Apple continues its transition from products to services

Quarterly revenues for gadget giant Apple were up year-on-year but down for the full year, as the company increasingly relies on services.

The headline of Apple’s latest quarterly announcement read: ‘Services Revenue Reaches All-Time High of $12.5 Billion’. This achievement masked the fact iPhone revenues continue to decline, which in turn dragged full year revenues into the red. On the whole, however, these were solid results for Apple and it seems to be managing its strategic transition well.

“We concluded a groundbreaking fiscal 2019 with our highest Q4 revenue ever, fueled by accelerating growth from Services, Wearables and iPad,” said Tim Cook, Apple’s CEO. “With customers and reviewers raving about the new generation of iPhones, today’s debut of new, noise-cancelling AirPods Pro, the hotly-anticipated arrival of Apple TV+ just two days away, and our best lineup of products and services ever, we’re very optimistic about what the holiday quarter has in store.”

The services side of things was the focus of the tech press in its analysis. Apparently Apple pay transaction volume overtook that of PayPal in the most recent quarter. A significant initiative that illustrates the symbiosis of the services and hardware side is Apple’s decision to offer interest-free financing of new iPhones through its own credit card. This will also be a significant blow for the postpaid phone contract sector as subscribers will no longer be dependent on operators for handset financing.

The fact that iPhone shipments are declining is not disastrous, so long as Apple maintains the massive iOS installed -base. As the Apple Pay numbers show, Apple’s services are bound to do well so long as there are lots of iPhones in use. The financing initiative implies Apple is worried about that installed-base declining, however, and may not be the last time we see Apple further incentivising people to buy iPhones.

The columns in the table below are as follows: fiscal Q4 2019, Q4 2018, full fiscal year 2019, full year 2018.

Apple U-turns again to pull HK map app under pressure from Beijing

Apple has removed the crowd-sourced app HKmap.live, favoured by the protesters in Hong Kong, from its local App Store, after being blasted by China’s state media.

The submission of the mapping app, developed on top of the web version which could enable users to instantly track the police movements, among other things on the roads, was first rejected by Apple, on the ground that “the app allowed users to evade law enforcement.” This caused strong protest from both local users in Hong Kong and politicians in the US so Apple reversed its decision and made the app available. The US Senator Josh Hawley (R-MO) told his followers on Twitter that Apple admitted it “mistakenly” failed to go through full review process the first time:

Shortly after the change of mind by Apple, the People’s Daily, one of the Chinese Communist Party’s major propaganda outlets, accused Apple of “helping HK rioters engage in more violence”. Apple quickly undertook a second reversal in days to take down the app. The company said in a statement on the decision that the app “has been used in ways that endanger law enforcement and residents in Hong Kong.” The web version is still available.

This is only one of the latest actions Apple has taken after finding itself caught in a perfect political storm. One day earlier it also removed Quartz, the online news publication, from the China App Store, following complaints from the Chinese government. Apple told Quartz that the app “includes content that is illegal in China”, reported The Verge.

Quartz believed this might refer to its discussion on VPN technologies, the use of which is illegal in China, and its coverage of and links to coverage of the ongoing protest in Hong Kong. Quartz’s website is also blocked by China’s Great Firewall. A week earlier when Apple updated its operating system, iPhone users who set their locale to  Hong Kong and Macau found the Taiwan flag had disappeared from emojis.

This is just one of the highest profile cases of global companies contorting themselves to appease local political interests, with China the centre of attention not the least because of its reputation as one of the most censorious countries, Apple vs. China only epitomises the delicate balance almost all global companies are forced to strike, and not always successfully. Whenever they enter markets that operate very differently to their domestic one, these companies, especially those from North America and Western Europe, have to make a choice between the values of their origin and market pressure.

