iTunes is almost as big a biz as OEM Windows

Apple's iTunes, software and services group generated almost as much revenue in 2013 as did the Microsoft division responsible for licensing Windows to computer and smartphone makers, according to comparisons of the companies' financial statements.

Last year, Apple recorded $US16.8 billion from sales in its iTunes, iBooks, App Store and Mac App Store; its AppleCare extended warranty program; its iCloud and other services; and other odds and ends it tosses into the financial bucket.

During the same stretch, Microsoft booked revenue of $US18.4 billion for what it calls its Devices and Consumer (D&C) Licensing group, which covers all the Windows licensing to OEMs, including Windows Phone; sales of "perpetual" licenses of Office to consumers; and the multi-billion-dollar income from patent licensing deals the Redmond, Wash. company has struck with Android smartphone manufacturers.

The difference between the two groups' revenue, $US1.6 billion, was about 9 per cent of Microsoft's D&C Licensing sales for the year. Put another way, Apple's iTunes et al recorded 91 per cent of the revenue of Microsoft's D&C Licensing throughout 2013.

According to independent analyst Horace Dediu, that revenue gap would have closed slightly -- to less than $US1.3 billion -- if Apple had not lowered the prices of its iWork apps and OS X Mavericks to zero last fall. Dediu pegged the money that Apple left on the table at $US350 million for 2013's fourth quarter.

"What's interesting about the iTunes revenue is that it grows off the cumulative installed base," said Ezra Gottheil, an analyst with Technology Business Research. "It's just additive. If Apple adds, says 50 million devices in a quarter, then the cumulative base is growing even if sales [of those devices] are not."

That, of course, is the definition, more or less, of a service-based business model, which relies on a large installed base of customers to serve with, well, the service.

Gottheil estimated the installed base of i-devices -- iPods, iPhones and iPads -- at 600 million, providing a huge market for the goods and services sold by the iTunes division.

In the December quarter, the group's revenue climbed 19% when compared to the same period the year before. Each quarter of the year, the year-over-year increase was in double-digits, with a high of 30% in the second quarter. "The revenue grows because the installed base [of devices] grows," Gottheil reiterated.

Meanwhile, Microsoft's D&C Licensing division's revenue decreased 6 per cent in the fourth quarter compared to 2012.

Apple's iTunes, software and services group recorded revenue in 2013 of over $US16 billion, nearly as much as the Microsoft division that sells Windows to computer and smartphone makers. (Data: Apple, SEC filings.)

Unlike Apple's iTunes, Microsoft's Windows OEM revenue -- the bulk of D&C Licensing's sales -- isn't tied to the installed base of Windows-powered devices, but to new hardware sales. When PC shipments tank, as they have the last two years, Microsoft's revenue drops as well. That's one reason why Microsoft, under former CEO Steve Ballmer, said it wanted to shift income to services. It's also why the company's pushed hard to convince customers to, for example, subscribe to Office 365.

But revenue doesn't tell the whole story, Gottheil warned. Profits matter too, and there Microsoft has the upper hand. D&C Licensing's gross margin for the December quarter was a whopping 92.5 per cent, with about $5 billion in gross profit.

"There ain't no better business than the software business," Gottheil quipped, referring to the very high margins software has historically enjoyed.

Because Apple doesn't report gross margins on its financial statements, a direct comparison is impossible. But most believe iTunes is not delivering huge profits. "The reason [iTunes/software/services] is largely ignored is because it is not responsible for a significant contribution of profit," said Dediu in an email reply to questions today.

Gottheil argued that the non-profit days were behind iTunes, and that it is adding to Apple's bottom line. "Everyone used to think that iTunes was running just slightly ahead of break-even," Gottheil said. "I don't think that's true anymore. I think it has a pretty good margin now."

He cited the scale of the iTunes, software and services division's operation, which drives down costs, as well as the explosion of in-app purchases, which require little or nothing on Apple's part, as major factors in boosting margins.

And iTunes provides other benefits to Apple beyond revenue and profit, the experts contended.

"iTunes/Software/Services is a critical component (along with Retail) which sustains Apple's core business," Dediu asserted. "It's important to understand it as a part of an integrated approach to [Apple's] business. The inter-dependency of the iTunes/Retail/Product operations is crucial to understanding both the strength and the weakness of Apple."

Gottheil put it more prosaically. "It's all goodness, it's all incredibly sticky," he said of iTunes, pointing out that the more a person spends on the goods and services it provides, the less likely he or she is to desert to another mobile ecosystem, because the apps and music and services won't make the move, too.

"Overall, this is not a bad business Apple has going," Gottheil said.

Gregg Keizer covers Microsoft, security issues, Apple, Web browsers and general technology breaking news for Computerworld. Follow Gregg on Twitter at @gkeizer, on Google+ or subscribe to Gregg's RSS feed. His email address is gkeizer@computerworld.com.

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