Why It’s Time to Stop Calling Apple a Hardware Company

October 26, 2016, 4:09 PM UTC

Hardware has long been the core component in Apple’s business. But if its fiscal fourth-quarter earnings taught us anything on Tuesday, it’s that software could ultimately be the company’s secret weapon.

Apple on Tuesday announced fiscal fourth quarter revenue of $46.9 billion, a 9% decline compared to the same period last year. Apple’s business slumped on year-over-year revenue declines in its iPhone and Mac divisions, which were off 13% and 17%, respectively. While Apple sold fewer iPads in the last quarter than it did during the same period in 2015, its revenue was static, due in large part to sales of its higher-priced iPad Pro. Even Apple’s Other Products division—which includes Apple Watch, Apple TV, Beats, and the iPod—saw sales slip by 22% during the quarter.

But there was one bright spot: Apple’s (AAPL) Services business. The division—which includes Apple Music, Apple Pay, and App Store revenue—saw revenue soar 24% to $6.3 billion. In an earnings call after Apple announced its results, CEO Tim Cook highlighted the Services business, saying that it’s nearly doubled its revenue in the last four years. Better yet, it’s on pace to be the size of a Fortune 100 company sometime during Apple’s next fiscal year.

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And while Apple’s iPhone business is still its largest, generating $28.2 billion in sales in the last fiscal quarter, alone, the Services business is now in second place, ahead of the iPad, Mac, and all other hardware.

For those who have watched Apple closely over the years, the company’s software success is nothing short of astounding. After all, Apple is a company that, since its inception, has relied on hardware to drive its business. While software was important to create a differentiated user experience over the years, it never took center stage. Indeed, software has historically been used by Apple to boost its hardware’s appeal.

But in the last several years, Apple has laid the groundwork to shift its strategy. The company gets a sizable slice of the revenue developers generate off the apps they build for iPhones, iPads, Macs and other hardware. Over the last couple of years, Apple has charged a nominal fee as part of its attempt at becoming a major player in mobile payments with Apple Pay—a service that saw transaction volume soar 500% last quarter and is adding one million new users each week. Arguably, its most important software move has come via Apple Music, a streaming service that’s growing quickly and one of the chief reasons Apple’s Services division is expanding so rapidly. And who can forget about iCloud?

It’s easy when examining Apple’s financials for its last fiscal quarter to get caught up with a declining iPhone business or trouble in Macs and iPads. But looking only at hardware is so 2010. In 2016, Apple is as much defined by the software services it offers as by its hardware. And when taken as a whole, Apple’s business is still quite strong, due in no small part to software.

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In its fiscal first quarter, which includes the crucial holiday shopping period, Apple is forecasting its highest-ever quarterly revenue. Granted, the period includes a 14th week, which gives Apple additional time to reach the $78 billion quarterly revenue mark. But as CFO Luca Maestri explained on Tuesday, the company is bullish on the holiday season for other reasons. Notably, Maestri mentioned Apple’s Services business alongside the iPhone 7 to explain why the company believes its fiscal first quarter will be successful.

“Let me say a few things on the 14th week and revenue up for the December quarter,” said Maestri. “Keep in mind that December quarter a year ago for us was an all-time quarterly revenue record. We think we can grow this year. As [Apple CEO] Tim [Cook] said, the interest from customers on iPhone 7 and 7 Plus is very strong. The strength of our Services business, you’ve seen we’ve grown 24% in September. We think we can continue to grow very well into the December quarter.”

It’s unlikely that the Services business will outpace the iPhone anytime soon, and with new Macs around the corner, software might soon find itself in third place. But there appears to be no stopping Apple’s Services business. And even as the company deals with the ebb and flow of hardware cycles, its Services division will likely only grow, steadily buttressing its business and profits.

Welcome to the software game, Apple.

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