Increasingly we have seen companies surrender to market pressure, which has led to more either remedial or even pre-emptive self-censorship. Such conflict has a long history in the digital age. Back in 2010, Google pulled out of China when it decided to no longer comply with the latter’s demand for censoring search results. In the same year, India, Indonesia, UAE, Saudi Arabia, among others, demanded access to the encrypted communication carried out by the then king of instant messaging, BlackBerry Messenger, for national security and data localisation purposes. RIM, the then owner of BlackBerry, bowed to the Saudi pressure, and Nokia, who also operated messaging services, decided to set up a local data centre in India.

Recently we have seen Google’s repeated attempts to re-enter China, by offering willingly to censor content to please the Chinese authorities, despite backlashes in its own office. Meanwhile games developer Blizzard had faced a backlash for acting against a Hong Kong protester, as has the US NBA for similar activity.

Apple rejects crowdsourced map app used by Hong Kong protesters

HKmap.live is a crowdsourced web app that shows the location of Hong Kong protests and police activity. Apple has rejected the app version of it.

This is the feedback the developers got from Apple, which they shared in a tweet. “Your app contains content – or facilitates, enables, and encourages an activity – that is not legal … Specifically, the app allowed users to evade law enforcement.” The tweet goes on to object to the assumption that the app is used to break the law, but Apple seems to be saying that any app used to identify the location of coppers is intrinsically illegal.

Initial reports on the matter implied Apple had banned a pre-existing app, but the developers subsequently tweeted to clarify that the app had been rejected during the review process and to say that its main frustration was the glacial progress of that process. It also noted that anything can be used for illegal purposes in the wrong hands and that the app is designed only to provide information. It has received some support for its position.

This minor controversy puts Apple in a delicate position as it raises the question of whether its decision was influenced by pressure from China. The Hong Kong protests were prompted by apparent attempts by China to exert greater direct control over the semi-autonomous region and have become a significant embarrassment to the Chinese government. If it continues to the block the app, Apple will be under increasing pressure to demonstrate it’s not doing so for political reasons.

Apple finally gets the memo on sacrificing margin for market share

By making its entry-level new phone cheaper than last year’s one and only charging a fiver for its new video service, Apple is further compromising its premium image.

The roman numerals experiment is over, which means no more X in the iPhone nomenclature. Now we have the entry-level iPhone 11, the iPhone 11 Pro that has additional wide-angle and telephoto cameras on top of the regular one, and the iPhone 11 Pro Max, which is the same as the Pro but bigger. The most significant change, however, is the pricing of the 11, which is $50 less than the XR was last year at $699, which is also $100 less than the Google Pixel 3. The price of the other two phone remains the same.

On top of that the pricing of the new Apple TV+ SVOD service, which will launch on 1 November, has been announced at $5 per month, a lot cheaper than the standard Netflix package that costs $13 per month. The latter is a sensible acknowledgement that Apple TV+, which will only have original content, won’t have a fraction of the amount of stuff you can get from Netflix, while the phone pricing must surely be in response to increasing competitive pressure from the sub-premium market.

“With the tight integration between hardware, software and services, the advancements in iPhone 11 bring an unparalleled user experience at an affordable price to even more customers,” said Apple marketing boss Phil Schiller. “Apple TV+ is an unprecedented global video service with an all-original slate,” said Jamie Erlicht, Apple’s head of Worldwide Video. “We look forward to giving audiences everywhere the opportunity to enjoy these compelling stories within a rich, personalised experience on all the screens they love.”

The pricing angle has caught the attention of the commentariat. Bloomberg notes that not only is the iPhone 11 price cut significant, but the XR has had $150 knocked off it. “We view this as an admission that Apple stretched too far with the price points at last year’s launch,” Chris Caso, an Analyst at Raymond James & Associates, is quoted as saying in the Bloomberg piece.

On top of the aggressive price point for Apple TV+, anyone who buys a new iPhone, iPad, Apple TV, Mac or iPod gets a year’s subscription for free, which is not just a great way for Apple to seed TV+ into its existing customer base, but provide a strong incentive for new sales too, so this is a smart move. Having said that it’s further evidence of Apple’s sudden willingness to sacrifice margin at the altar of market share.

