Apple needs to 'raise its game' in this one key area, or there could be trouble ahead (AAPL)

Lisa Eadicicco

Apple's business is in excellent shape, especially when it comes to the iPhone. The company delivered a monstrous earnings report in April, revealing that it did $58 billion in revenue in the first three months of the year alone. That's up 23% from the year prior.

But the driver behind those strong results, the iPhone, might not be enough to keep Apple ahead of the competition in the future.

Following Google's big annual event, Google I/O, the analysts at Jeffries released a report emphasizing how important cloud services are — and how Google is far ahead of Apple in this space.

"We continue to believe Apple needs to raise its game in Cloud Services to combat competition from Google in the long term," Jeffries wrote in its most recent note. 

This doesn't have much of an impact on Apple right now, but Jeffries highlights a scenario in the future in which it might. It all boils down to what the main driver behind smartphone sales is.

Right now, hardware is viewed as one of the most important factors when buying a phone. That is, people look at how the phone looks and feels, the build materials, the quality of the screen, how fast it performs, and so on. This is an area where Apple excels, since it's a hardware-focused company. 

But Apple could be in trouble if the main driver behind device sales becomes the quality of cloud services rather than hardware.

Here's what Jeffries writes in its latest report (emphasis is our own):

As mobile usage models increasingly migrate to the Cloud, catalyzed by growing adoption of hardware-lite devices like Smartwatches, we expect more of the user experience to be increasingly driven by superior Cloud Services such as Google Now. This represents a longer term threat to Apple's hardware-centric business model.

This echoes the same sentiment Jeffries wrote in a lengthier report from November 2014:

If user perception of device value shifts from device hardware (and software) to Cloud Services, Apple's iOS hardware ASP premium would be at risk...A shift in user perception toward Cloud Services could further challenge Apple's product differentiation.

Today, you can get most of Google's core services on the iPhone, including the new Google Photos service with unlimited storage, plus Google Now, Gmail, Chrome, Google Maps, Hangouts, Google Drive, and many more.  

But what really impressed Google I/O attendees — and the analysts at Jeffries — is how Google plans to tie all of your apps together. This is the killer feature that could eventually make the Android experience smoother than iOS, according to Jeffries. It really shows the potential benefits of Google's cloud services that you'd only be able to get on Android. 

Here's what Jeffries had to say in its most recent note (emphasis is our own):

While we believe Google's Play Store revenues are growing faster (off a lower base) than iOS app store, Google's Now on Tap signals a more fundamental shift away from a litany of apps powered by disconnected data sources, to a more context-aware and unified Cloud Service that over time could make device-based apps less relevant. At ~1m apps each, we think the last thing either iOS or Android ecosystems need is new apps. With fewer apps to install/update, or to switch across, we think user experience could improve dramatically.

If it's features like Google on Tap, which are largely powered by the cloud and how apps communicate, that drive smartphone sales, Jeffries thinks Apple could face more challenges ahead. This will be even more important as smaller devices, such as smartwatches and fitness bands, become more popular, since they largely rely on taking the information already stored in your Google account or Apple account and relaying bits of data that are most relevant to you on your wrist. 

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