors. The digital storefront is very popular with users (based on usage trends) and developers. (Most developers don’t pay Apple anything beyond a nominal developer fee to transact business through the App Store.)

No one is questioning the App Store’s success or popularity. Instead, competitors see a way to turn that success into a weakness. Due to extensive lobbying efforts, most of which were driven by Apple competitors, governments and regulatory bodies from around the world are investigating the claim that Apple is relying on monopolistic behavior to achieve App Store success.

Competitors see these regulatory investigations as a potential vulnerability in Apple’s armor. Breaking up or watering down the App Store would allow competitors to leverage the iOS ecosystem to their advantage. In essence, Apple would lose control over app distribution in its own ecosystem. Competitors would no longer be subject to revenue share arrangements with Apple. In addition, they would be able to establish their own digital storefronts to go direct to customers.

Guerrilla Warfare

Companies like Epic don't want there to be a genuine debate about the App Store. If the debate were to boil down to one’s experience using the App Store, Epic and other App Store critics would lose.

However, the goal is to change the narrative and position the App Store as being fundamentally broken with the only remedy being alternative app stores free from Apple oversight. This sentiment is summarized in the following tweet from Epic Games founder and CEO Tim Sweeney:

“At the most basic level, we’re fighting for the freedom of people who bought smartphones to install apps from sources of their choosing, the freedom for creators of apps to distribute them as they choose, and the freedom of both groups to do business directly.”

We are witnessing a guerrilla war that is being waged by Apple’s competitors. This campaign includes companies and CEOs trying to win the moral high ground by appealing to consumers’ and developers’ emotions. Other goals include trying to distract and tire Apple with relentless App Store attacks coming from all directions and using the press to do much of the heavy anti-App Store lifting.

Nearly every article written about Apple’s latest App Store controversy and battle inevitably includes paragraphs of boilerplate language regarding the App Store’s growing list of regulatory issues around the world. Meanwhile, no space is dedicated to the holes and hypocrisy found in competitors’ claims and allegations against the App Store. This is a classic example of a PR guerrilla warfare tactic utilized by competitors in an attempt to sway the discussion and public opinion.

There are then companies running to the press to paint Apple as the evil behemoth going after small business owners during the pandemic. Facebook, Airbnb, and ClassPass have relied on such shady tactics to attack Apple. Portraying Apple as a small business killer is a new low.

True Intentions

To a certain extent, companies like Epic have been successful in quelling App Store debate. Allegations that Apple is milking developers in order to drive revenue and profit growth are passed around with no supporting evidence or numbers. (My financial estimates for App Store profitability on both a net and gross basis are found here.) Pointing out that the App Store isn’t as profitable as consensus assumes is now met with backlash. None of this was the case just 12 months ago.

The lack of perspective coming from customers is also glaring. Consumers, not Apple, are the group who ultimately ends up supporting tens of millions of developers financially. However, most of the commentary written about the App Store has come from the perspective of competitors with pending lawsuits against Apple.

Hijacking what had been a genuine debate regarding the App Store’s treatment of independent developers in order to prop up their own ambition, companies like Epic are revealing their true intentions. These companies aren’t going after the App Store with the interest of independent developers or users in mind. Advocating for an alternative app store is not pro-developer or pro-consumer. Instead, it’s just a way for these companies to make more money.

Monopolies

At the heart of Epic’s fight against the App Store is the need to have both developers and users on its side. There is a simple reason for such a goal. Epic’s underlying arguments against Apple regarding antitrust are fundamentally weak.

In a 62-page lawsuit filed against Apple, Epic alleges the company holds a monopoly in iOS app distribution and iOS in-app payment processing. There is one problem with such claims: Apple doesn’t have monopolies in any particular product device category. Meanwhile, claiming Apple has a monopoly on what goes on in the App Store is equivalent to claiming Apple has a monopoly on a premium experience.

In what is an ironic twist, Epic ends up demonstrating Apple’s lack of a monopoly in mobile gaming and app distribution. According to Epic, two-thirds of Fortnite users play the game on non-Apple hardware. If Apple held a monopoly on mobile app distribution, Apple’s decision to remove Fortnite from the App Store would have been a lights out moment for the game. Gamers have alternatives if they want to use them.

Need for Debate

It’s time for these guerrilla warfare tactics against the App Store to be called out in an effort to have a genuine debate about the App Store. Such a debate is sorely needed. It wouldn’t be about revenue share percentages, alternative app stores, or items like sideloading. Instead, the discussion is found with how Apple should balance customer and developer interests.

Some iOS developers feel like Apple is treating them like second-class citizens in its ecosystem. These developers want to know why Apple doesn’t go out of its way to make sure they are making as much money as possible. Instead, they feel they are being constantly attacked by App Store review. It’s a valid concern that Apple needs to take seriously.

