February 3, 2008

Is Apple Really Skimming From Rentals To Pay for the Apple TV?

Filed under: Apple, Media, Technology — Tags: — Tom @ 4:09 pm

Apple TVIt’s been a long time since I’ve posted anything here, but I’ve been roused from blog neglect.

John Gruber at Daring Fireball pointed out a Computerworld story by Seth Weintraub in which Weintraub accuses Apple of “subsidizing” the cost of the Apple TV with money skimmed from iTunes movie rentals. (No, really. When I say skimmed, I’m not trying to introduce hyperbole. He actually makes reference to Tony Soprano when describing the practice.)

The story received enough attention for Weintraub to address the Daring Fireball traffic directly, nastily adding

Also Valleywag, Gizmodo, Macrumors, and Mac Daily News among others have picked up this story and may have made it easier to understand for Mr. Gruber and his readers…

(Note that those sources simply link to or report on Weintraub’s story, without addressing his argument in a substantive way.)

In the comments, a number of people have pointed out that the article is kind of silly. Weintraub responded once stating that the commenter “managed to miss the point of the whole article,” and responded to additional comments with “See above.” It seems that the possibility that the article itself is a bit of a reach has escaped him.

I don’t think everyone’s just missed the point. There are a few reasons why rational people might draw a very different conclusion than Weintraub.

The Price Drop Isn’t U.S. Only

“Why did the US version price drop from $299-$399 to $229-$329 while the rest of the world still has to pay the same price for Apple TVs? … Apple is subsidizing the cost of the Apple TV hardware with movie rentals.” The problem with this conclusion is that price reductions are for the U.S. and Canada, despite the lack of rental content being offered in the Canadian iTunes store.

We’re Using iSuppli Numbers?

I don’t really want to debate the margins but we have to acknowledge that iSuppli’s numbers are at best educated guesses and at worst wildly inaccurate. Anyone can purchase a 160GB internal hard drive for at or near the prices iSuppli quotes — I suspect that Apple is doing much, much better.

Did We Expect Apple to Provide Movie Rentals at Cost?

Weintraub said in an update, “The point is the SUBSIDIZING Apple TV… Of course Apple deserves a cut of the products they sell.” He dismisses the sentiment that obviously Apple expected to make money from movie rentals, and thinks that perhaps capital letters will somehow make things more clear. But in the article he plainly makes the implication that even with music and video, Apple is merely trying to recover the cost of bandwidth.

Apple has always said that it made money on music and movies, just not very much. Movie rentals are no different — Apple is selling them at a profit. In other news, so does Blockbuster — the rentals aren’t there to improve margins on candy sales. Maybe this is a bit more complicated than Weintraub’s allusions to the game console market would allow.

Apple TV Isn’t the iPod, and Movies Aren’t Music

Weintraub seems to discount Apple’s approach based on the perceived dynamics of the music player market. With the iPod, there was a general belief that the store existed to provide content for the players and to create Apple lock-in.

(This belief isn’t necessarily supported by the facts, as reports have shown that most users’ experience mirrors my own — most of my music is ripped from my CD collection, and only slightly supplemented with iTMS purchases. The actual story is probably more complicated and related to risks associated with allowing another company to dominate the music download market.)

The movie download market has proven very different. Legal complications and DRM make ripping of movies far less common. There is no way to burn DVDs of purchased digital movies. And the market has demonstrated that there is limited appeal to viewing movies on one’s computer or media player. So where the iPod had massive back catalogs of music itching to be set free and an easy way to do that, the digital movie download/rental market desperately needs a simple way to get those movies to the living room television. And many companies have jumped in to try and create that mechanism.

Competition has heated up. There are some big players making a bid to deliver digital rentals to the family TV, including

Oh, We’re Talking About Made-Up Margin Numbers

“Of course, the exact amount that Apple pulls from the studios is a secret. I would guess that it is about $1 – $2 per movie…. The aggressive margins on TV content could very well be why NBC Universal dropped its iTunes relationship last year and why it took so long to get all of the studios signed up for movie rentals.” Here’s where Weintraub really seems to run off the rails — he says that no one knows what the margin is on rentals, makes a guess then cites that “aggressive margin” as a possible reason why Apple had trouble getting content.

It’s completely unfounded speculation that ignores a host of very real, very public explanations — NBC Universal wanted to force bundles on people, they wanted more flexibility to vary prices (higher or lower, depending on who’s telling the story — my guess is that the studios aren’t lining up to give me a deal) and that they’re trying to recapture control of how people can watch content with heavy DRM and forced ads on their website and Hulu. In fact, Weintraub’s supposition only makes sense if you buy into his premise — that Apple needs a 40% to 50% margin on movie rentals to pay for the Apple TV. It’s far more likely that Apple is getting the same or less than it does on music downloads, somewhere between 20% and 30%.

Simple Explanations are the Best

For me — and obviously other commenters on Weintraub’s blog — the logical conclusion is that Apple needs some broad adoption of the Apple TV if they’re going to gain any traction in digital movie distribution. The price cuts for the Apple TV (regardless of how much Apple is actually earning) are simply a smart business move to compete with a host of other solutions.

The VUDU is an especially strong offering and Apple needs to do something to address that. But they don’t need to find $70 to make up for the Apple TV price cut — the margins are likely larger than iSuppli suggests already, and even iSuppli says there’s some profit there. Maybe the confusion is that the margins aren’t as large as Apple’s computer hardware business. Did anyone expect them to be?

Weintraub’s conclusion that Apple must be “taking a bit off the top” is a puzzling non-revelation. The idea that Apple gets a portion of movie rental revenue is beyond obvious. And the idea that Apple needs to direct that money to boost the Apple TV margin? Weintraub never adequately explains why this would even be necessary — there’s never any suggestion that Apple is losing money on the Apple TV, just that the margin isn’t large enough.

Unless Weintraub has some inside information on what Apple’s margin expectation was when they launched what Jobs called a “hobby,” why is it so hard to consider that they’re just trying to price it competitively and create a compelling ecosystem of products?


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