Consumer software is eating the world.

Author - Yannick Oswald

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The hot topic in the tech world this last month has been the battle royale between Apple and Epic, the maker of Fortnite. The reason is Apple's App Store monopoly (today a billion people use iPhones, over half of the US market and 80% of American teenagers...) and its 30% commission cut (in the first year, 15% thereafter) of mobile app subscription revenues. The latest news here is that Apple suspended Fortnite’s App Store account. A lot has been said about this, so I won't bother you with that. Instead, let's take one step back and focus on the 'so what' for B2C SaaS.

A couple of days after Epic's public attack on the iPhone maker, Apple hit a staggering $2 trillion market cap, making it the most valuable US company ever and the largest market cap in the world, and this two years after topping $1 trillion for the first time. While the company has been riding a hot hand for years on the strength of Apple’s iPhone sales, the phone is not why investors are betting on it. As illustrated in the chart below from August 2020, Apple has been seeing a decline in smartphone sales growth over recent years, along with the rest of the industry.

The fastest-growing product categories are, by far, services (50% LTM) and wearables (48% LTM). If we drill down one step further (Q2 2020 figures below), you can see that services ($13,2B) are by far the biggest category behind the iPhone ($26,4B). All hardware product sales together were $46.5B (total net sales minus services sales).

If we now look at the Gross Margin, services represent 39% of Apple's gross margin. Considering the growth rate, services (gross margin $8.8B) are becoming the most important category, more important even than the iPhone (estimated gross margin of $7.9B)!

Ok, so what are these services? Let's break them down.

As you can see, the App Store is the biggest driver of Apple’s services revenues. Launched in 2008, a year after the iPhone, and followed by in-app subscriptions in 2011, the platform has grown colossal revenue-wise. In 2019, the platform recorded about $50B in gross sales and made somewhere between $10B and $15B of commission, with 50-70% coming from gaming products. I mean, if the App Store were an independent firm, it would rank 64th on the Fortune 500 companies... Long gone are the days where Apple justified its 15-30% commission to cover the costs to run the platform. And, of course, Apple does not want to give up any of these revenues to the subscription apps that use the store as their distribution platform. If you want to dig deeper into this topic, here a great read with commission benchmarks by Bill on the 'greed of marketplaces'. I love how he puts it, 'there is a big difference between what you can extract vs. what you should extract. Water runs downhill...'.

But let's take a second to imagine what a lower Apple take rate would mean for B2C SaaS companies. Their unit economics would become even more attractive... They would increase their gross margin even further and give most of them a higher margin than B2B SaaS players. Couple this with annual plans driving day 1 acquisition marketing payback, lower R&D investments than B2B, and much less customer support, and you can see why we are excited about this model.

The other service products are Apple Music (the estimation is based on the assumption that the ARPU stands at about $7 per month), iCloud (with an est. ARPU of $2 per month, strategically a key service, as it helps to increase switching costs for Apple products, effectively helping to lock in customers. I can see this service category grow substantially over the next years...), Licensing and Fee Revenues (a bulk of the revenues likely come from Google, which pays Apple to be the default search engine for Siri and Safari), Third-Party Subscriptions, and other services such as Apple Care, TV+, Archade gaming, and News+.

Apple One. Cupertino's next hit will be a software product, not hardware.

It is no surprise that Apple now wants to boost its other services beyond the App Store, and follow the footsteps of Amazon and its Prime offering, one of the biggest B2C SaaS offering out there. Therefore, the company is readying a series of all-in-one bundles under Apple One that lets customers subscribe to several digital services (incl. new ones in hot categories such as virtual fitness classes, plus software and hardware bundles) at a lower monthly price. The bundles should encourage customers to subscribe to more services, generating more recurring revenue that Wall Street is so enamored with these days.