Andy Zaky has an interesting article up over at Bullish Cross where he argues that by accounting for the purchase price of an iPhone over the course of 24 months, Apple is shooting itself in the foot as investors and analysts won’t fully appreciate Apple’s financials.
The underlying problem with the subscription method of accounting is that it makes Apple’s financials appear radically weaker than they actually are.
That’s a good point, but Zaky fails to take into full consideration the fact that if Apple recognized income from iPhone sales on a rolling basis, it would have to charge customers for significant iPhone software updates. The reason why is because there is an accounting requirement which dictates that non-subscription devices (such as the iPod Touch) are subject to a fee when upgraded. Apple has chosen to amortize the sale of an iPhone over a 24 month period on a subscription basis, and in doing so, it can provide iPhone users with new features without having to charge them. This also explains why iPod Touch users are forced to pony up some hard earned cash when a significant software update is released.
Again, Zaky is correct in pointing out that this method of accounting misrepresents Apple’s actual financial health, but Apple isn’t in the business of tailoring its business to the needs of investors. Rather, Apple is more concerned with keeping its consumers happy, and if they do a good job of that, business booms, profits go up, and last but not least, investors are finally happy.
If you focus on the consumer first, investors and analysts will eventually catch on once profits can’t be ignored. But if your adjust your business to keep short term investors and analysts satisfied, consumers will inevitably suffer as a result. Imagine the outrage if Phone users (who already pay a hefty data fee) had to pay 10 bucks every few months for a new iPhone software update. Apple decided to give its customers the best user experience possible at the expense of bending over backwards to make things easier for analysts. It might hurt Apple in the short term (as an investor), but investors aren’t Apple’s demographic.
January 21st, 2009 at 10:04 am
Does this requirement for charging for updates only affect mobile devices? OS X is updated all the time without charge. No subscription based accounting for Mac sales. Or is there a qualitiative difference between a update, such as 10.5.1 to 10.5.2, versus going from 10.5 to 10.6? Seems to be just a matter of degree of change.
January 21st, 2009 at 10:21 am
There’s a qualitative difference. Think about an update to iLife. Apple charges $79 to upgrade. Minor enhancements and the fixing of bugs in Mac OS X are free to the user.
January 21st, 2009 at 10:38 am
C’mon, you’re wrong. Dead wrong.
Zaky says SEVERAL times in his post that Apple made it’s accounting choice so that it may provide free updates to iPhone owners. SEVERAL TIMES!!!
So, suffice it to sat he does NOT “fail to take (updates) into consideration.”
Have you read his post? Because you’ve made a very glaring error here.
January 21st, 2009 at 11:00 am
Christian, I know that Zaky references the free update issue in his article. What I was trying to point out, and not well apparently, is that he doesn’t take into consideration just how much of an uproar there would be if Apple started charging for iPhone updates.
Apple is trying to grow its iPhone business, so why would it give users another reason NOT to pick the iPhone? Again, iPhone users pay a hefty data fee every month – an added fee on top of that would not be good for business and would probably hurt iPhone sales in the short and longterm.
January 21st, 2009 at 12:20 pm
Edible,
Now that’s a GOOD POINT! There would be an enormous uproar if Apple were to start charging for software upgrades to the iPhone.
However, if they had just charged from the beginning it probably would have been less so.
I’m with Zaky on this one. Apple gave up billions in reported revenue to provide the occasional $10 free update. Bad move. How many updates have they had so far? One? Two?
Besides, if the iPhone really is OSX in your pocket— well, don’t you pay for OSX updates? Tiger wasn’t free and neither was Leo or any that came before. Apple still manages to give “point” updates (10.5.1, 10.5.2, etc..) for free and they don’t take OSX sales over two years (or the “life” of the machine). And there’s no uproar when being charged for major updates: Tiger to Leo, etc…
If this is OSX it should be treated as such. $10 for a major OSX update is a steal, isn’t it? I paid $80 for Leo.
January 21st, 2009 at 12:21 pm
“The reason why is because there is an accounting requirement which dictates that non-subscription devices (such as the iPod Touch) are subject to a fee when upgraded.”
The reasons are a bit trickier.
If you pay for the phone, you get a phone with whatever capabilities Apple provided. If you add new features, that is an expense. You need to have a way to say “This expense of adding new features gave us this much in revenue.” The way you would normally do this would be to release a new product with the new features. But what about the people who already bought the product? Well, you charge them money for it. Thus, you can say that adding these features brought in this much revenue.
Of course, who wants to nickel-and-dimed paying for these. As EdibleApple says, Apple wants to delight their customers and getting free features is a good thing that makes customers happy–even if it makes accountants unhappy. So the solution is to account for the revenue over 24 months and that gives you revenue to charge against to keep the accountants happy.
Of course, no one has explained what will happen in 6 months to those people who stood in line for the first-generation iPhone…
January 21st, 2009 at 12:36 pm
What you said was probably the main driver for subscription accounting.
However, remember that with the original unsubsidized iPhone, AT&T paid a monthly fee to Apple (out of the data plan paid for by the subscriber). That charge would’ve been hidden in the subscription accounting, and may have also pushed Apple in this direction.
January 21st, 2009 at 9:10 pm
Hmmm, I don’t see why it’s such a problem to spread the earnings over 24 months. Consider that the accounting method works to smooth out bumps in revenue. This is not a bad thing when entering a recession. You’re still “earning” off of a sale that happend up to 24 months ago. That helps the bottom line later on, when a downturn occurs. What with a downturn (not that Apple seems to be noticing any major effects…), the accounting method looks pretty good to me.