After writing last week’s newsletter on Brand and NPS Surveys, using Apple as an example, I found it serendipitous that the Wall Street Journal wrote a piece about Apple as a gaming giant:
Apple raked in more profits from games than Xbox maker Microsoft Corp., gaming giants Nintendo Co. and Activision Blizzard Inc. and PlayStation maker Sony Corp. —combined—in its fiscal year 2019, according to a Wall Street Journal analysis of figures released as part of the company’s recent antitrust trial.
Apple’s operating profits from games that year totaled $8.5 billion, according to the Journal analysis, exceeding the other four companies’ combined gaming operating incomes in the same period.
$8.5 billion in operating profit1. And that’s just for games.
How did Apple get there?
A massive market of customers
If you’re a gaming company and you want to sell games to consumers, you have to figure out how to tell people about your games and convince them why they should play your games instead of other people’s games. You’re going to be competing against every other established player in the gaming industry.
You’d be lucky if you delivered just one smash hit. You’d have to deliver multiple hits to have a reputation for delivering stellar games. But once you have a reputation for delivering stellar games—that is, you’ve build a successful gaming brand—gamers might buy games from you without thinking too hard about the game itself. “This developer makes awesome stuff; they just made a new game; I’m going to buy it,” they might say to themselves.
In contrast, Apple doesn’t make games. But people trust that Apple makes good products—Apple has a successful brand—so when Apple offers to sell you games via an app store, a certain percentage of people are going to buy games. That’s a lot of gaming revenue for Apple, just because they have an existing relationship with customers to whom they can sell games.
I’m not trying to argue that gaming on an iPhone or iPad is a great experience. I have an iPhone but I’m not sure I've ever bought a game from the App Store. But I did buy AirPods. The point is that because of Apple’s massive customer base, they have access to a massive market of potential customers for their new products. Not every Apple customer is going to purchase every new Apple product, but it’s a major advantage to have an existing customer base when you want to enter a new market.
Of finance and revenues
Tim Cook disagreed with the operating margin calculation:
During the trial, Apple vehemently denied the accuracy and during public court testimony Mr. Cook took issue with the margins as well.
Under questioning from Apple’s lawyer, he said the company had never tried to determine the specific profitability of the App Store as a stand-alone business and that he couldn’t put an exact figure on how profitable it might be. The practice of not tracking business-unit profitability, he said, dated back to a desire by Mr. Jobs to encourage cooperation across the company’s various units. The internal document that calculated operating margin, which wasn’t made public, was a “one-off presentation,” he said.
It’s reasonable to want to push back on that. “You’re telling me that you’re the most profitable gaming company in the world and you didn’t even know it? That can’t possibly be true.” If you think financial success in business happens as a result of understanding finance-y things and being able to compare businesses using finance ratios, then I guess that yes, Tim Cook’s answer could be surprising.
On the other hand, if you think financial success in business happens as a result of creating something of value for customers and convincing them to buy your product, and doing that over and over again so that customers inherently trust you to continue delivering great products, Tim Cook’s answer is perfectly reasonable. Apple has built a reputation of being able to build reliable products that delight customers. And it’s done so on a massive scale.
I’m inclined to believe Apple on this one. Even though customers are the only source of revenue for a business, it’s still remarkably difficult for companies to align around customers, such that entire books have been written about how to do just that. If a company manages to turn a blind eye to certain financial metrics while focusing on the customer and running a healthy business, we shouldn’t be surprised when outstanding financial success is the result.
Revenue includes the operating costs. Profit is revenue minus costs. While Apple’s overall operating margin from its most recent 10-k looks to be 24% for all products and services, the Journal article states, “an expert witness for Epic named Ned Barnes, a forensic accountant, calculated that Apple’s App Store generated a 79.6% operating margin” $8.5 billion in operating profit comes out to $10.7 billion in revenue at a 79.6% operating margin.