How Netflix Could Eat The Core Of Apple's Services Business

After experiencing a rare lull last spring, Apple is soaring once again. Part of the reason is the anticipation surrounding the next version of the iPhone, which most expect will come out at some point this fall. The newest iteration is rumored to have an array of new features, including enhanced video capabilities and glass encasing, ginning up speculation that it will be the most expensive model ever.

Whatever the case, Apple will sell millions of them and report off-the-charts earnings when that time comes because that’s what it always does during upgrade cycles, and that’s good news for its investors. At the same time, there is a danger in the extent to which the company relies on the iPhone, which accounts for roughly two-thirds of its revenue, especially as its share of the market has declined and with global smartphone sales beginning to flat line.

Apple needs to diversify, and perhaps no one realizes this better than Apple itself. It’s the reason why CEO Tim Cook has begun to trumpet the company’s burgeoning service business which, among others, includes AppleCare, iCloud, iTunes and Apple Music. During the last earnings call, he set aggressive growth targets for that segment, announcing that it will seek to double service-based revenue – which already exceeds $24 billion annually – by 2021.

It is not a foregone conclusion that Cook and Co. will be able to pull this off. It’s the most valuable company in the world, with billions in cash on hand, so it can pretty much do anything it wants, right? Perhaps, but there are a few reasons to believe that Apple’s emphasis on services won’t produce the results that the company anticipates. Consider the following:

**Apple could soon need developers and service providers just as much they need Apple

Apple has reportedly ceded some ground to app makers, agreeing to slash its take in half from those that offer subscription-based services, including video streaming companies. The move was viewed by many as an olive branch to businesses that lean heavily on the iTunes store, many of which have long decried Apple’s cost structure, along with its uneven vetting process and unwillingness to share analytic data.

The thinking goes: It’s a numbers game, and with the amount of subscription-based app developers growing, the company will more than likely make up the difference by allowing that business to stream in and by being a better partner. At the same time, though, it’s hard not to see this as an acknowledgment that the likes of Netflix and Amazon Video are the future of television, and Apple knows that it needs to preserve their revenue streams.

Viewed that way, then, it’s almost a plea to those companies not to circumvent iTunes as a distribution channel. Yet, that’s almost assuredly what they will try to do eventually – which makes Apple’s services growth goals lofty.

**Content is king and Apple doesn't have any of its own.

Streaming services have invested billions in building up their own libraries of original content to complement the shows and movies they already have rights to. Subscribers get immediate and unfettered access for a relatively low flat monthly fee (though Amazon, as part of a broader strategic goal, essentially gives away its content to anyone who has a Prime membership).

Apple, of course, has content in the iTunes store, but it’s far more expensive to access, doled out on an a la carte basis, and none of it is original. Consumer preferences are fast making this business model unviable.

To solve this problem, the company either needs to invest in building a production wing of its own or buy a studio. Lionsgate would be perfect, giving the company exclusive rights to valuable existing content and ownership over new releases. Otherwise, Apple could eventually become a bit player in the content game, as streaming services continue to provide consumers not only more of what they want but at a far better value.

Apple isn’t 'all in' on video games.

Mobile gaming is big business, and Apple is raking in billions each year from game makers. But other than the iPhone and iPad, it doesn’t have another gaming platform, leaving consoles to Sony and Microsoft and VR to Oculus. That could be a mistake as e-sports and VR begin to mushroom. Those are areas where Samsung, Facebook, Electronic Arts, Activision and Amazon, via Twitch, are making waves, and it’s hard to believe Apple couldn’t leverage Apple TV to develop a console and/or produce VR hardware to better compete. Teens and millennials are watching less TV, and, in part, it’s due to video games. By ignoring part of what these groups want, the company is taking a huge risk. Over time, major game makers will demand a bigger slice of revenue for add-ons and games, putting even more pressure on Apple.

Going forward, Apple will still make billions on services and remain one of biggest companies in the world, but it’s a hardware and distribution company at heart, and with the smartphone market getting saturated and ever-more competitive Apple's failure to correctly forecast the value of owning content will become more apparent with each passing day.

By CEO Ross Gerber

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