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Evaluating Apple's Services Strategy Ahead Of The Apple Watch 5 Release

Apple's brand has been synonymous with leading industrial design and usability for decades. And despite naysayers claiming a lack of innovation at Apple, the company continues to drive markets. As we await the next round of product launches next week, it's important to review Apple's overall strategy.

After reviewing a variety of announcements from smartphone manufacturers and consumer electronics companies, it's clear that the competition has caught up to Apple in many ways. Today, Microsoft's Windows 10 operating system is more intuitive and rivals MacOS in many aspects of usability. Voice assistants such as Alexa and Hey Google often offer better results to spoken questions. Dell, Lenovo and HP offer compelling hardware designs for PCs that have taken computing out of the realm of the generic gray box. Meanwhile, Samsung and Huawei are pushing the boundaries of material innovation with foldable smartphones.

At the same time, multiple device markets are reaching peak adoption rates. For example, smartphone penetration has reached the 90th percentile in many countries. PC sales were better than expected, but overall, the category isn't growing. Given the quality and longevity of PCs and smartphones, it's also increasingly difficult to get a consumer to upgrade. Growth in a saturated device market is challenging to navigate, but not impossible. Market selection and segmentation remain critical. For example, Apple clearly seeks to address the high margin segment of the market of the PC market.

Apple acceleration to software and services for long-term growth

In a market where other hardware manufacturers offer compelling designs, where can Apple differentiate and grow? Of course, there's always usability but increasingly Apple's layering services on top of its hardware to grow the business. While much of the recent commentary on Apple's strategy focuses on declines in smartphone sales, the company has been consistently ramping its services play. The services play isn't new for Apple, but several items are different today.

First, Apple's upped its game in the sophistication of its services. Moving beyond music and iCloud, Apple launched a more extensive service strategy that broadened its play in the content, finance and healthcare market. Second, consumer behavior changed toward purchasing more services. Thirdly, cloud computing and mobile network advances make it easier to deliver network-connected services. These shifts in market dynamics afford more long-term potential for a services strategy to generate revenue. In case you missed it, Apple's services play is already paying off for the company. If we unpack Apple's services strategy and success, it focuses on three key areas of content, financial services and wearables.

Content is king.

Apple recently shared its updated services strategy showcasing product enhancements, the launch of News+, and new Apple-exclusive content for the Apple TV. Apple's exclusive original content should position it to compete more effectively against Amazon Prime Video and Netflix subscription services. Even before the addition of new content, the services strategy appears to be bearing fruit. At its last earnings call the company announced that services revenue was $11.5 billion, up 13% from last year.

Deepening the everyday relationship with a new payment option

Apple Pay is now completing nearly 1 billion transactions per month, more than twice the volume of a year ago. According to Apple, monthly transaction volume is growing four times faster than PayPal. Apple announced a new credit card named the Apple Card to up its game in the rapidly changing financial services market. Credit cards are a well-established market, but Apple touts simplicity, transparency, and privacy as its key areas of differentiation.

Apple's disruption play focuses on eliminating fees (annual fees, international fees, late fees) and providing consumers with more information on their spend. Additional credit card incentives, such as cashback, look relatively similar to the competition but are tablestakes in the marketplace. Becoming the credit card of choice provides Apple with the opportunity to offer other promotions and engagement options. One of the more significant benefits is that the credit card provides a small discount on Apple products, which was previously unavailable. For example, Apple Card offers 3% cash back on Apple purchases, 2% cash back on all purchases made via Apple Pay and 1% cash back on other physical card purchases. While not a substantial discount, ever piece adds up.

Securing your personal and financial data, a winning combination.

After a wave of security breaches created an unprecedented loss of consumer financial data, Apple's message on security should also resonate with consumers. The Apple Card stores a unique device number in the secure element of the iPhone.Every purchase requires the consumer's unique device number along with a one-time, dynamic security code that the iPhone generates when a person authorizes a purchase. A simple, elegant two-factor solution that happens nearly instantaneously using Apple Pay.Of course, in finance, there are many questions, such as how assistive can Apple be if it analyzes your buying behavior? Does it need to attract millions of cardholders to consider this a win and what can it learn? In truth, Apple wins merely be being a credit card company. It makes a small percentage of every transaction. For Apple specifically, it should get the benefit of lower merchant processing fees on Apple purchases services purchases because it's now a credit card issuer. The deal with Goldman Sachs showcases how Apple's partnering for a win-win.

Apple offers some of the best privacy controls in the industry today. Of course, every consumer company seeks to use your data to customize its service to you. However, many of these companies have leveraged user data for their profit. The challenge is to deliver a right-time experience that is personalized, learning, predictive, but while maintaining your privacy. We can debate if Apple's security features offer enough protection and choice, but the company is still leading the industry.

At the 2019 WWDC, Apple announced a few key wins for consumer privacy. It offered a new single sign-on service that allows consumers to sign in with their Apple ID. It also provided a new way to protect your privacy with third-party app developers. Apple now offers the ability to automatically generate an email alias that can be used to sign in to applications. It also provided new privacy controls such as single-use location permissions to apps and updates to HomeKit to support more secure video. On the personalization front, home-based Apple products, such as the Apple TV and HomePod, received multi-user support that enables these devices to recognize and personalize menus and content for each household member. The combination of its recent announcements provides a good foundation for services innovation and differentiation.

