Monday Note

In reaction to last week’s technical speculation on the putative iTV, several commenters raised questions about content providers, distributors, and “pipes”. Does iTV help or harm NBC, Netflix, and Comcast? How does the [one last time: “putative”] iTV make money, and for whom?

Indeed, the column ignored an important – perhaps the most important — part of the product: the Money Pump, a.k.a. the Business Model. While Apple displays a sharp, fulfilling sense of aesthetics and simplicity in the design and implementation of new products, the company didn’t reach the pinnacle of high-tech profitability by merely practicing l’art pour l’art. Apple isn’t deaf to a more practical art form: cash register music.

Starting with pipes, let’s look at smartphone carriers as an analogy. When AT&T “won” exclusive iPhone distribution rights in the US, it appeared that they had traded their birthright. The iPhone bore no AT&T customizations, no stickers, no craplets. Worse, the carrier had to let Apple run the content distribution table with iTunes.

As we’ve since seen, the trade turned out well for AT&T. With more subscribers because it’s an iPhone!, and with more revenue per customer, the device yields AT&T a $100 monthly ARPU, much higher than the $50+ industry average.

With this in mind, should we think of an exclusivity deal between Apple and a “TV carrier”? Perhaps another AT&T deal, this time for their TV + Internet U-Verse line.

AT&T’s network topology — a dedicated set of wires running into each subscriber’s home — is ideal for voice and Internet traffic. But the company is at a disadvantage when it comes to distributing several hundred TV channels, something a cable provider has no problem with. Comcast simply taps into the coax cable that passes by each house and feeds the same anonymous, multiplexed signal into the set-top box for authorization and decoding. (This is an oversimplification and ignores the evolving topologies made possible by optical fiber…but we’re still far from the dream of Fiber To The Home)
iTV could give AT&T an opportunity to take the lead in 21st Century TV, to stop fighting Comcast on its own ground. The resources AT&T deploys today to bring old-style TV channels into markets dominated by cable carriers could be re-allocated to the fast Internet access that lets several iTV devices run in the same home. (Try asking today’s friendly AT&T U-Verse salesperson how many DVRs you can have. “One” is the general answer, as this U-Verse user document cautiously explains. Comcast will let you have — and pay for — as many as you like.) A simpler, more focused life, stealing subscribers from the incumbent, a higher Phone + Internet Access ARPU… For AT&T, this could be a repeat of the original iPhone deal.Realistic? I don’t know if AT&T is bold enough to make such a move.

For cable TV incumbents, the money pump equation is different. By “virtue” of their dominant position, they have more to lose, they have these expensive, inflexible, and tricky channel bundles to protect. What looks like a potential ARPU uptick for AT&T could turn into a subscriber revenue decrease for a cable operator supplying Internet access to iTV viewers using apps instead of channels.

This gets us to iTV content. It will either be “free”, meaning subsidized by advertising; by subscription, like Bloomberg BusinessWeek on a tablet; or pay-as-you-go, one show or game at a time. One reader suggested we’d end up paying more than we do with today’s bundles. It’s a possibility, but we might be happy to pay more in exchange for the freedom to pick and choose, as opposed to today’s situation where adding an “extraneous” channel to an existing bundle is a chore that makes you feel like you work for the cable company and not the other way around. Who knows, we might even spend less overall — while giving more money to the better creators.

We now move to content providers. As they ‘‘appify’‘ their channels, will they be willing to give Apple 30% of the app revenue? If the app is “free”, no problem: 30% of zero isn’t terribly onerous. But even for a free channel, there’s the question of sharing ad revenue: How much for CBS, how much for Apple? This isn’t a random example, we just heard Lee Moonves, the CEO of CBS, say that his company turned down a streaming TV deal with Apple because of a disagreement over ad revenue. CBS and others have to see how iTV will make them more money. (The same is true for game developers who could use iTV as a vehicle for living room or networked games.)

Finally, Apple itself. Their emotive talk about the purity of the software architecture, the praise for the elegant kerning of the Garamond Light Condensed ITC font on Keynote slides…such talk is important and relevant, it addresses the very reasons for Apple’s success, but we shouldn’t forget what rings the Big Cash Register: hardware. The iTV product itself has to generate billions in hardware revenue or stay what it is today, what Jobs felicitously called a hobby, a mere hundreds of millions of dollars of hardware revenue. That’s nothing when compared to the tens of billions — soon $100B — in iOS mobile devices revenue.

How to get there? Recall last week’s No Set-Top Box configuration:

I’ve added a twist, one simplification. Why have two devices, one iTV and one Wifi Base Station or Time Capsule? A unified device saves room, power, the need to have disk storage in two places – and it will help justify a unit price that’s greater than the current $99 for Apple TV.

Let’s put the price tag of this unified device at $299, the price of today’s 2TB Time Capsule. If Apple can sell 10 million units, that’s $2.9B in revenue… Not bad, but put that number into the context of Apple’s overall revenue estimates: $120B in 2011 (calendar year, not fiscal), $160B in 2012, and $200B in 2013. $2.9B in iTV revenue doesn’t get it out of the hobby category. Apple would need to sell 100 million units, $29B in revenue, to really “make a dent in the universe”.

What about the revenue iTV will generate through the App Store as users buy apps-as channels? Consider iTunes: It made about $2B in revenue in the 2011 Fiscal Year ended last September (probably much less in profits as this is a complicated organization with many revenue streams and an expensive infrastructure). iTunes is hardly a loss leader, but its purpose is to fuel iOS device sales, not the other way around. By analogy, the App Store and advertising revenue share isn’t going to make or break iTV.

In last week’s Monday Note, I argued against an Apple-made big-screen TV: Too big, can’t be brought back to the store for repair, the computer inside would become obsolete much more quickly than the screen itself.

Friends tell me I’m wrong. A Big Screen might be the answer to the revenue question. At $1,500 or more, an Apple HDTV set might achieve revenue levels in the tens of billions, and, unlike today’s TV set industry, it might even be profitable.

(As an aside: Last week, Sir Howard Springer, the courageous Welshman running Sony, let it be known that while his company is — “like Apple” — in the process of re-inventing the TV, “Every TV set we make loses money”. We also heard about Logitech giving up on Google TV after losing tens of millions in the misadventure. And Adobe decided to stop Flash development for TV. The news from the TV front could be better.)

As a big beautiful flat-screen set, or even as a separate module, an iTV sounds like a great idea. But translating the dream into a viable 21st Century TV product looks considerably more difficult. To be successful, the iTV needs to make money for carriers, for content developers, for distributors, and for Apple itself. None of which is self-evident.

Still, the ossified TV ecosystem is ripe for disruption, ready for an annoying innovator.

—JLG@mondaynote.com

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