Are we seeing Apple erring more on the side of customers to the determinant of developers? It may be an uncomfortable question to ask within Apple, but it deserves to be investigated.

Apple positions its customers, not profit, as the guiding light for everything it does. This customer-first focus extends to the App Store as well. Management’s actions with the App Store can be traced to ensuring the store’s viability and vitality. Both are critical for maintaining the App Store as a benefit for consumers. If users are content and happy, developers end up benefitting as well. The two go hand in hand.

There are three things that can help keep the customer versus developer dynamic found with the App Store in proper balance:

1) Allow increased in-app communication between developers and customers. Letting developers communicate more freely with users in apps stands to be a positive development for both parties. Allowing developers to include language like “visit our website for additional ways of buying our service” wouldn’t hurt customers and would be viewed positively for developers. Odds are good that we will see Apple make some changes on this front given the European Commission’s review of App Store practices.

2) Give developers more say over App Store guideline enforcement. App Store guidelines can be thought of as laws with no direct mechanism (like voting) for getting revised or rewritten. The ability to bring cases before some kind of review panel would be a step in the right direction. If there were something like the Supreme Court for App Store guidelines, a panel of Apple executives could determine if certain App Store guidelines would end up harming the broader ecosystem. Last month, Apple announced something along this lines.

3) Come up with the next App Store. By spending time now coming up with tomorrow’s App Store, Apple can benefit both developers and customers. The lack of attention given to this topic is telling. While Apple competitors are eager to replace the App Store with their own mobile app stores, the entire app dynamic loses its relevancy when thinking about wearables. We are going to need a complete rethink of apps as we proceed further into the wearables era.

Dragged Through the Mud

It’s difficult to envision any other product or feature other than the App Store that has done more in bringing such a wide variety of innovation to a billion users. It’s not an understatement to say that the App Store changed the world and is still doing so today. 

By painting Apple as a monopolistic giant relying on App Store “tolls” and “taxes” to surpass a two trillion dollar market cap, competitors are dragging the App Store through the mud. Revenue share percentages and angst over App Store guidelines end up being distractions for what is ultimately a classic case of wanting more power. With Apple pulling away from the competition like never before, it’s not a mystery as to why competitors see urgency.

Listen to the corresponding Above Avalon podcast episode for this article here.

Receive my analysis and perspective on Apple throughout the week via exclusive daily updates (2-3 stories per day, 10-12 stories per week). Available to Above Avalon members in both written and audio forms. To sign up and for more information on membership, visit the membership page.

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Above Avalon Podcast Episode 159: AirPods as a Platform

Apple is turning AirPods into a platform for what comes after the App Store. AirPods will augment our environment by pushing intelligent sound. In the first episode of Season 6, Neil goes over how AirPods have evolved from an iPhone accessory into the early stages of a platform well positioned to reshape the current app paradigm for the wearables era. Additional topics include the AirPods Pro launch, AirPods Pro initial impressions, AirPods sales, examples of AirPods as a platform, and the three sources from which AirPods will derive its platform power.

To listen to episode 159, go here. 

The complete Above Avalon podcast episode archive is available here. 

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Neil Cybart Neil Cybart

Measuring Apple's Content Distribution Arm

Apple has had a busy year expanding its content distribution arm. With the addition of Apple News+, Apple Arcade, and Apple TV+, Apple has revamped its paid content bundle offerings. Combining these new bundles with platforms like the App Store and iTunes, Apple will be in a position to have a content distribution arm bringing in more than $30 billion of revenue per year by FY2022.

Mapping Out Apple’s Content Distribution Arm

There are two parts to Apple’s content distribution arm: paid bundles and platforms. Paid bundles offer users access to third-party content (first-party content in the case of Apple TV+) for a set price each month. Platforms offer users the ability to consume a wide range of third-party content via paid and free downloads, in-app purchases, and paid subscriptions.

Exhibit 1: Apple’s Content Distribution Arm

 
 

Paid Bundles

  • Apple Music. Launched in 2015, Apple Music now has more than 60 million paying subscribers in more than 100 countries. In the U.S., an individual membership that includes a music catalog of 50 million songs goes for $9.99 per month ($99.99 per year) with student ($4.99 per month) and family ($14.99 per month) pricing also available.

  • Apple TV+. Apple’s new direct-to-consumer paid video streaming service will launch on November 1st in more than 100 countries. Built into the Apple TV app, Apple TV+ will include nine original video series and movies at launch, and new series and movies will be added each month. Apple is spending approximately $2 billion per year on original video content. An Apple TV+ subscription will go for $4.99 with Family Sharing although Apple is having a limited time promotion of one free year of Apple TV+ with a qualifying Apple device purchase. A detailed look at Apple’s TV+ strategy is available here.