Turning Apple Watch into a your health companion

Of course, the iPhone remains the crown jewels of the company, but Apple Watch offers a wide range of upside for Apple. In its earnings call, Apple stated that June was the best-ever quarter for its services business, and wearables growth accelerated to over 50%. The combined revenue of services and wearables business is now more than eight times what it was ten years ago. As Apple said, its size is now approaching that of a Fortune 50 company. According to Apple, its wearables business is larger than over 60% of the companies in the Fortune 500. At this point, 75% of the people buying Apple Watch in the June quarter were first-time customers. Given Apple Watch's tie to the iPhone, this bodes well for future iPhone sales.

This year Apple launched watchOS. The move toward offering a separate watch-specific development environment was a much-needed step to solidify developer interest. The company also showcased new Watch health features such as menstruation and fertility tracking. Deals with insurance companies, such as Aetna, UnitedHealthcare, have already increased adoption rates but offer longstanding opportunities to expand adoption in the smartwatch segment of the wearables category.

Challenges remain with Apple's services play

Apple's hardware-enhanced services play is a solid strategy, but it's not without issues. Participation in content and finance markets are table stakes for a company such as Apple because these are two products that consumers use almost daily. Without it, Apple's hardware products wouldn't be as compelling. However, that doesn't mean Apple's going to run away with the content market. Amazon, Netflix, and a wide array of startups offer competitive content services that consumers continue to purchase.

Apple has its work cut out for it in carving a niche out in the video content market. In addition to acquiring and creating content, Apple must be sensitive to competitor pricing. For example, Acorn TV with Amazon Prime is $4.99 a month but $5.99 on Apple or direct from Acorn TV. Apple's services have to be simple and financially compelling. Additionally, the competition has established a high bar for creating original content. As a result, content costs are steep and could quickly erode Apple's service profit margins. 

Apple's services play increases in value as it increases distribution. Apple's typically married its services play with its hardware, but as it moves closer to a services strategy, we've seen gentle cracks in this stance. For example, Apple offered an Apple TV app for Samsung TVs, eliminating the need to purchase a separate hardware device. Apple Music is available on multiple operating systems, but other apps such as News+ are not. Apple News+ is a new subscription service in the Apple News app that lets you access magazines and content from specific news sites. News + is the evolution of Apple's News service and a digital magazine service called Texture that it purchased and folded it into the new offering. Additionally, the Apple Watch is tied to the iPhone. Could Apple separate its Watch platform from iOS devices? Only if it could find a way to control health data privacy but one has to ask this is the best use of Apple's engineering resources.

Underpinning services is a robust software platform

Even with these challenges, Apple has one of the most coveted items in the technology market: an active consumer platform. To succeed at a service play, a technology vendor must be one of a handful of companies that have a platform. For example, Apple, Google, and Facebook all have an active consumer platform. In Asia, WeChat, which is owned by Chinese tech giant Tencent, has more than a billion monthly users. In case you hadn't kept track, Apple now has 1.4 billion active users across the portfolio. Of those, almost 1 billion (900+million) are smartphones. As a result, iOS and the new iPadOS, provide a set of platforms with a large developer and user base. Contrast this with Google's Android, which has 2.5 billion active users as of May 2019. But unlike iOS, many Android users are running older versions of the software. Only 10 percent of Android users were on the most current version of the operating system in May. A fragmented Android ecosystem presents challenges for companies trying to create set of services that operate on the latest versions of Android but spells opportunity for Apple. 

Will it work in an age of declining device sales?

First of all, hardware is not dead yet. It's not even just a flesh wound (that one's for the Monty Phyton fans out there.) While the cadence of hardware purchases will slow, hardware upgrades remain vital for supporting the next generation of compute-intensive animation, virtual reality, and artificial intelligence applications. Apple will always be a hardware company, but it's no surprise that many aspects of product differentiation in the hardware space occurs in software and services.

As we move into new services landscape, brand loyalty can quickly shift amongst providers. Today's consumers aren't wedded to Comcast for TV, nor banks like Wells Fargo for financial services. In the long run, Apple has the opportunity to become the trusted financial partner of choice for millennials and future generations.

Furthermore, it will also be one of several primary content providers for consumers. Additionally, Apple's already a leader in the growing wearables market. The digital health market is nascent and provides significant upside for Apple, Samsung and other wearable device makers. Apple has all of the foundational elements to make a services strategy work, but the challenge for Apple will be to balance hardware and services innovation. It will be interesting to see what Apple has up its sleeve for the Watch Series 5 announcement and the healthcare marketplace.

Questions

1. Which competitive strategy does Apple use to outpace its competitors? Give example from the above excerpt.

2. Make a list of as many concepts/terms as possible that you have studied in your course of Strategic Management and explain any three of them with the examples taken from the above case.