How Important Are Licensing Revenues To Apple’s Services Business?

by Trefis Team
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Apple’s (NASDAQ:AAPL) Services business has posted robust growth over the last few years, emerging as the company’s second-largest segment after the iPhone. Services is essentially a catch-all segment for the Apple’s non-hardware sales, and includes revenues from the company’s content and app businesses, iCloud storage, Apple Care warranty and licensing revenues. In this note, we take a look at the licensing aspect of Apple’s business, which we believe is likely the most lucrative revenue stream for Apple.

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Google’s TAC Payments Account For Much Of Apple’s Licensing Revenues

While Apple receives licensing payments from various third parties, a bulk of the revenues likely comes from search behemoth Google, which is dependent on Apple for a valuable pipeline of search and other traffic coming from its iOS devices. The fees, which are known as a traffic acquisition costs (TAC) are paid for the privilege of being the default search engine on Apple devices. While Apple does not disclose the revenues it earns from licensing, analysts at Bernstein estimate that Google paid Apple over $3 billion for licensing in 2017. This translates into roughly 10% of Apple’s Services revenues and close to a third of Google’s TAC payments. This revenue stream is likely a very valuable part of the Services business, as Apple incurs practically no costs to earn these revenues, unlike the content and iCloud business, where costs are likely to be higher.

Apple’s licensing revenues saw an uptick in Q2 FY’18, with the company indicating that licensing was the top contributor to the 31% year-over-year jump in Services revenue the company witnessed for the quarter. A bulk of this jump also likely came from Google, as Alphabet – Google’s parent company – saw an uptick in TAC payments over Q1, citing changes in “partner agreements” as a key reason for the increase. Although Bernstein estimates Google will make over $4 billion in TAC payments to Apple in 2018, the growth rate of these payments will probably slow down in the long term. While Apple’s bargaining position with respect to negotiating these fees is strong (being the gatekeeper to perhaps the most affluent base of mobile device users), Alphabet indicated to its investors that its costs paid to distribution partners could start slowing this year, at least relative to its revenues.

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