We spoke to Ed Barton of analyst firm Ovum to get his take on the TV+ move. “The price point and a free year of access for new Apple device buyers are aggressive moves which will help drive early growth and usage,” said Barton. “But it’s still, by volume of content, a very limited video service with no catalogue content wholly reliant on new, untested intellectual properties.

“The strength of the Apple hardware and services ecosystem means that it practically can’t fail and a lot depends on how effectively and frequently Apple drops new shows to maintain viewers’ interest levels. Apple’s $6 billion production investment and its ability to surface and promote Apple Video content to a global audience of hundreds of millions throughout its tightly integrated hardware and software ecosystem give the service huge potential.”

On top of the phone and telly stuff Apple also unveiled the latest versions of its Watch and iPad in a mega-launch that it would previously have scattered throughout the year. Just as with the phones the new devices are largely spec upgrades, but we were reminded what a relative bargain the iPad is at just $329 (Apple is still charging $130 for a modem, for some reason, and it’s hard to see why anyone would pay that when they can just tether).

One other announcement was Apple Arcade, a gaming subscription service that Apple has been banging on about for a while. Just like TV+ it costs a fiver a month (although there’s no free subscription offer) and offers a smallish selection of exclusive games. People are less impressed with the games service though.

“It’s difficult to get excited about the games subscription, it does include some exclusive, new titles which didn’t appear particularly noteworthy from a gaming perspective,” said Barton. “Most of the games included didn’t sell well on a standalone basis so it’s difficult to see who this will appeal to. Perhaps there is a casual gamer segment which appreciates the simplicity of a subscription for a heavily curated selection of mobile games, but I won’t hold my breath.”

Since smartphone innovation has been stagnant for the best part of a decade, Apple decided to seek revenue and margin growth from flogging services to its installed base. Apple TV+ is a major step further in that direction, but the decision to be more aggressive on pricing is also a sensible strategy when it comes to expanding that installed base and thus the addressable market for its services.

Losing face in seconds: the app takes deepfakes to a new depth

Zao, a new mobile app coming out of China, can replace characters in TV or movie clips with the user’s own facial picture within seconds, raising new privacy and fraud concerns.

Developed by Momo, the company behind Tantan, China’s answer to Tinder, Zao went viral shortly after it was made available on the iOS App Store in China, Japan, India, Korea, and a couple of other Asian markets. It allows users to swap a character in a video clip for the user’s own face. The user would choose a character in a clip from the selections, often iconic Hollywood movies or popular TV programs, upload his or her own picture to be used, and let the app do the swapping in the cloud. In about eight seconds the swap is done, and the user can share the altered clip on social media.

While many are enjoying the quirkiness of the app, others have raised concerns. First there is the concern for privacy. Before a user can upload their pictures to have the app do the swapping, they have to log in with their phone number and email address, literally losing face and giving away identification to the app. More worryingly, the app, in its earlier version of terms and conditions would assume the full rights to the altered videos, therefore the rights to the users’ images.

Another concern is fraud. Facial recognition is used extensively in China, in benign and not so benign circumstances alike. In this case, when an altered video with the user’s face in it is shared on social networks, it is out of the user’s control and will be open to abuse by belligerent parties. One of such possible abuses will be payment. Alipay, the online and mobile payment system of Alibaba, has enabled retail check-out with face, that is, the customer only needs to look at the camera when leaving the retailer, and the bill will be placed on the users’ Alipay account. By adding a bit fun into the process, check-out by face not only facilitates retail transactions but also continuously enriches Alibaba’s database. (It would not be a complete surprise if this should be one reason behind the euphoria towards AI voice by Jack Ma, Alibaba’s founder.) The payment platform rushed to reassure its users that the system will not be tricked by the images on Zao, without sharing details on how.

Though Zao is not the first AI-powered deepfake application, it is one of the best worked out, therefore most unsettling ones. In another recent case, involving voice simulation and the controversial scholar Jordan Peterson, an AI-powered voice simulator enabled users to type out sentences up to 280 characters for the tool to read out loud in the distinct, uncannily accurate Jordan Peterson voice. This led Peterson to call for a wide-ranging legislation to protect the “sanctity of your voice, and your image.” He called the stealing of other people’s voice a “genuinely criminal act, regardless (perhaps) of intent.”

