This year was an interesting one for Apple — but not necessarily in a good way. iPhones aren’t selling the way they used to, the Apple Watch isn’t a big hit and Alphabet is emerging as a bigger and formidable competitor. And that has Wall Street asking some serious questions about Apple’s future.
At the beginning of the year, Apple experienced a watershed moment: The money it makes from the iPhone dipped for the first time in recent memory. Apple has a large portfolio of products that support its success as one of the most valuable companies in the world, but its primary driver for that growth has always been the iPhone. Every year, Apple has been able to come out with a new iPhone that has been able to tap into an insane amount of consumer demand, have a blowout performance and then set the stage for the next one.
Then, 2016 happened. With the iPhone 6s being largely an iteration of the iPhone 6, and also the demand for a larger phone from Apple finally sated, the company essentially entered a holding pattern for the year until its next iPhone came out. The iPhone 7, of course, came as expected — but it remains to be seen as to whether it’ll be a breakout success as much as the iPhone 6 was.
The result: a drop-off in Apple’s annual revenue for the first time in, well, a very long time.
It’s very hard to draw a comparison between the last two cycles of the iPhone, simply because the demand for larger iPhones was so strong. Apple itself acknowledged that multiple times throughout the year, and it showed up in the company’s financial performance. Still, it also exposed a weakness within Apple. There has long been suspicion that global demand for smartphones in general is tapped out, and while there are some growing markets, the iPhone has always been a premium product and it’s hard to tell whether or not there is a lot of room to grow left for the original pioneer of the smartphone.
Still, Wall Street adores growth, especially in the largest companies in the world. While Apple’s engine is slowing, Alphabet is still showing it can keep the boat steady at least for a little longer in its advertising business. And while Apple may be losing its Wall Street halo effect, Microsoft has an opportunity to capture that. The biggest example of that, it would seem, would be the launch of the highly praised Surface Studio — which is a direct encroachment on Apple’s turf. Not surprisingly, Microsoft has been rewarded in the past year by Wall Street as it has started to tell a different story under new CEO Satya Nadella.
Here’s a quick rundown of the company’s iPhone sales over the past few years. As we can see, sales of the iPhone are sort of down nominally throughout the year, but they remain down nonetheless:
And, as expected, the dip in iPhone sales — even amid other products like the Apple Watch and the iPad, had a meaningful impact on the company’s revenue:
It was inevitable that Apple would slow down. There are only so many people willing to shell out a lot of money for a smartphone, especially upfront, and only so many markets with that kind of buying power to expand into. The thing is, we might not have expected it to happen this soon, though the signs were somewhat on the wall with the nominal iteration for the iPhone 6s and rapid experimentation from other providers — especially in markets like China, with competitors like Huawei.
Those alternative models, including the ill-fated Galaxy Note 7 — which, as a disaster, should be a huge boon for Apple during the holiday quarter — are not only tapping the curiosity of consumers but also demand on the lower end of the buying spectrum, as well as preference for Android devices. While Apple has hit a pretty good sweet spot in terms of price-to-quality compared to other smartphones, it still sits somewhat on the upper end of the purchasing power bracket.
This year was seemingly a disappointing one for Apple, though somewhat expected. But Apple CEO Tim Cook gave investors a glimpse at a possible return to growth as a result of the next holiday quarter in its last earnings report. Apple has had a pretty rocky road throughout the year in terms of its share price, though for the year, it’s more or less ended up where it started.
But, with that, there’s a sort of nervous subtext to it: Microsoft, too, never saw a dramatic amount of growth in its stock. Apple is not Microsoft — it has a large portfolio of strong products and continues to generate and sit on more cash than the rest of the largest companies in the world. And the company is rapidly trying to expand beyond its traditional focus on smartphones and tablets, touting its services revenue on recent calls.
“We remain very confident about the future of our Services business given the unmatched level of engagement, satisfaction and loyalty of our growing installed base,” Cook said on the last earnings call. “We have almost doubled the size of our services revenue in the last four years, and as we’ve said before, we expect it to be the size of a Fortune 100 company in fiscal 2017.”
That is, of course, going to be critical for Apple. As its hardware sales begin to potentially top out, and it faces increasing competition from other smartphone competitors, it needs to diversify its revenue stream. Apple has largely been quiet about the performance of the Apple Watch, which has already shown to strike fear into the hearts of other smartwatch makers like Fitbit and the now-defunct Pebble.
If there was any indication why that kind of diversification was important, you can look to the second quarter this year — when Alphabet, for a split second, became the most valuable company in the world and surpassed Apple. In looking at the comparison, it appeared that at the time Wall Street saw a company with a diverse set of services and a small hardware play as more valuable than a company with a large portfolio of devices and a nominal services play. Billions of dollars in services revenue, of course, isn’t small, but in the scheme of Apple it isn’t as gargantuan as its hardware business.
If there were a U.S.-based company that could prove a legitimate threat to Apple’s turf, it would be Alphabet, which is going after a broader services-driven set of devices like the Pixel and Google Home. Those are powered by the massive machine learning algorithms run behind Google’s search, while Apple has taken a more narrow approach to giving its users a smart assistant with Siri. Apple, thus far, hasn’t shown any interest in getting into a device like the Echo or Google Home, which at least appears to have some kind of latent demand that hasn’t been tapped yet.
Earlier in the year, Apple also signaled an interest in augmented reality, which may be an indicator that it’s looking to diverge in strategy away from Amazon and Alphabet in terms of a different kind of interface for the universe around a user. It has Siri built into the AirPod, its wireless earbud, which already seems like it’s driving users to a universe that looks more like Her with a voice-enabled AI on the go.
“We are high on AR for the long run,” Cook said earlier this year. “We think there’s great things for customers and a great commercial opportunity. And so we’re investing and the #1 thing is to make sure our products work well with other developers’ kind of products like Pokémon. And so that’s the reason you see so many iPhones out in the wild right now chasing Pokémons.”
But there’s another significant problem looming for Apple throughout all this. On the company’s Q3 earnings call — where, as expected, it essentially reported that it was in a holding pattern — Apple CEO Tim Cook said he “wasn’t sure” the company would meet the demand for the iPhone 7. This would be a huge missed opportunity for Apple, as the iPhone 7 was widely praised for its design and especially its camera, and it has a massive opening with the Galaxy Note 7 recall.
“It’s hard to say,” Cook said at the time of the earnings call in response to an investor question about whether the iPhone would hit supply/demand equilibrium by the end of the holiday quarter. “I believe that on iPhone 7 we will, on iPhone 7 Plus I’m not sure. I wouldn’t say yes at this point because the underlying demand looks extremely strong on both products but particularly on the iPhone 7 Plus versus our forecast going into the product launch.”
That’s not a “no,” but it’s not a “yes” either. And Apple, if it’s going to continue to flex its dominance, needs a strong “yes” — and not just something rounded up to a “yes.” And if it wants to keep its Wall Street golden status, it may even need a very strong “yes.”