Consumer software is eating the world.
Updated: Aug 31
The hot topic in the tech world this last month has been the battle royale between Apple and Epic, the maker of Fortnite. The reason is Apple's App Store monopoly (today a billion people use iPhones, over half of the US market and 80% of American teenagers...) and its 30% commission cut (in the first year, 15% thereafter) of mobile app subscription revenues. The latest news here is that Apple suspended Fortnite’s App Store account. A lot has been said about this, so I won't bother you with that. Instead, let's take one step back and focus on the 'so what' for B2C SaaS.
Apple, a $2 trillion market cap?!
A couple of days after Epic's public attack on the iPhone maker, Apple hit a staggering $2 trillion market cap, making it the most valuable US company ever and the largest market cap in the world, and this two years after topping $1 trillion for the first time. While the company has been riding a hot hand for years on the strength of Apple’s iPhone sales, the phone is not why investors are betting on it. As illustrated in the chart below from August 2020, Apple has been seeing a decline in smartphone sales growth over recent years, along with the rest of the industry.
The fastest-growing product categories are, by far, services (50% LTM) and wearables (48% LTM). If we drill down one step further (Q2 2020 figures below), you can see that services ($13,2B) are by far the biggest category behind the iPhone ($26,4B). All hardware product sales together were $46.5B (total net sales minus services sales).
If we now look at the Gross Margin, services represent 39% of Apple's gross margin. Considering the growth rate, services (gross margin $8.8B) are becoming the most important category, more important even than the iPhone (estimated gross margin of $7.9B)!
Ok, so what are these services? Let's break them down.
As you can see, the App Store is the biggest driver of Apple’s services revenues. Launched in 2008, a year after the iPhone, and followed by in-app subscriptions in 2011, the platform has grown colossal revenue-wise. In 2019, the platform recorded about $50B in gross sales and made somewhere between $10B and $15B of commission, with 50-70% coming from gaming products. I mean, if the App Store were an independent firm, it would rank 64th on the Fortune 500 companies... Long gone are the days where Apple justified its 15-30% commission to cover the costs to run the platform. And, of course, Apple does not want to give up any of these revenues to the subscription apps that use the store as their distribution platform. If you want to dig deeper into this topic, here a great read with commission benchmarks by Bill on the 'greed of marketplaces'. I love how he puts it, 'there is a big difference between what you can extract vs. what you should extract. Water runs downhill...'.
But let's take a second to imagine what a lower Apple take rate would mean for B2C SaaS companies. Their unit economics would become even more attractive... They would increase their gross margin even further and give most of them a higher margin than B2B SaaS players. Couple this with annual plans driving day 1 acquisition marketing payback, lower R&D investments than B2B, and much less customer support, and you can see why we are excited about this model.
The other service products are Apple Music (the estimation is based on the assumption that the ARPU stands at about $7 per month), iCloud (with an est. ARPU of $2 per month, strategically a key service, as it helps to increase switching costs for Apple products, effectively helping to lock in customers. I can see this service category grow substantially over the next years...), Licensing and Fee Revenues (a bulk of the revenues likely come from Google, which pays Apple to be the default search engine for Siri and Safari), Third-Party Subscriptions, and other services such as Apple Care, TV+, Archade gaming, and News+.
Apple One. Cupertino's next hit will be a software product, not hardware.
It is no surprise that Apple now wants to boost its other services beyond the App Store, and follow the footsteps of Amazon and its Prime offering, one of the biggest B2C SaaS offering out there. Therefore, the company is readying a series of all-in-one bundles under Apple One that lets customers subscribe to several digital services (incl. new ones in hot categories such as virtual fitness classes, plus software and hardware bundles) at a lower monthly price. The bundles should encourage customers to subscribe to more services, generating more recurring revenue that Wall Street is so enamored with these days.
Driven by the App Store and potentially Apple One, software, and not hardware, is most likely to become Apple's most important product. Maybe even ever.
Consumer software is eating the world
While the lines between consumer and enterprise are disappearing (Slack, G Suite, Paypal, etc.), this trend has accelerated over the last months (just think of Zoom). The same can be observed between private and professional lives with work from home. People are now expecting superior consumer-ish experiences from all types of software, not only successful mobile consumer apps. This one trend, among others, will only give more tailwind to B2C SaaS products. The new G Suite is a great early example of this new mobile-first thinking.
Here an analogy a friend shared recently with me. B2B Cloud computing has exploded since Salesforce pioneered the SaaS model two decades ago. In 2008, top public cloud companies had a market cap of $14B. Until 2018 this number grew to $500B. In 2020 it hit $1.7T. 94% of enterprises are using cloud solutions today... To compare this with B2C SaaS, let's have a look at revenues. Public B2B SaaS companies are generating $120B revenue run rate (and this number will grow substantially over the next years), while the App Store and Google Play are managing about $80B in Gross Sales, with gaming companies still owning the majority! While Netflix and Spotify have paved the way, I am pretty sure that B2C SaaS will catch up (potentially even take some market share from B2B 😉), and that will see multiple billion-dollar public B2C SaaS companies in the years to come.
If you are building a company in the space, please do reach out to us. A bunch of our B2C SaaS companies are rocking and I would love to share our learnings with you.
It is harvest time for Mirabelles plums. I love this time of the year. A great way to finish the summer and get ready for a rocking 'rentrée'. If you happen to be in Paris this month, let me know.
Life is awesome,
Other content I have found useful
A great article by my friend Vinnie Lauria in the FastCompany: 'What will happen to TikTok? The Chinese tech giants’ growth playbook holds clues'. "The tech giants of the US and China share one core value: growth at any cost, in order to dominate the market. They just have different philosophies on how to get there."
A great nuanced read by Scott Kupor on IPOs, Direct listing and SPACs: There’s a popular narrative now that evil investment bankers are intentionally underpricing traditional IPOs, lining banker pockets, and those of their clients. The proof is seemingly obvious: IPOs are 50x oversubscribed! Proponents of this view believe the Direct Listing, or now the SPAC, is the panacea for these woes. An IPO is far from perfect, but this narrative is also false.
A brief review of the five B2B enterprise and developer-focused tech companies that filed S-1 registrations last week. B2B SaaS is hot right now. As Microsoft CEO Satya Nadella put it: "We have seen two years' worth of digital transformation in two months." Which is to say, every company everywhere is suddenly under immense pressure to modernize their IT infrastructure.
I wrote earlier this year a post about why are investors are obsessed with retention. Here a brilliant overview by Lenny of retention benchmarks across business models:
'Faster Than Fast: SMB Retailers Move to Shopify': A great overview of key players by Chris. We have seen several "Shopify for X" or "built on top of Shopify" startups in YC's most recent batch. This post does a great job of explaining the importance of the platform.