Apple Bought Beats Because Streaming Fits Its Demographic

$3bn seems like a large amount of money for Apple to have invested in a brand-led headphone business, even though there were obvious parallels with Apple's own user base. Figures released over the last few weeks suggest that the headphone business was purely incidental to the real purchase: Beats Music, the curated music service.

Album sales have been declining for a while - partially as a result of consumers abandoning the CD and partially because buying tracks on iTunes is eminently more sensible than hoovering up a whole album loaded with filler. iTunes is important here because there isn't really another service that sells as much digital music to the consumer.

Last week fewer than four million albums sold in the US, a poor result for combined digital and physical sales and ominous given that overall digital music sales declined over the last year, for the first time since Apple launched the iTunes Music Store.

At the same time music streaming subscriptions are on the rise - Midia Research is predicting that there will be 37m people paying for streaming music by the end of this year - with another 210m using free, ad supported services. The same report claims that 45% of people who have bought downloads are now using streaming services - not necessarily exclusively, but I'm sure that once those users have moved to a rental rather than purchase model, they aren't likely to jump back.

With iTMS revenue falling and streaming looking a likely replacement Apple faced a real problem. Its users were the sort of tech savvy, adventurous and, above all, financially capable users who would see the benefits of a jump to streaming services. Which meant that Apple required a streaming service. At the same time it didn't want to panic those iTMS customers who weren't ready to abandon the service into doing just that by going big on an Apple branded store. In the short term purchasers generate more profit than streamers.

Beats Music allows Apple to continue servicing downloaders needs through the iTMS whilst offering a service for those who prefer streaming. Ultimately the Beats branding will disappear and Beats Music will become part of Apple's core assets. That time will only come when Apple decides that the iTMS is in its final throes.

Until then will Beats pay back its $3bn purchase price by keeping customers in the Apple fold?

If Apple converts 1% of it's iTMS customers to Beats each year,  that's a revenue stream of around $100m, rising to $500m by year five. The division of streaming revenues is a murky subject right now, but if we assume that Apple maintains its 30% cut, then that equates to $450m in profit by year five. That's a pretty good return on a $3bn investment, without even considering the contribution of the headphone business.

While the purchase of Beats cost more than building its own streaming service, the benefits Apple gained - including removing a direct brand-driven competitor from the market - clearly add up to a clever move on the part of Tim Cook and team.

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