Editor’s note: Apple’s latest earnings report shows a big obstacle for the tech giant. Year-over-year revenue declined for the first time since 2003 and a reason is: People love their iPhones. So what’s Apple to do? Technology Business Research analyst Jack Narcotta offers his in-depth analysis.

HAMPTON, N.H. – Despite year-to-year revenue decline for the first time since 2003, Apple (Nasdaq: AAPL) remains the king of its market in 1Q16.

TBR believes the obstacles the company will face into 2017 will have less to do with margins or profits, and more to do with overcoming challenges presented the hundreds of millions of customers that are keeping older iPhones longer. Apple’s puzzle to solve through 2017 will be ensuring that slowing or negative growth does not affect customers’ perception of the company, on which Apple has built much of its value propositions and go-to-market strategies.

More than ever, the iPhone is the hub of Apple, and TBR believes Apple’s focus will remain squarely on ensuring the iPhone – and the services attached to it – remains top-of-mind in emerging markets and in its loyal existing customer base. Reversing forecasted year-to-year revenue and gross profit declines of approximately 15% and 19%, respectively, in calendar 2Q16 are secondary concerns given the iPhone’s lock smartphone profits and its brand strength in APAC, particularly in China. In 1Q16, Apple’s revenue declined 12.8% to $50.6 billion, and its gross profit fell 15.8% to $19.9 billion.

Revenue growth and margins will decrease, but Apple’s dominance in the premium market will continue unabated. Revenue from Apple’s Services segment will emerge as a priority as iPhone demand cools, but Services, Mac PC, iPad and Other Products segments will be dwarfed by the iPhone. In 1Q16, Mac PC and iPad revenue declined 9% and 18.7% year-to-year, respectively, to $5.1 billion and $4.4 billion. Services and Other Products climbed 19.9% and 29.6% year-to-year, respectively to $6 billion and $2.2 billion.

A weakened iPhone business will still ably shoulder the load for Apple

Should year-to-year revenue declines continue through 2016, TBR does not expect Apple to reduce its headcount or spending earmarked for its data center and manufacturing initiatives; the profits Apple’s premium devices generate each quarter more than protect its global infrastructure and processes. A bundle of expanded initiatives in mobile device services and enterprise computing ensure that Apple will continue to hire developer, engineering and retail talent, albeit to a slower degree than in the past. TBR believes Apple will rein in operating expenses, especially sales and marketing, allocated to fueling aggressive growth that mirrors prior gains.

The remarkable profitability of the iPhone ensures Apple claims the majority of profits from the computing devices space. TBR estimates the iPhone alone typically accounts for between 60% and 65% of the total gross profit generated each quarter by the 17 vendors included in TBR’s Devices and Platforms Benchmark, and typically carries a gross margin of 45%, more than double that of its closest competitor, Samsung. The iPhone allows Apple to bankroll new initiatives in wearables (Watch), enterprise computing (iPad Pro), services (Apple Music, Apple Pay, HealthKit) without risking profitability.

iPhone unit shipments declined 16.3% year-to-year in 1Q16 to 51.2 million, which TBR believes is due in part to weaker demand caused by iterative, not innovative, updates, as well as saturation in U.S. and Europe smartphone markets. TBR believes a growing number of Android competitors willing to sacrifice profits in APAC to steal market share from Apple was also factor. The iPhone SE, with an ASP starting at $399, was released at the end of 1Q16, and per Apple was not included in 1Q16 iPhone segment revenue and shipments.

However, unit shipment decline is not an indication Apple is poised to enter a free-fall comparable to Samsung, for example. Overall demand for the iPhone will slow, but the growing loyalty among its China customer base and its maturing partnerships with China’s largest operators — China Unicom and China Mobile — will offset weaker demand from consumers in the U.S. and Europe. A full quarter of sales for the lower-priced iPhone SE will also help stoke demand in emerging markets such as India.

The iPhone excels at guiding customers into Apple’s ecosystems

More important for Apple is that those customers remain ingrained in Apple’s profitable software and service ecosystems. Apple smartly tethered its Services segment to the iPhone, enabling Services growth to coincide with growth of the iPhone. As users become ingrained in Apple’s ecosystem, they are more likely to make additional purchases of media, content, services and applications. TBR expects Apple’s App Store, iTunes and services ecosystems to play larger roles for Apple through 2017, especially as year-to-year Services revenue climbed 19.9% to $6 billion.

Since the introduction of iTunes in 2001, Apple has maximized revenue potential from each customer, even if those customers are not purchasing new phones. While Apple has excelled at capitalizing on the synergies among media, apps and mobile devices, the smaller revenue per transaction simply cannot fill the revenue and profit gaps created by fewer iPhones shipped each quarter.

Additionally, the contrasting scales of its iPhone and Services segments pose a unique challenge for Apple. In 1Q16 the iPhone generated 65% of Apple’s total revenue compared to 11.8% for Services. With the iPhone no longer guaranteeing overall revenue and profit growth, TBR believes the fast-growing Service segment illustrates a potential leading direction for Apple post-iPhone. Apple has indicated subtle shifts in its go-to-market strategy since 4Q15, with an emphasis on what a user can do with an iPhone versus the iPhone itself. However, while Apple has excelled at capitalizing on the synergies among media, apps and mobile devices, the smaller revenue per transaction, and its uneven reputation as a streaming media and cloud service provider will further hinder the segment’s ability to fill the revenue and profit gaps created by fewer iPhones shipped each quarter.

(C) TBR