Why Apple and Microsoft are Moving to Become Powerhouses in Services

In a recent column, I wrote about a new great divide coming out of Silicon Valley in which one side believes the best business model is to sell products and services vs. the other side that gives away services that are subsidized by advertising.

As I pointed out in this article, both business models are valid, but the one that relies on advertisers for their revenue have the biggest challenge when it comes to protecting their customer’s privacy as advertisers need as much data on the prospective customer to more accurately target their ads.

Although the advertising-supported model is exciting and still important, it is becoming clear that those selling products and services, such as Apple, Amazon, and Microsoft have perhaps the most sustainable models.

Apple’s earnings call on May 1, 2018, was quite important in that it showed that Apple’s service revenue during the last quarter was $9.2 billion and if made a stand-alone company on its own, services would be a Fortune 300 company. This was a 31% increase in services revenue from the same quarter a year ago. To be clear, 62% of Apple’s revenue still comes from iPhone sales. But overall sales were strong in the last quarter, and Apple had record sales and revenue in iPhones, Apple Watch and especially services.

The chart below puts Apple’s latest quarter sales and revenue in the context of their overall earnings.

I don’t think I can emphasize enough that Apple is transitioning to making services a much more critical mix of to their revenue balance and making it the second cornerstone to drive their profitability. More importantly, the actual products they create are extremely important in that they become the mechanism to deliver these services. You can bet that Apple will double down on existing hardware and very likely introduce even more devices that funnel services to these devices shortly.

At the moment, Apple leads the pack by providing a complete ecosystem of hardware, software, and services, which is what makes them hard to compete within this new age where services are becoming increasingly important to the overall user experience.

But if you have been watching Microsoft’s strategy over the last four years, you know that they are rapidly moving to be more of a services company too. In their case, they use their partner’s hardware as the funnel to deliver apps and services like Office 365 and more recently, Microsoft 365, in which their OS, applications and other services encompass a new bundle of products for which they charge an annual rate.

This transition to a services company by Microsoft is as essential for them as it has been for Apple. And by creating a dedicated sand-boxed store in which only approved apps are allowed in the store, this gives Microsoft more control of the security for these apps and services as well as brings them a new set of revenue streams.

While this new strategy is good for Microsoft, it is not necessarily good for their partners. In the past, PC vendors had the freedom to bundle software and even security services on top of Windows in which they received legitimate revenue that helped them make money on PC’s that had small margins. But with Microsoft forcing all apps and services through their sand-boxed store, their partners are now blocked in many cases from doing their added-value software and services outside of this store.

To say that their PC vendors are not happy with this new Microsoft program would be an understatement. With PC margins shrinking, and now being blocked from adding additional value without it going through the store and paying Microsoft part of that transaction, these PC vendors are starting to look for other ways to make extra money on a PC sale.

Unless Microsoft changes their tune and becomes more lenient in allowing their vendors to add services and make additional money that goes to them and not Microsoft, I see them being more aggressive in supporting an OS platform that does allow for this type of freedom.

That OS platform will most likely be coming from Google’s Chrome OS. What PC vendors have found is that Google’s G-Suite is getting strong interest and adoption in some big enterprise accounts like Salesforce.com and they see an opportunity to use Chrome OS to gain back some control in which they can add their own apps and services to a laptop platform. How widespread this move will be is up to debate, but you can expect to see the big PC vendors being more active in promoting Chromebooks as a real alternative to Windows-based PC’s to gain at least some of their ability to make extra money with laptops in light of this problem they have now with Microsoft. They already have Chromebooks in educations, but a move to offering them in the enterprise is what makes this interesting.

While there is still money to be made in hardware, the amount of PC’s and laptops sold each year continue to shrink and this move for Apple, Microsoft and others to add services to their offerings are critical for their long-term survival. That is why you should be looking for more and more services from these companies that will be more subscription based as they steer more and more of their R&D in this direction.

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Tim Bajarin

Tim Bajarin is the President of Creative Strategies, Inc. He is recognized as one of the leading industry consultants, analysts and futurists covering the field of personal computers and consumer technology. Mr. Bajarin has been with Creative Strategies since 1981 and has served as a consultant to most of the leading hardware and software vendors in the industry including IBM, Apple, Xerox, Compaq, Dell, AT&T, Microsoft, Polaroid, Lotus, Epson, Toshiba and numerous others.

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