By Philip Elmer-DeWitt
August 5, 2009

Apple passed an important milestone last quarter that nobody on Wall Street seems to have noticed: the iPod, once Apple’s (AAPL) No. 1 source of revenue, fell into third place after the Mac (No. 1) and the iPhone (No. 2).

Think of Apple’s business model — as Steve Jobs often does — as a three-legged stool: Mac, iPod, iPhone. As recently as 2006, the iPod leg accounted for 55.5% of Apple’s revenue. By last quarter, its share had shrunk to less than 18%.

But this is a good thing, argues Bullish Cross‘ Andy Zaky, a day trader and occasional blogger whose estimates of Apple’s earnings regularly beat — by a long shot — the estimates published by professional analysts.

“Many Apple critics have argued that Apple would essentially fall off the earth because at some point in time the iPod’s growth would collapse,” says Zaky. “The second part is true.  The iPod growth rate has in fact fallen off a cliff as Apple posted its first yearly drop in iPod sales ever in Q3.”

“However,” he adds, “Apple is still firing on all cylinders thanks to the explosive growth of the iPhone.”

To make his point, Zaky has prepared three charts that pretty much say it all.

The first shows in percentage terms how much the iPod has contributed to Apple’s revenue stream since 2006 Q1. The spikes represent holiday sales seasons, when iPods are popular gifts, but the downward trend is clear.

The second chart shows the rapid growth of iPhone revenue as reported quarterly using generally accepted accounting principles (GAAP). This caveat is necessary because Apple spreads revenue from iPhone sales over the life of a 2-year contract. If you use non-GAAP numbers, revenue from the iPhone last quarter was considerably higher: $2.9 billion, according to Apple CFO Peter Oppenheimer.

Zaky’s third chart puts it all together. It shows the relative height of the three legs in terms of their contribution to Apple’s quarterly revenue. As you can see, the iPhone passed the iPod for the first time in 2009 Q3. The Mac, however, is still the largest and most important leg of Apple’s three-legged stool.

Zaky predicted all this back in January in a long post that warned (incorrectly, as it turns out) of the “downfall of Apple,” in part because the iPhone appeared to be cannibalizing iPod sales.

“The Phone itself has acted as a destructive double-edged sword regarding the appearance of Apple’s financial health. On the one hand, the handset market is significantly larger than that of the MP3 market. And so it makes a whole lot of sense for Apple to have entered that market… On the other hand, it would be incredibly naive for one to believe that iPhone sales aren’t cannibalizing iPod sales to some degree. While not everyone who is in the market for an iPhone is in the market for an MP3 player, iPhone purchasers who are in both markets have little need to own both an iPod and an iPhone.

“The main problem with the iPhone cannibalizing iPod sales is that it makes iPod unit sales growth appear significantly weaker than it actually is. The iPhone is basically an iPod with a phone. One who decides to buy an iPhone over an iPod touch is essentially buying an iPod. Yet, analysts, traders and the media don’t portray it that way. Instead, the financial community tends to view any apparent weakness in iPod unit sales growth as being attributed exclusively to either market saturation or weakness in the consumer.

“Yet, if one were to combine iPod and iPhone sales, he or she would get a drastically different picture regarding iPod unit growth…” (link)

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