Which Is Apple’s Best i-Business: Software or Hardware?

Apple iTunes iPhone and Mac

Source: Apple.com

In the third quarter of the year, Apple’s (NASDAQ:AAPL) fastest growing business wasn’t the iPhone. It wasn’t the Mac, and it certainly wasn’t the iPad. Instead of one of its hardware product lines, Apple reported strong results with software. iTunes, software, and services represented the fastest-growing segment of Apple’s business, as chief executive Tim Cook reported on the company’s quarterly earnings call. The category includes both iTunes Music and the App Store, for which Apple reported very strong results.

Cook told investors during the earnings call on Tuesday, “For the first nine months of this fiscal year, the line item that we call iTunes Software and Services has been the fastest growing part of our business. iTunes billings grew 25 percent year-over-year in the June quarter and reached an all-time quarterly high, thanks to the very strong results from the App Store.”

The “iTunes, Software, and Services” category, which Apple’s earnings release explains “includes revenue from sales on the iTunes Store, the App Store, the Mac App Store, and the iBooks Store, and revenue from sales of AppleCare, licensing and other services,” brought in revenue of $4.485 billion during the 2014 June quarter. That’s up 12 percent from the $3.99 billion reported for the category in 2013′s June quarter, just one year ago. In the nine months ended June 28, 2014, the category brought in $13.455 billion, up 14 percent from $11.791 in the same nine-month period a year ago. The iTunes category’s $4.485 billion revenue is also not far behind the $5.889 billion brought in by the iPad product line, or the $5.54 billion from Macs.

Apple attributed the growth in the iTunes, Software, and Services category to growth in net sales by the iTunes Store. iTunes billings grew 25 percent year over year, as Cook noted during Tuesday’s earnings call, rising from $2.4 billion in the third quarter of 2013 to  $2.6 billion in the third quarter of 2014. The company’s earnings release noted: “Growth in net sales from the iTunes Store was driven by increases in revenue from App sales reflecting continued growth in the installed base of iOS devices and the expansion in the number of third-party iOS Apps available. This was partially offset by a decline in sales of digital music. ”

The iTunes store enables users to buy movies, TV shows, apps, games, books, and podcasts. Apple licenses third-party digital content to offer along with apps to users on Mac and Windows computers, plus on iOS devices. Apple’s iTunes, Software, and Services category is performing strongly despite a broad decline in the popularity of purchasing music for download, as consumers shift to a variety of streaming services from Spotify to Pandora. Apple itself has made moves into that area, both with iTunes Radio and with its $3 billion acquisition of Beats Music.

However, it’s also remarkable that revenue from the sales of media, apps, and services isn’t far behind the revenue of product lines like the Mac or the iPad. The growth in app and content sales is driven both by Apple’s content deals, and its positioning as the premier operating system for developers. As the Los Angeles Times notes, that helps Apple compete with other smartphone makers.

“Companies like Amazon, which has just started selling its first smartphone, and Google (NASDAQ:GOOG), which makes the Android operating system, also want to sue their content deals to entice customers to buy their gadgets. Yet Apple seems to be more than holding its own against them for now. These companies, as well as Microsoft (NASDAQ:MSFT), need to attract developers to help their products stand apart. Despite the fact that Android commands a bigger marketshare, Apple still appears to hold the financial advantage when it comes to developers.”

And according to the Los Angeles Times, Apple chief financial officer Luca Maestri touted the strength of the App Store during the company’s earnings call, telling investors on Tuesday: “App Store momentum remains very strong, and cumulative app downloads have topped 75 billion. We continue to be amazed by our vibrant and diverse development community and we’re extremely proud that our developers have now earned over $20 billion from sales of their apps through the App Store, nearly half of which have been earned in the past 12 months. ”

The growth in the iTunes, Software, and Services category is an interesting counterpoint to the performance of the Mac and iPad, the product lines that are closest to it revenue. While Mac sales increased, sales of the iPad decreased, and Apple explained, “Net sales and unit sales increased for Mac due to strong demand for MacBook Air which was updated with faster processors and lower prices in April 2014 and due to sales of the new Mac Pro which became available in December 2013. Net sales of iTunes, Software, and Services grew primarily due to increased revenue from sales of iOS Apps, AppleCare and licensing. Net sales and unit sales for iPad declined in the third quarter of 2014 compared to the same period in 2013 due to lower unit sales in many markets.”

Apple’s software and services are likely to become increasingly important to Apple’s bottom line, with the category representing a full 12 percent of the company’s total net sales in the third quarter of 2014. And while consumers and investors look with anticipation to upcoming product launches, like the iPhone 6 and the rumored iWatch, it’s worth noting that Apple has an increasing number of competitors on the hardware front, each creating smartphones and smartwatches from which Apple will need to differentiate its own products.

But what remains unique about Apple’s offerings is its premier ecosystem of media, software, and services. The company may need to leverage that category in order to stand out from the competition. Since it’s already the fastest growing segment of Apple’s business, it makes sense for Apple to keep it on the trajectory toward growth, which it could do by adding better features and more choices to make iTunes and the App Store the most attractive ecosystem for content distributors, app developers, and consumers.

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