One can only imagine the impact of seamless image doctoring coupled with flawless voice simulation on all aspects of life, not the least on the already abated trust in news.

The good news is that the Zao developer is responding to users’ concerns. The app said on its official Weibo account (China’s answer to Twitter) that they understood the concerns about privacy and are thinking about how to fix the issues, but “please give us a little time”. The app’s T&C has been updated following the outcry. Now the app would only use the uploaded data for app improvement purposes. Once the user deletes the video from the app, it will also be deleted in the cloud.

Zao Weibo

Google exposes massive iPhone hacking operation

Google’s Project Zero security team has revealed a vulnerability in iOS that exposed large numbers of users to a hack that allowed the installation of a monitoring implant.

This kind of hack is called ‘zero-day’, the definitions of which vary, but which refers to a vulnerability in a piece of software that leaves it open to exploitation by outside actors. The stated aim of Project Zero is to make zero-day hard and it goes about doing so by trying to find such vulnerabilities. Apparently it always publishes these findings after giving the owner of the software time to address the vulnerability and Apple was told about this one back at the start of February this year.

“Now, after several months of careful analysis of almost every byte of every one of the exploit chains, I’m ready to share these insights into the real-world workings of a campaign exploiting iPhones en masse,” wrote Ian Beer of Project Zero in the blog post detailing the findings. “Let’s also keep in mind that this was a failure case for the attacker: for this one campaign that we’ve seen, there are almost certainly others that are yet to be seen.”

This is at best very embarrassing for Apple, which prides itself on the relative lack of malware on its close software platforms. The malware was able to install itself on iOS devices if they merely visited an infected website, with no manual download required. Upon successful installation the malware apparently granted the bad guys access to everything on the phone, including passwords, chat histories, etc.

Google is, of course, Apple’s sole rival in the mobile operating system space, so it does seem pretty convenient that it should be discovering iOS vulnerabilities and publicising them. Project Zero’s policy, it seems, is to publish all such findings after an appropriate delay to allow for patching, which it should be stressed Apple did immediately, but you have to wonder whether it’s quite as keen to bring Android’s failings into the public domain.

Apple given golden opportunity to crack India with relaxed rules

Apple has struggled to gain any sort of traction in the Indian markets to date, but new Government rules could perhaps open the door a crack.

India is a market which represents a significant opportunity for the major players in the digital economy. It has the second-largest population globally and a smartphone penetration rate of roughly 24%, but one of the few markets worldwide where smartphone shipments are increasing quickly. Thanks to certain market disruptions, India is currently under-going its own digital revolution, with the increasingly wealthy middle-class easing into the digital euphoria Western consumers have been accustomed to as the norm.

Year Smartphone penetration1 Average income (US $)2
2018 23.9% 2,020
2017 21.9% 1,830
2016 20.4% 1,690
2015 18.6% 1,600

1Statista 2World Bank Group

The evolution of India and the surge of the digital economy in the country is moving at a dramatic pace. The opportunity for profit is monstrous, but this is a tricky market to crack.

This is the conundrum which Apple is currently facing. It currently has less than 2% of market share across the country (which isn’t increasing), and premium prices are stifling any genuine ambition to increase this.

Indian consumers are gradually spending more on devices, though by the time Apple’s prices would be deemed palatable, other brands might have already developed a strong sense of loyalty; do not underestimate the power of the Android/iOS divide.

Brand Market share
Xiaomi 31%
Samsung 26%
Vivo 6%
Oppo 6%
Realme >1%
Apple >1%

Figures curtesy of Counterpoint Research – Q2 2019 shipments

However, there is a glimmer of hope. The Indian Government has this week announced it will relax rules which dictate how foreign companies can operate in the country. Fortunately for Apple, the easement will allow it to sell directly to customers through its eCommerce channels.

