What's driving Apple's huge Services business?

While revenue from iPhone sales declined in Q1, Apple reported all-time revenue records from the App Store, Apple Pay, cloud services and other Services categories.

Apple on Tuesday published its Q1 financial results, reporting that services revenue grew by 19 percent year-over-year to reach an all-time high of $10.9 billion. On a conference call Tuesday, Apple CEO Tim Cook and CFO Luca Maestri outlined the factors behind the growth of Apple's Services business -- and those constraining it.

In addition to posting Apple's highest-ever global Services revenue, the company also had all-time records across multiple categories of Services, including the App Store, Apple Pay, cloud services and the App Store search ad business. Nearly 16 years after launching the iTunes Store, Apple generated its highest quarterly music revenue ever, thanks to the popularity of Apple Music, now with over 50 million paid subscribers. 

Apple Pay saw more than 1.8 billion transactions in the quarter, well over twice the volume of the year-ago quarter. Apple Pay was launched in three new countries in the December quarter -- Germany, Belgium and Kazakhstan -- and is now live in 27 markets around the world. In Germany, Cook said, Deutsche Bank reported more activations for Apple Pay in one week than for Android in an entire year.

Revenue from cloud services was up by more than 40 percent in the quarter, while readership of Apple News set a new record with over 85 million monthly active users. In the US, Cook said, the latest data from comScore shows that Apple News has the largest audience of all news apps.

"In summary, we're very happy not only with the growth but also the breadth of our Services portfolio," Cook said, noting that the largest category represents less than 30 percent of total Services revenue.

The Services business is growing in part because of Apple's install base, which by the end of December grew to 1.4 billion active devices, according to Maestri.

Additionally, he said, "Within this install base, the percentage of users paying for at least one service is growing very strongly." This is happening for a few reasons, he said. First, Apple is simply offering more services, as well as increased distribution coverage for many services. Also, Apple has increased the number of payment methods it accepts on its digital stores, making it easier to purchase services.

Apple is also growing its Services business by increasing the scope of those services, Maestri said. For instance, Apple Pay started as a way to make payments in a store or app, then became available on Safari, and then expanded with a peer-to-peer service.

In spite of all this, the growth rate of the Services business has decelerated, Maestri acknowledged. Foreign exchange plays a role, he said, noting that roughly 60 percent of Apple's Services business is outside of the United States.

Additionally, Apple was impacted by the ban on new video games in China, which was in place through most of 2018.

"The App Store in China is a large business for us," Maestri said. "We believe this issue of approval around new game titles is temporary in nature but clearly affecting our business right now."

Lastly, Apple saw some deceleration in Apple Care, which had very strong growth in 2018, Maestri said.