Apple forecasts slower services growth as AI costs rise

Slowing growth and AI costs

Apple reported that its services revenue grew by 10% to $31.6 billion during the September quarter. This growth was supported by record revenues in video, cloud services, payments, and advertising. However, the company is bracing for a cooling period in the coming months.

Chief Financial Officer Kevan Parekh forecasted that services growth will slow to between 8% and 9% in the December quarter. He attributed this sequential pressure to several factors, including third-party licensing and foreign exchange fluctuations. Additionally, the company expects higher costs from the rollout of Siri AI to impact margins.

The financial outlook came as a bit of a surprise to some investors, causing Apple shares to fall about 4% in after-hours trading on Monday. While the App Store saw steady performance, management noted that mobile gaming weakness will likely continue into the December period. These factors combined suggest a transition period as Apple integrates more complex technology into its ecosystem.

The economics of AI features

To manage the high costs of artificial intelligence, Apple is planning to introduce usage limits on features that rely on server-side models. These include Siri AI and intelligent photo editing, among other tools. The company intends to offer a way for power users to pay for more capacity in the future.

The company is also changing how it accounts for these new technologies in its financial reporting. Apple will defer a portion of hardware revenue to reflect Siri AI as a service bundled with new devices. This move helps the company accurately represent the value of the software integrated into its physical products.

As pymnts.com reported, the company is still determining the exact mix of requests that will run on-device versus through Private Cloud Compute. This distinction is important because running models on the cloud involves higher computing requirements and expenses. Management will record these server inference expenses within the services cost of sales.

Expanding the services bundle

Apple is actively expanding its services portfolio to create more value for its massive user base. The company recently expanded iCloud+ to include bundles with Apple TV and Apple Arcade. These moves are designed to increase the stickiness of the ecosystem for the more than 1.5 billion active subscriptions.

The company reported that its installed base now exceeds 2.5 billion active devices. This scale provides a significant platform for deploying new services, even as the company faces hardware-specific challenges. For instance, while iPhone sales rose 17%, the company saw a 10% decline in iPad revenue and an 8% drop in wearables.

Despite these mixed hardware results, the growth in third-party paid subscriptions remains a bright spot. These subscriptions grew at a double-digit rate, showing that users are increasingly willing to pay for digital content. Apple aims to leverage this trend as it moves toward a more service-oriented business model.

Enterprise and local AI use

While the consumer side focuses on subscriptions, Apple is also seeing practical applications for AI in the enterprise space. Some businesses are already using local models on Mac Studio devices for productivity tasks. These local models allow companies to perform work, such as pricing estimates, without relying on cloud tokens.

In contrast, some companies are using AI for specific operational tasks like loss prevention. For example, Gap is currently running loss-prevention AI on Mac Mini units across hundreds of stores. This specific use case is notable because it eliminates the need for cloud-based costs by running the AI locally on the hardware.

Apple CEO John Ternus emphasized that the company is focusing on security and privacy as it expands Siri's capabilities. He noted that Siri is built on a modern orchestrated-driven architecture, which provides room for growth. The goal is to ensure users understand what information they are allowing these agents to access as they become more integrated into daily life.

Supply chain and pricing

The company faced several logistical hurdles during the recent quarter, including constraints on advanced-chip manufacturing. While these constraints are easing, memory availability is expected to restrict shipments of Macs and iPads during the December period. These supply issues are a primary reason for the cautious growth forecasts.

To combat rising costs, Apple raised prices on the Mac and iPad in June and on the iPhone in September. These price hikes were intended to offset higher memory costs and other inventory expenses. However, the company still expects memory costs to account for most of the sequential margin decline in the next quarter.

Looking ahead, the company expects total revenue growth of 7% to 10% for December. Gross margins are projected to land between 45% and 46% during this time. While AI investment will continue, management expects operating expenses to grow more slowly than they did during the previous fiscal year.