In by-gone years, a foreign company had to source 30% of its production locally to create a retail presence in India. This presence includes online channels. With such reliance on China for the manufacturing elements of the supply chain, Apple has always struggled to meet these requirements. As a result, Apple’s devices have been sold through local partners, who add a premium to an already premium product; it has struggled to gain a foothold in the market.

Another element tied to this is the brand story. The Apple Store is a presence in 25 countries around the world, not only presenting a direct-selling opportunity, but a chance to offer an experience to current and potential customers. This is a fundamental building block in the Apple strategy, which is all about creating a brand and an identity to cultivate customers into the loyal iLifers you see around the world today.

Thanks to new elements being considered by the Indian Government, Apple now meets the requirements and will allegedly begin selling products through its own eCommerce channels in the coming months. These new considerations take into account more iPhones will be manufactured in India, not only for Indian consumers, but for export to Europe as well. This is massive win for Apple.

In short, there are two massive benefits for Apple. Firstly, it can own the purchasing relationship with the customer, dictating the messaging and reducing the price while maintaining profit margins. Secondly, it can begin to create the Apple experience for customers to nurture the sense of loyalty which is so critical to the Apple success over the years.

Apple is an incredibly successful smartphone manufacturer because it creates excellent devices, but the work which has been done to build loyalty with its customer base should never be underestimated.

Think back to the 90s and 00s when you saw Apple adverts on TV. None of these adverts ever really discussed products in the way you would expect but talked about the Apple experience. A huge proportion of advertising today is designed around story-telling and brand experience, but Apple was arguably one of the first to do it and remains one of the best at building this experience.

The result of these campaign was an ‘us’ and ‘them’ mentality which persists today. Whether it pins iOS versus Android, or Mac versus PC, the split is very apparent, and crossover is very rare. Not only does this segmented approach maintain loyalty for the individual products, it presents significant cross-selling opportunities. How many iPhone users have an iWatch, an iPad or a Mac also? We suspect a high percentage.

Shifting people into, and keeping them in, the Apple universe can partly be attributed back to the brand marketing campaigns, the closed ecosystem and ownership of sales channels and brand experience. And now, it presents another massive opportunity moving forward; software and services revenues.

Period Net sales Software and services revenue Percentage of total
Q3 2019 53,809 11,455 21.2
Q2 2019 58,015 11,450 19.7
Q1 2019 84,310 10,875 7.7
Q4 2018 62,900 9,981 15.8
Q3 2018 53,265 10,170 19
Q2 2018 61,137 9,850 16.1
Q1 2018 88,293 9,129 10.3

Figures taken from Apple financial reports – USD ($) in millions

Apple CEO Tim Cook has made a big deal about software and services, and he is very right. It attracts recurring revenues without the R&D and manufacturing price tag. There will of course still be R&D, but smartphones are very expensive products to produce at the level Apple customers demand.

Generating revenues through AppleCare, iTunes, Apple Music, iCloud, Apple Pay, Apple Books, Siri, maps, search or TV subscription services becomes substantially more profitable once people are bought into the ecosystem. And as you can see from the table above, it is becoming an increasingly important facet of the financial spreadsheets.

With many users persisting with the OS they have become accustomed to, if Apple wants to make India a profitable market, it will have to start embedding itself in the minds and lives of Indian consumers today.

The Indian market is one which offers great prospects and profits for those who play their hands wisely. Up to now, Apple would have been written off by many industry commentators, but will changes to the rules, the door is slightly ajar. But that is all it is right now.

Apple will have to convince smartphone users it is a better alternative than the Android ecosystem, while also justifying the premium it traditionally charges for products. This will be a very difficult battle, but Apple is in a better position today than it was yesterday.

Apple and Samsung both had a mixed second quarter

While Apple registered modest growth, with the strong performance of Services compensating the declining iPhone sales, Samsung’s revenue and profit continued to plummet, thanks to weakness in the semiconductor market.

