One of the easily overlooked aspects of last week’s iPad keynote is how Apple revolutionized software pricing. “The days of spending hundreds of dollars to get most out of your computer are gone,” charismatic software chief Craig Federighi enthusiastically remarked just before revealing that OS X Mavericks will be a free upgrade to everyone.
The move has ushered in “a new era of Mac,” he said. And of course on the iOS side, the iLife and iWork suite of apps for content creation and productivity has gone from paid to free for every new iOS device owner.
The best part: future updates to iWork/iLife apps and upcoming new versions of the Mac operating system are going to continue to be completely free. What sort of dark magic is that?
Alright it’s not magic, it’s actually some deferred accounting and just sound marketing.
“We are turning the industry on its ear”, CEO Tim Cook told investors on a conference call. “Some other folks charge $199 for each of these, the operating system and the productivity apps. We wanted to make it a part of the experience.”
And finance chief Peter Oppenheimer made it clear that Apple’s fans will never going to have to buy OS X upgrades again because future OS X releases will be free, no strings attached.
“We are now making iPhoto, iMovie, Pages, Numbers, and Keynote available as free downloads to customers who purchased new iOS devices”, he acknowledged. “We are also making Mavericks and future updates free to our Mac customers.”
In doing so, Apple is adjusting its accounting because the company will be still spending money on software development without getting anything in return. So who’s going to fund R&D work and pay for the programers who write these apps?
“As a result of these additional rights and features, we are deferring a greater portion of sales of each iOS device, Oppenheimer announced on the call.
Apple is actually required to defer some revenues from hardware sales to account for the decision to offer software updates for free. An unintended consequence: an additional $900 million in deferred net revenue in the December quarter.
So what’s all this deferral business? Think of it in terms of, say, magazine subscriptions where a publisher collects the money upfront for the year, but can’t recognize it immediately until it actually delivers the magazine at your doorstep.
Likewise, Apple must gradually recognize revenue from hardware over time because the good (an iOS device, for example) is not entirely part of the price paid as new features will get added by way of free software and OS updates after the sale.
Therefore, Apple can’t book revenue for those products until they are fully delivered. A side-effect of deferred accounting is that Apple’s December quarter alone will “hide” nearly $1 billion as this sum gets set aside for later recognition.
Why $1 billion (or $900 million, to be more precise)?
Because Oppenheimer said Apple would defer between $15 and $25 per iPhone or iPad sold (a $5 increase) and between $25 to $40 per Mac sold (a $20 increase). Multiply those numbers with Apple’s expected December quarter sales and you’ll get the $900 million in deferred revenue over a two-year period.
Got that? No? Doesn’t matter.
Eagle-eyed readers will remember the company similarly switched to this accrual accounting method when it stopped charging iPod touch users for iOS updates.
Companies are bound by law to go deferral by U.S. laws whenever features are added to the products that’ve already shipped. Unhappy investors should talk to their senator about killing such obscure account regulations.