Apple’s service revenue growth offers optimism amid tough year, and a glimpse of the future

For a company known for its gadgets, Apple can’t talk enough about growth in its Services revenues these days.

The headline of its earnings press yesterday: “Services Revenue Grows 24 percent to All-Time Quarterly Record of $6.3 Billion.” In the earnings call with analysts, Services was the second thing CEO Tim Cook highlighted after relaying the iPhone numbers.

“We had a record-setting quarter for Services, with revenue growth accelerating to 24 percent, reaching $6.3 billion,” Cook said. “App Store revenue continued to skyrocket, while Music revenue grew by 22 percent, thanks to the growing popularity of Apple Music. In fact, J.D. Power recently announced that Apple Music enjoys the highest customer satisfaction rating in the streaming music market.”

And that’s as it should be. Services has become the second-largest category of revenue for Apple, ahead of Mac and iPad sales. In a year in which sales in just about every other product category were down and the company reported its first annual revenue decline since 2001, Services has become Apple’s shining star.

That’s particularly critical as the company faces slowing iPhone sales. The universe of Apple device owners continues to grow, and analysts believe it’s important the company be able to leverage this group by selling more apps, Apple Music subscriptions, iCloud accounts, and Apple Pay.

While Apple continues to boast about innovative new features on its gadgets, analysts aren’t so sure they really stand out against competitors as much as they used to. And with most of the smartphone growth coming at the lower end of the market, Apple faces some tough challenges if it wants to grow device sales again.

Services could play an important role in Apple’s future growth, allowing the company to capture more revenue from each user over a longer period of time. In that respect, there are many reasons for optimism in the most recent quarter.

Executives said that the rate of growth in the App Store has continued to increase for five straight quarters, putting to rest concerns that people were suffering mobile app fatigue. In the most recent quarter, App Store revenue was up 43 percent compared to the previous year.

“So what that means in practice is that what we are seeing with our customers that consume our services is that the people that are actually taking advantage of our services over time tend to spend more and more on our services,” said Apple CFO Luca Maestri. “We’ve got customers that are very engaged with our products. They’re very loyal, and so you see this upward trajectory of our Services business.

While the company didn’t update its number of Apple Music subscribers, the 22 percent increase in music revenue shows that Apple has overcome the drop in sales of digital downloads.

Apple also said that Apple Pay transactions increased 500 percent year over year for the September quarter. And it’s hoping to accelerate that growth with Apple Pay now built into the Safari browser.

The company says it expects Service revenue growth to at least match the 24 percent increase reported in the last quarter. And looking down the road, executives noted they are continuing to build new data centers to support the operation of these services.

“We’ve also put a lot of emphasis on our Services business, and on making the ecosystem even better,” Apple CEO Tim Cook said. “We remain very confident about the future of our Services business, given the unmatched level of engagement, satisfaction, and loyalty of our growing installed base.”