  • Apple Arcade. Launched two weeks ago at $4.99 per month with Family Sharing, Apple Arcade offers subscribers access to approximately 70 exclusive games, and new titles will be added each month. Available in more than 150 countries, Apple Arcade utilizes a new business model for the App Store with Apple funding game development although ownership rights remain with the game developer.

  • Apple News+. Launched this past March, Apple News+ offers subscribers access to approximately 300 paid magazines and a handful of news publications. Built into the Apple News app, Apple News+ monthly subscription pricing of $9.99 includes Family Sharing with access for up to five other people. Apple News+ is currently available in the U.S., Canada, UK, and Australia.

Platforms 

  • App Stores (iOS, tvOS, macOS). With 2.2 million iOS apps available to download, the App Store remains a cultural phenomenon. Various business models are supported through the App Store including paid and free apps, ad-supported, in-app purchases, and paid subscriptions.

  • Apple TV App. The new Apple TV app offers “channels” through which users can subscribe to approximately two dozen third-party video bundles.

  • iTunes. Despite Apple deemphasizing iTunes by breaking out functionality into different apps, the platform still represents a source of paid download revenue. 

  • Apple Books. Apple offers a wide range of paid and free titles.

  • Apple News. Launched in 2015, Apple News offers users a wide selection of free and ad-supported written content from around the web. Apple News has 90M monthly active users thanks to prime real estate on Apple devices and a heavy emphasis on human curation.

  • Apple Podcasts. Apple is the leading distributor of podcasts with more than 600,000 available. Apple currently doesn’t directly monetize the Apple Podcasts app.  

Subscription Estimates

In order to measure the size of Apple’s content distribution arm, one can first estimate the number of subscriptions Apple will generate from its four paid content bundles. Those totals can then be used to derive revenue estimates. The final step is to come up with growth trajectories for Apple’s various content platforms.

Exhibit 2 includes my estimates for the number of paid subscriptions Apple can achieve for its four paid bundles within three years, or by the end of FY2022 (September 2022). These estimates assume additional refinement and a certain amount of evolution such as an improved user interface for Apple News+, a larger video catalog for Apple TV+, and a continuously expanding number of games in Apple Arcade.  

Exhibit 2: Apple Paid Content Bundle - Subscription Estimates (YE2022)

 
 

One important consideration found with these paid bundles is that each supports Family Sharing. While my estimates call for the four paid bundles to have a total of 188 million paid subscriptions, Family Sharing will mean that the number of Apple users having access to at least one paid bundle will likely exceed 350 million. This amounts to roughly one in three Apple users having at least one paid subscription to Apple Music, Apple TV+, Apple News+, or Apple Arcade.

Additional explanation regarding my paid bundle subscription estimates follows:

Apple Music. As shown in exhibit 3, it took Apple a little less than three years to reach 40 million Apple Music subscribers with the service available in more than 100 countries. Apple is currently adding 1.3 million to 1.4 million Apple Music subscribers per month. My 95 million Apple Music subscriber estimate by FY2022 reflects Apple being able to maintain the current growth rate over the next three years.

Exhibit 3: Number of Apple Music Subscribers 

Tailwinds for Apple Music subscriber growth include the paid music streaming pie continuing to expand and Apple seeing continued success competing against Spotify in developed markets. Growth headwinds include Apple already experiencing some of the easier subscriber growth in the U.S.

Apple TV+. Apple has a few things going for it when it comes to grabbing a significant number of Apple TV+ subscribers in the coming years.

  1. Netflix and Hulu have shown that many U.S. consumers see value in paying for direct-to-consumer video streaming bundles. In addition, the market will likely support a number of players and not just Netflix. A similar phenomenon is observed outside the U.S. as Netflix follows a localized content strategy.

  2. Apple went with an aggressive $4.99 per month launch price for Apple TV+ as well as a limited time promotion of one year free with a qualifying Apple device purchase. Such a promotion will introduce quite a few Apple users to Apple TV+ in a very short amount of time.

My 55 million subscriber estimate for Apple TV+ assumes Apple sees stronger adoption for the service than it achieved with Apple Music over the same amount of time. For context, Disney expects Disney+ will be able to grab 60 million to 90 million subscribers by 2024. However, that range is likely conservative.

Apple Arcade. According to Apple, 500 million people visit the App Store each week. After taking into account Family Sharing, the number of families accessing the App Store each week may be closer to 350 million. My 30 million paid subscriber estimate assumes nine percent of families outside of China who frequent the App Store will sign up for Apple Arcade over the next three years.

