Taking Apple TV beyond a hobby

on March 6, 2014

Apple’s TV device made the headlines again this past week when Tim Cook mentioned at the annual shareholder event that it was a billion-dollar business for the company in the last fiscal year. Apple subsequently made clear that this included content as well as hardware sales connected with Apple TV. Though Tim Cook made clear that such numbers make it a little harder to describe it as a mere hobby, it’s still a tiny fraction of Apple’s overall revenues. It’s likely that the Apple TV in its current iteration (the small black puck) has sold around 20 million units in total at this point, at $99 a pop. To put that in context, consider that Apple hasn’t sold fewer than 20 million iPhones in a single quarter since 2011, and that it routinely sells that many iPads each quarter. The Apple TV generated under 1% of Apple’s revenues in the last fiscal year. At this rate, Apple is still selling two to three times as many Macs each quarter as it is Apple TVs.

Why won’t the Apple TV take off in the same way as Apple’s two biggest products? The biggest single reason is that, although it serves three useful functions, it doesn’t solve a fundamental issue in the category in the same way as the iPhone and iPad do. What is the fundamental issue in the TV category? Consumers want single-input, single-interface access to all their video content, and instead are presented with having to switch devices, inputs and apps to get from one show to the next. The things they want to watch are spread across traditional television services from cable, satellite and telco (CST) providers, online subscriptions like Netflix and Amazon Instant Video, free, ad-funded services like Hulu and networks’ own apps and websites, and pay-per-use services like iTunes, Amazon Instant Video and Vudu. There are apps dedicated to helping you figure out which of your many services might carry the particular show you want to watch – that’s how bad things are.

Apple TV does now carry lots of apps which allow you to watch a variety of content without switching inputs on your TV, but that’s only a partial solution. You’re still having to hop between apps, with no universal search to allow you to locate shows across them (unlike Roku). But there are other hassles too – people still have to maintain multiple subscriptions and authenticate themselves to the various apps they want to use. Apple has simplified this somewhat by allowing customers to subscribe to Netflix and other services through their Apple ID. But the authentication process you have to go through to watch HBO Go, the Disney channels and other TV Everywhere content is a significant hassle. Entering usernames and passwords on any TV device is a pain in the neck, and having to do it repeatedly is even worse. The ideal scenario in the current environment would be connecting your Apple ID to your CST provider ID and then having it automatically authenticate you across all your apps – something it sounds like Apple might have been trying to accomplish as part of its talks with Time Warner Cable.

Though adding universal search and one-time authentication would represent progress, it would be progress of a very incremental kind, leaving consumers with many of the existing hassles they deal with today, and not solving the fundamental fragmentation in the TV space. It would leave the Apple TV without a comprehensive live TV offering (beyond the specialized sports channels it offers today). That was likely the major focus of the Time Warner Cable talks, which are obviously now unlikely to come to fruition. But that, too, would have represented a short-cut to what has to be the end game for Apple in this space: offering a full-service TV subscription offering that would combine traditional live linear broadcasting with on-demand viewing of both recent and back-catalog TV shows and movies. That kind of offering would be truly disruptive in the way the iPhone and iPad were before, and would finally make the Apple TV a compelling offering, truly differentiated in the market and offering something really unique: a single-input, single-interface, single-account TV service.

Besides goosing Apple TV sales, this would help Apple in a couple of other ways too. One of the reasons why investors are so easily spooked when it comes to Apple, and why its valuation always seems way out of whack with its performance, is that its business model relies on huge, roughly yearly hits in its two major product categories. Annual iPhone and iPad releases have to succeed in a huge way to keep the company’s growth and profit trajectory going. The problem is that there is always the risk – entirely theoretical so far – that one of these hits will turn out to be a dud. Adding the kind of annuity revenue stream an Apple TV service would offer – several hundred dollars per year per customer – would provide the sort of predictable revenue stream that investors like to see, which might offset some of the perceived risk associated with the hardware business.

The other big thing this service would do is reinforce the appeal of the Apple ecosystem, and of an all-Apple portfolio of devices in the home. Many people today combine iPhones with Nexus tablets, iPads with Samsung Galaxy smartphones, and all of the above with a Roku, a smart TV or a Playstation or Xbox for TV viewing. An Apple TV service, available like most of Apple’s other services exclusively on Apple devices, would provide a powerful glue that would stick all those devices together and give consumers very strong reasons to buy only Apple products.

The big questions remanning are whether such a service would actually make any money, and whether it’s even possible for Apple to put such a service together. On the first point, there’s solid evidence that it is possible to make very good margins in this business. The closest parallels to what Apple would offer are the cable networks, since they also acquire content rights and sell them to consumers on a subscription basis, but without the delivery infrastructure that CST providers need. These companies in the US have very good margins, in most cases at or above Apple’s recent levels (these numbers are all specifically for the cable network divisions of these companies):

US cable network marginsAnother company with an analogous business model is Netflix, particularly its US streaming business, which has been generating steadily increasing margins which are now in the mid-20s, just below Apple’s recent levels. While neither Netflix nor the cable networks’ businesses are exact analogies for what Apple would do in this space, there is good evidence here that packaging and delivering high quality video content on a subscription basis can be very profitable.

The bigger challenge is content rights, which is no doubt why we’ve seen many stories over the last several years about Apple trying to acquire them. The kind of bundle of live, recent and back catalog content rights we’re talking about here is unheard of, and Apple would be charting new territory (something it has a good history of doing). But Apple has both the existing audience (Intel’s biggest problem), content relationships, and DRM and other structures in place to reassure content owners that it can make a success of this business. And DISH has reportedly just signed just the sort of deal Apple will need to sign with Disney, already a strong Apple partner, which is promising. However, this remains the biggest challenge to this strategy, and the Time Warner Cable talks may well have been a sign that Apple wanted an interim solution while it works to create the ideal product.

The other thing worth thinking about is broadband providers’ bandwidth caps and their impact on this sort of service. As long as people are only using Netflix and Hulu to supplement traditional CST-provided TV, their bandwidth consumption is likely to stay within the 250GB caps that are starting to be implemented by major broadband providers. But if such a service became the only way a household consumed video, it would significantly increase consumption and might lead to problems.

Overall, the only way I can see for Apple to turn the Apple TV into something more than a hobby is to truly disrupt the TV space, and the way to do that is to launch not a TV set, but a TV service, with Apple TV, iPhone and iPad as different ways of accessing that service. This would finally turn Apple TV into a truly unique product, it would provide a very different kind of revenue for Apple in the form of predictable, recurring monthly subscription fees, and it would cement the Apple ecosystem as a compelling option in consumers’ minds. And this would be a substantial new revenue opportunity for Apple – just those cable networks listed above generated over $70 billion in revenue last year, almost entirely in the US. Given the content relationships Apple already has in many other markets, it could expand the service beyond the US in the coming years, providing a significant ongoing source of revenue growth.