Jan 4, 2019 7:00 AM

Forget the iPhone Shortfall. Apple's All About Services Now

Like others before it, Apple must navigate a shift from selling devices to selling content and services like the App Store.

Mairo Cinquetti/Getty Images

Only a few months ago, Apple was crowned the first company to be valued at more than $1 trillion. Now, in the wake of a surprise profit warning, its entire future is being questioned. Both reactions are extreme. A victory lap wasn’t warranted last summer, nor is a eulogy now. The company is at an inflection point. Apple, like others before it, is attempting to navigate the shift. It’s fair to wonder if it can; it’s premature to conclude that it can’t.

Apple’s dramatic announcement of a multibillion-dollar revenue shortfall came at a particularly sensitive time for financial markets, which have been sinking on fears about the economic outlook. It took only a few hours before a rough thesis emerged that the combined effects of the China-US trade war, waning consumer confidence, and market volatility are finally denting economic activity domestically and globally, with more pain ahead. As Apple CEO Tim Cook explained, the company “did not foresee the magnitude of the economic deceleration, particularly in Greater China.” Investors took that as a sign that we are potentially on the verge of an economic cliff.

The read on Apple itself was even more negative. One Goldman Sachs tech analyst not only slashed Apple’s share price target but also compared the company’s challenges to those of Nokia in 2007, when that company dominated the global cell phone market and was hit by a sudden shift in how often people upgraded their phones. We know how it ended for Nokia.

Apple’s precipitous decline from a $1 trillion company in the summer to a $675 billion company after warning of weaker iPhone sales has not been in isolation. Other tech shares have been plunging, albeit not as precipitously. Apple’s specific challenge is how to transition to a business less about selling stuff than providing services to people who buy your stuff. I’ve written about this over the past year; this week, it’s more relevant than ever. From its elliptical communications over the past few years—emphasizing the growth of Apple Stores, the robustness of the App Store, and storage—it’s been clear Apple knows that it is at peak hardware and that simply selling more devices is not a viable path forward, however lucrative it has been until now.

That may be why the company announced it would no longer disclose the number of iPhones, iPads, and Macs it sells each quarter. It may also be why, a few hours after the revenue warning, it issued a press release touting record-breaking App Store sales over the holiday week of $1.2 billion. If it could maintain that pace going forward, that could be more than $60 billion in App Store business a year. Not all that goes to Apple—it’s shared with developers—but it’s a very high-margin business. It would not nearly make up for the possible shortfall from a saturated smartphone market, with fewer sales in China and longer times between user upgrades, but it would be a start.

Step back from the gyrations of the moment, and there’s an emerging strategy for Apple: Sell fewer iPhones and assorted devices such as Macs and iWatches at a higher price than mass-market rivals, and then flood those millions of users—who have higher than average disposable income because they were able to afford those devices in the first place—with apps and content that they will pay for. Who knows how well that will work, but it is certainly a coherent approach to a world saturated with smartphones and computers, most of which offer a considerable amount of Apple’s functionality at less cost, albeit less cool.

Other once-dominant hardware companies have been unable to make a smooth transition. IBM tried to compensate for the commoditization of its hardware by becoming a consulting-software-services company. It has remained large and profitable, but nowhere near the size or influence of its former self. HP, even as multiple separate companies, has a similar trajectory. Blackberry nearly died, is no longer in the hardware business at all, and is now a much smaller, marginally profitable software and encryption company. That doesn’t augur so well for Apple.

But none of those occupied quite the space that Apple now does as a consumer brand par excellence. That glow will fade soon if it is not replenished, but it hasn’t yet. The troubles of the Chinese market are, in that sense, a distraction; China was reaching peak iPhone even without trade war tensions, given Apple’s high-end profile and strong local competition from Huawei, Oppo, and Xiaomi. This recent warning may have originated with China, but it was coming from somewhere soon, and Apple knew it.

Watching how this bellwether adapts and evolves is fascinating theater. It raises key questions of the curse of size, what to do when you reach the top, and how to find a new mojo when the old one becomes stale. We cotton to these stories because they replay the eternal human questions in the drama of markets and boardrooms. Apple is to tech what Trump is to politics: an endlessly absorbing story with high passions, unknown outcomes, and an outsized ability to command the narrative.

As a final note, Apple's “massive” miss should be kept in perspective. The company is still projected to generate more than $250 billion in revenue in 2019; it will still be one of the largest and most profitable companies in the world; and its challenges will not decimate Cupertino, California, or the Foxconn workers in Shenzhen, China, who assemble its devices. Breathless headlines notwithstanding, Apple’s travails are not all that travailish. Its success with a different model is uncertain, but for now it is addressing its challenges about as well as any.