Apple News+. My 8 million subscriber estimate reflects Apple continuing to evolve News+ in the coming years. Limited availability will remain a major headwind for subscriber growth as it reduces the addressable market to a fraction of Apple’s billion users. In addition, my 8 million subscriber estimate is influenced by larger headwinds found with consumers not seeing value in many of the magazines included in Apple News+. At the end of the day, the scale associated with paid written news simply isn’t in the same league as video and music streaming. For context, the two largest news sites in terms of the number of digital subscribers, the NYT and WSJ, have 3.0 million and 1.8 million digital subscribers, respectively.

Revenue and Gross Profit Estimates

When estimating revenue and gross profit for Apple’s four paid content bundles, the accounting treatment associated with revenue sharing arrangements needs to be considered. Apple reportedly relies on a 50% revenue share arrangement with Apple News+. Similar to how App Store revenue is reported on a net basis, Apple will only report its share of Apple News+ revenue. Apple will report Apple Music, Apple Arcade, and Apple TV+ revenue on a gross basis as those services do not include any type of revenue share arrangement.

Exhibit 4: Apple Paid Content Bundle - Revenue Estimates (FY2022)

 
 

For this exercise, my gross profit estimates reflect costs tied directly to each paid content bundle. For Apple Music, the approximately 70% of every dollar that is paid out to music rights holders is taken into consideration. For Apple TV+ and Apple Arcade, the amount of cash spent on content is taken into consideration. It is important to point out that SG&A costs are not reflected in these calculations.

Exhibit 5: Apple Paid Content Bundle - Gross Profit Estimates (FY2022)

 
 

Apple’s Other Content Distribution Businesses 

With estimates for Apple’s content bundles in hand, attention turns to estimating the amount of revenue generated by Apple’s content platforms. While Apple does not break out the amount of revenue generated by the App Store or iTunes, management has provided various financial clues that allow one to back into accurate App Store revenue estimates.

In FY2019, my estimate is that the App Store will be responsible for approximately $13 billion of revenue and $8 billion of gross profit. Apple reports App Store revenue on a net basis, reporting only its share of revenue although the full costs to run the entire App Store (84% of apps don’t bring in any revenue) are passed through the income statement. After taking into account every other content distribution platform, including iTunes, my estimate is that Apple will bring in close to $15 billion of platform revenue and $9 billion of gross profit in FY2019.

When forecasting revenue trends for Apple’s content platforms over the next three years, it is important to consider the possibility of Apple’s new content bundle offerings cannibalizing a percentage of paid downloads and in-app purchases. For example, a portion of App Store revenue will likely flow to Apple Arcade over time while iTunes revenue continues to decline due to Apple Music. Assuming 10% of App Store revenue ends up being cannibalized by Apple Arcade, my estimate is that Apple’s various content platforms will see 6% growth year-over-year leading to $16 billion of revenue in FY2022.

Adding my $15 billion revenue estimate for Apples four paid bundles with my $17 billion revenue estimate for Apple’s platforms leads to an overall content distribution arm expected to bring in $32 billion of revenue and $15 billion of gross profit per year by the end of FY2022. 

Exhibit 6: Apple’s Content Distribution Arm - Revenue and Gross Profit Estimates (FY2022)

 
 

Risks

The following items represent risk factors to my estimates:

  • Industry dynamics. The single largest risk factor is mostly out of Apple’s control – the degree to which people will be willing to pay for written content from traditional magazines, rent music and videos, and pay a set price each month to access games.

  • Competition. My estimates do not assume much adoption among users in China. Accordingly, China / WeChat do not represent risk factors to my estimates. Instead, Amazon’s digital content distribution aspirations represent a much larger risk. 

  • Regulation. There are a number of parties looking to attack the App Store on antitrust grounds. At this time, my estimates do not reflect any material adverse change to App Store economics from these efforts.

Takeaways

Based on the preceding estimates, there are a number of takeaways:

  1. A $32 billion revenue run rate per year is roughly double the amount of revenue Netflix currently earns in a year. However, when considering Apple’s overall business, the content distribution arm will likely represent approximately 11% of Apple’s overall revenue. This reinforces the view that content distribution will continue to represent a relatively small fraction of Apple’s overall business.

  2. Apple’s paid bundles will likely have lower profit margins than Apple’s content platforms given how Apple is funding original content for Apple TV+ and game development. Apple Music revenue being reported on a gross basis also pressures overall margins found with the paid bundles.

  3. The App Store will likely remain the most profitable piece of Apple’s content distribution arm for the foreseeable future given that revenue is reported on a net basis.

  4. While Apple’s overall content distribution arm will be highly profitable, it likely still won’t be as profitable as Apple’s other services including AppleCare+, iCloud, Search Ads, and Licensing. While different accounting treatments (net vs. gross revenue recognition) play a role in driving down profitability, the larger factor is that Apple will need to continue investing in Apple TV+ and Apple Arcade.

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