Next month the iTunes Store will turn 10 years old. Apple has only ever intended that the store should "break even," but according to an analyst it is now making money.
This is quite a feat because: "At break-even the cost of operating iTunes stores would be about $3.75 billion," explains Asymco analyst Horace Dediu.
Dediu has published an excerpt from his iTunes Business Review report in which he claims that the iTunes Store started to generate a profit when Apple folded its Software group into the operation. He describes the Software group as "one of the forgotten heroes of Apple."
He notes that by transitioning products from traditional boxed software to Mac App Store downloads, Apple has been able to fold them into the "catalog of third party apps while lowering prices".
Based on his estimate that Apple's software generated $3.6 billion in revenues in 2012, Dediu believes that iTunes – which now includes sales of Apple’s own software - generates 15% operating margin on gross revenues. "That’s over $2 billion a year."
"What is known as iTunes today has quintupled in seven years", he suggests that operating costs are now "spread more evenly" and that therefore the "possibility exists for some operating margin".
In a separate note, Dediu points to The Critical Path's talk show "Making Sausages" in which discusses how he evaluated the data Apple now provides on iTunes store sales.
Regarding the podcast he writes: "The more we deconstruct and take apart iTunes, the more we come to respect how is cannot exist independent of the system it’s a part of."
"Its scope and scale and its history and future all indicate that there is more to it than just a store and that it might be a platform in its own right."
The first few minutes of the podcast is adverts. Presenter Moisés Chiullan finally introduces Dediu after nearly two and a half minutes of waffle.
When he finally starts talking, Dediu explains that he was able to draw conclusions about the profits being generated by the software sales within the iTunes division because Apple had simplified the way it reports the division's performance.
Music and other…
For many years it was included in the financial reporting under "Music and other services," Dediu explains: "Even thought music wasn't the only thing being sold through iTunes Store".
He continues: "We had a proliferation of media types. We had video come in. We had TV shows. We had movies. We had books. And eventually we had the Mac App Store. The interesting thing was that this still was called, even as late as last year, music and other."
"In fact within that division, within that reporting line, were iPod accessories. Which again were historically broken out as something separate from the iPod, and put into this 'music and others' as a catchall. And so the problem was you couldn't read that line and understand what was going on with the whole store because of these accessories in there and also Apple's own software was its own division," he adds.
"All those things used to be broken out separately, but now they are sold through the Mac App Store or the regular App Store and with those items we didn't know if they were counting as part of the music and accessories division or part of Apple's software," Dediu explains.
Changes to Apple's reporting structure
Apple has now changed the way it reports the activity of the division. Last quarter the company started to report everything from the software division via iTunes: "Because everything is sold through the online store". The company also started to break out its accessory business: "The iPod business is now iPod plus accessories, the iPad business is now iPad plus accessories," explains Dediu.
"The main point is that iTunes now is mainly a store, a transactional business," Dediu states.
Because Apple has now restated the accounts for the past two years, Dediu was able to refer to the old accounts and evaluate the "delta between the two".
"That was the trick that I used. Having two sets of books," he reveals.
However, he warns: "I would be cautious about interpreting any statement that iTunes is profitable as being actually what's happening or being what they [Apple] care about."
Why evaluate iTunes sales?
Why would Dediu want to look into this aspect of Apple's business then? HE explains: "The bottom line is I want to understand, what would this look like if it was separated out and competing against another company that has a similar business model."
"This iTunes business looks a lot like Amazon's business, and therefore can we compare these businesses as if they were standalone," he asks.
"You can try to analyse Apple's software, vis-à-vis another software company, namely Microsoft," he adds.
He explains that what gave him the incentive to break down the iTunes store in this way was when he evaluated the iPhone as a business. "I started by looking at iPhone as a business and said look at how much more successful it is as a business than lets say a Blackberry or Nokia in terms of volumes, in terms of profits in terms of value created and sales level."
"That's why I started to do this, if you separate the iPhone you might as well separate the other bits as well."
"And having taken iTunes apart it gives us the final step of understanding Apple," he admits.