Apple’s Q2 2019 results (its financial Q3 2019) were respectable, if not exciting. The total sales went up by 1% to $53.8 billion from $53.3 billion a year ago, therefore making it the company’s record June quarter in terms of revenue. Gross margin slightly declined from 38.3% to 37.6%, and the operating margin dropped from 23.7% to 21.5%.

The iPhone contributed almost $26 billion, a decline of 12% from $29.5 billion the same quarter in 2018. This represented the first quarter when the iPhone accounts less than half of the total revenues since 2012. Notably, the iPhone is the only product category that reported year-on-year decline this quarter, with growth reported in Mac (+10.7%), iPad (+8.4%), Wearables, Home and Accessorie (+48%), and Services (12.6%). The $11.5 billion revenue generated by Services now accounts for 21.3% of the company’s total income.

“These results are promising across all our geographic segments, and we’re confident about what’s ahead,” said Tim Cook, the CEO. “The balance of calendar 2019 will be an exciting period, with major launches on all of our platforms, new services and several new products.”

If by “promising” Cook meant decelerated decline, he was right. Apple’s revenues continued to drop in Europe (-1.8%) and Greater China (-4.1%), the second and third largest markets after the Americas, albeit at a slower pace. Greater China would have registered a growth on constant currency, Cook insisted.

When it comes to the “balance of calendar 2019”, Apple gave a guidance showing mild improvement in Q3 (its financial Q4). The midpoint guidance points to a 16% growth in revenue, largely similar gross margin (38%), similar operating expenses, implying an improved operating margin of about 24%.

While the iPhone’s shrinking contribution may be expected, the strong performance of Services was encouraging. The company claimed it now had 480 million subscriptions across all its service portfolio, and both Apple Pay and the ad income from App Store search delivered triple-digit growth. The 3rd-party subscription revenue generated by the App Store went up by 40%. The Service growth momentum is likely to be further strengthened by the launch of the video streaming service Apple TV+ and the subscription gaming service Apple Arcade in the next quarter. The Services strength helped lift Apple’s share price by 4.2% pre-market.

Apple 2019_Q2A

Apple 2019_Q2B

A few hours later Samsung Electronics announced its less impressive though not surprising Q2 numbers. The company continued to see its profit plummeting by more than half, a trend we have seen in the preceding quarters, and largely in line with the profit warning the company published earlier this month. The total revenues declined by 4% to KRW 56.13 trillion ($47 billion) with the operating profit coming in at KRW6.6 trillion ($5.6 billion), down from KRW14.87 trillion ($13 billion) a year ago, indicating an operating margin of 11.8%, down from 25.4%. The net profit of KRW 5.18 trillion ($4.4 billion) represented a 53% decline from Q2 2018.

Not everything is bleak. IT & Mobile Communications division, Samsung’s largest revenue generator and which includes Samsung’s mobile handset business, reported a 7.8% sales growth although the operating margin declined by 41.5%. The revenue growth was largely driven by the strong sales of the Galaxy A series geared towards the young users. This has helped Samsung gain market share in a contracting smartphone market. On the other hand, the flagship Galaxy S10 series have met “weak sales momentum”, the company conceded. Recently Samsung announced that it has fixed the problem with the Galaxy S10 Fold and is now ready to launch it in “select markets”.

Continued to be worrying is the Display and Semiconductor business division, the biggest profit generator for Samsung. Despite that the display panel business turned profitable after making loss in Q1, weakness in the memory chip segment drove the operating profit down by 71%, on the basis of a revenue decline of 27%, indicating strong price pressure. This has led to the data centre customers to continue to adjust the inventory levels, Samsung claimed.

Another uncertain, though Samsung did not explicitly discuss, is the on-going trade dispute with Japan, which has resulted in trade embargo on the export of selected high-end equipment from a few Japanese companies. This could potentially impact Samsung’s plan to deliver the more advanced semiconductors in the second half of this year. Samsung insisted that it did “see 2H demand recovery” though.

At the time of writing Samsung’s share price was down by 2.6%.

Samsung 2019_2Q