Apple’s most profitable line of business is making up for some hardware struggles

Apple’s third-quarter earnings report on Thursday showed a revenue decline in the company’s most iconic hardware products — iPhone, iPad and Mac. The current period could also be rough.

But offsetting the hardware softness is accelerating growth in services, Apple’s most profitable business. That’s the division that includes subscriptions, warranties, licensing fees, and Apple Pay. In the June quarter, services grew over 8% to $21.2 billion in sales, speeding up from 5.5% the prior period. In the fiscal fourth quarter, the unit will grow even faster, Apple said.

The division’s growth was “better than we expected,” Apple CEO Tim Cook told investors on Thursday.

Apple’s services business is critical for shareholders because it has stronger margins than hardware products, is more predictable because of recurring billing, and provides more ways for the company to make money from its installed base of over 2 billion devices. Gross margin for services in the June quarter was 70.5%, almost double the 35.4% margin for all of Apple’s hardware products.

“It goes from the fact that our install base continues to grow, so we got a larger pool of customers, to the fact that our customers are more engaged, as we have more transacting accounts and paid accounts on the ecosystem,” CFO Luca Maestri said on the earnings call.

Sales of iPads and Macs could fall double-digit percentages on an annual basis, though the company expects iPhone sales do better than the 2% decline the business posted in the latest quarter.

Apple won’t set growth records for its services business, which topped 38% at one point during the pandemic. But the business is larger now, and analysts expect it to post almost $60 billion in total sales in fiscal 2023.

“We know that there’s a lot of customers that we have that are very familiar with our ecosystem, they’re engaged in the ecosystem,” Maestri said. “Still, today, they’re using only the portion of the ecosystem that is free, and so we think that by offering better content and more content over time, we’re going to be able to attract more of them as paid customers.”

Apple’s report should reassure analysts who had worried over the segment’s dramatic slowdown since December 2022.

Contained in the services business is a variety of products. Apple never breaks down how the services pie gets sliced, but officials did give a number of data points on Thursday about why they’re again optimistic about the business.

Here’s what’s in services, according to Apple’s annual SEC filing:

• Advertising, which includes the company’s own platforms that serve ads on Apple News and in the App Store, as well as licensing arrangements like the company’s deal with Google to be the default iPhone search engine.
• AppleCare, the company’s extended warranty program.
• Cloud services, like iCloud storage.
• Digital content, like Apple Music, video subscriptions such as Apple TV+, and Apple’s cut from sales on its App Store.
• Payment services, including the fees Apple collects from use of Apple Card and Apple Pay.

“We set an all-time revenue record for total services and in a number of categories including video, AppleCare, cloud, and payment services,” Cook said on Thursday.

Maestri added that the company was also seeing growth in advertising, App Store, and music, although those only set June quarter records, suggesting there were other quarters with higher revenue from those categories.

Apple said it has over 1 billion paid subscribers, a number that’s doubled in three years, and is up by 150 million in the last year. Included in the figure is subscriptions to Apple’s owned and operated services as well as subscriptions to an app on its App Store, as the company takes a cut of each purchase.

Cook said the company’s deal with Major League Soccer to broadcast its games on Apple TV was beating internal expectations for subscribers, partially because of one star: Lionel Messi.

“The fact that Messi went to Inter Miami helped us out there a bit,” Cook said.

Apple shares fell a little over 2% to $187.15 in extended trading after the report.

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