Apple’s Paid Subscriptions Growth Reaccelerates, The Case for Higher Apple Gross Margins
Hello everyone.
We will conclude our Apple earnings review by looking at Apple’s paid subscriptions growth and gross margins. There are a few follow-ups that we have not covered yet. The discussion includes Neil’s thoughts on why Apple’s gross margins still have room to move higher.
Let’s jump right in.
Apple’s Paid Subscriptions Growth Reaccelerates
In keeping with its usual disclosure, Apple provided updated comments regarding the number of paid subscriptions across the Apple ecosystem.
Based on Apple’s commentary, here are my estimates for the number of paid subscriptions across Apple’s ecosystem (first party and third party) on a quarterly basis:
1Q20: 482M paid subscriptions
2Q20: 518M
3Q20: 553M
4Q20: 588M
1Q21: 623M
2Q21: 663M
3Q21: 705M
4Q21: 749M
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Apple’s Paid Subscriptions Growth, Apple Gross Margin Hits Decade High, Apple’s Next Marginal Customer (Daily Update)
Hello everyone. In today's update, we will address a few topics carried over from Apple's 1Q23 earnings release: paid subscriptions growth trends and gross margin improvement. We begin with Neil’s estimates for new paid subscriptions added across Apple’s ecosystem on a quarterly basis. The discussion then turns to Apple’s gross margin improvement. We go over the most likely driver of the stronger performance. The update concludes with an underlying story to be told about Apple’s gross margin hitting a 10-year high. Let's jump right in.
Apple’s Paid Subscriptions Growth
It’s been five months since we last examined Apple’s paid subscriptions trends.
In keeping with its usual disclosure, Apple provided an updated total during its 1Q23 earnings call for the number of paid subscriptions across the Apple ecosystem.
Based on Apple’s commentary, here are my estimates for the number of paid subscriptions across Apple’s ecosystem (first party and third party) on a quarterly basis:
1Q20: 482M paid subscriptions
2Q20: 518M
3Q20: 553M
4Q20: 588M
1Q21: 623M
2Q21: 663M
An Above Avalon membership is required to continue reading this update. Members can read the full update here. An audio version of this update is available to members who have the podcast add-on attached to their membership. More information about the podcast add-on is found here.
(Members: Daily Updates are always accessible by logging into Slack. If you haven’t logged into Slack before, fill out this form to receive an invite.)
Above Avalon Membership
Payment is processed and secured by Stripe. Apple Pay and other mobile payment options are accepted. Special Inside Orchard bundle pricing is available for Above Avalon members.
More information about Above Avalon membership, including the full list of benefits and privileges, is available here.
Apple Is in a League of Its Own
During Apple’s “Peek Performance” event held last month, the company announced not only a brand new Mac category with the Mac Studio, but also iPhone SE and iPad Air updates that will be well-received in the marketplace. Management fit so much into its 57-minute event, Apple’s entry into live sports was given just 65 seconds.
The primary takeaway from Apple’s event wasn’t found with any particular product. Instead, it was the sheer breadth of product unveilings that caught my attention. Over the past 18 months, Apple has held seven jam-packed product unveilings that have included a collection of new hardware, software, and services. Apple’s peers would be thrilled to hold just one of these presentations every year or two. There is no other company in the same league as Apple when it comes to maintaining and updating such a wide and comprehensive ecosystem of devices and services. The pace of Apple’s new product unveilings has played a role in the company pulling away from the competition.
Ecosystem Strength
It's easy to look at Apple’s quarterly earnings and reach conclusions about the company’s ecosystem strength. Apple’s financials, although strong, don’t tell the full story. With nearly 80% of Apple’s revenue attributable to hardware, the company’s financials remain heavily influenced by upgrading trends. Revenue, operating income, and cash flow metrics undersell how Apple is performing in the marketplace from a new user perspective.
The following new user estimates are obtained by combining Apple management commentary with my own product unit sales assumptions:
To get to the heart of what Apple is doing and how the company is executing so well, we have to go back to 2017 and 2018. Apple began to follow a new strategy that amounted to pushing all of its product category forward at the same time. Previously, Apple had been following a product strategy that can be thought of as a pull system. The company was most aggressive with the products capable of making technology more relevant and personal.
One way of conceptualizing this strategy is to think of Apple product categories being attached to a rope in order of which makes technology more personal via new workflows and processes for getting work done. As Apple management pulled on the rope, the Apple Watch and iPhone received much of the attention while the Mac increasingly resembled dead weight. Similarly, the iPad had hit a rough patch.
Apple is now utilizing a push system in which every major product category is being pushed forward simultaneously. As a result, the iPad, and in particular the Mac, has received more priority. We have also since seen Apple become more aggressive with expanding the number of SKUs available and giving consumers more price and feature options.
At the core of Apple’s product strategy shift was a doubling down on autonomy within its product development process. The Apple machine is operating at such speed and scale, it’s not realistic to think one person can control or run the machine. Apple wouldn’t be able to push its entire product line forward simultaneously if every decision had to go through one gatekeeper. Instead, the Apple machine was designed to take on a certain level of autonomy in order to instill Apple’s values in all employees. Designers of various disciplines have been given greater say over the user experience.
Floundering Competition
As product strategy changes were underway within Apple, the competition began to flounder. A growing number of bad product bets were placed, peaking with the ultimate misdirection in tech of the past decade: voice computing and the stationary smart speaker mirage. The subsequent embrace of stationary screens positioned on kitchen countertops has seen limited adoption. Foldable smartphone sales have not been impressive. Apple competitors are now struggling to capture consumers’ attention and money with routine annual smartphone updates.
We are at the point when tough questions have to be asked about Apple’s competition, or lack thereof. What company can realistically give Apple a run for its money? The number of paid subscriptions across Apple’s platform is increasing by 170 million per year. Google wants to compete in some hardware verticals that Apple plays in, but it’s fair to question Google management’s commitment. At times, their heart just doesn’t seem in it. Amazon and Microsoft have stronger motivations to do well in hardware, but their lack of design thinking is hard to miss. Meta would win the award for strongest public commitment to hardware, but the company’s culture and heritage don’t seem to mesh well with what it takes to do well in hardware. Snap, Spotify, Sonos, and the long list of smaller companies dabbling in hardware all lack the ecosystems to truly go up against Apple toe to toe.
When thinking of competition outside the U.S., a growing number of consumers are looking for entry points into comprehensive (and premium) ecosystems. Apple is selling both the all-around best smartphone in the market and tools and services designed to live both below and above the smartphone. Android switching rates are increasing while Apple entices hundreds of millions of iPhone-only users to move deeper into the ecosystem.
A risk that any company in Apple’s position will face is complacency. With most of its product categories, Apple’s largest competitor ends up being itself. The fact that Apple’s ecosystem updates are accelerating rather than declining as the competition breaks apart is a potential sign of Apple decoupling itself from the “competition drives us” mantra that is found in Silicon Valley. There is a deeper drive within Apple – a feeling that if Apple doesn’t create it, no one else will - that is driving teams forward.
Check out the daily update from April 5th for additional discussion on this topic.
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