Why Would Apple Want Beats?

Rumours started swirling yesterday that Apple was in talks to buy Beats. The supposed price tag is somewhere around $3.2 billion. All manner of speculation has arisen as to why Apple would want Beats, and why they would pay that kind of price for them. Almost all of the discussion has focused on Beat’s rather modest streaming service, which should’t be overlooked. But perhaps there is a bigger thing going on here.

Is It About Streaming?

First, I would expect that the Beats music streaming service is probably part of the attraction. Apple’s own iTunes Radio service has gained minimal traction, and the biggest (Pandora and Spotify) still dominate the market. But part of the challenge for Apple is that they still sell a lot of music as a retailer, making the utility of streaming for existing customers somewhat questionable. Apple’s big thing is to sell music, and people who come to the iTunes store are there primarily to buy, not stream. Spotify and Pandora, however, don’t offer music for sale, just for streaming. It’s a different customer base, and a different consumption mindset.

Beats might help raise Apple’s visibility in the streaming space, and perhaps give them a new face to put on the business. The one thing Apple has, when compared to an other streaming service or store, is a huge footprint in the music business. They likely have one of the most extensive set of global licences for content amongst all the players. But what they lack is the right “brand” when it comes to streaming. They are are retailer, not a broadcaster. The attraction with Beats isn’t that they have a streaming service they could add into iTunes. Instead, they have a separate brand that could use some help to grow the business. One of the challenges for iTunes is that is has become something of a monolith, and it is primarily a store. People turn to other vendors for streaming (like Pandora and Spotify) or rentals (like Netflix).

But where Beats is philosophically  a better fit, compared to other services, is in their design ethic. Beats headphones are, from what I’ve read, good but not necessarily great (of course, it varies by model. And for disclosure, I’m a Bose and Sennheiser user myself). But where Beats kill the competition is style and design. I’ve been tempted to buy a set of Beats simply because they are so attractive. They aren’t just headphones, they are works of art. I have a set of Sennheisers I use when I work, and while the sound quality is impressive, their design leaves something to be desired.

I wouldn’t be surprised to see Apple maintain the Beats brand and name for the streaming service, and perhaps move their existing iTunes Radio customers over to it. It would have its own player, its own portal and its own presence. But wouldn’t that mean that the Beats service is, in essence, competing with iTunes for customers? Not really, because they are two different customer bases. People interested in primarily streaming are less likely to buy and download music. Someone, like myself, who wants to have a copy of the music is less likely to use a streaming service. Granted, the consumer base isn’t two completely distinct segments, and there is a continuum along which consumers will fall. But there is a difference between being a “broadcaster” vs. being a “retailer”, and iTunes Radio muddies that iTunes brand to some degree. A separate service, Beats, that has a strong brand image may be a better way to build that business.

But What Else?

With all the focus on Beats Music, the Beats Electronics part of the business is being minimized in most discussions about the deal. I think this is a mistake, because it overlooks the success Beats has had. They apparently made north of $1 billion in revenue in 2013, and have shown healthy year-over-year growth. They have a strong presence in the younger demographics, driven by the efforts get Beats headphones on as many athletes and celebrities as possible. That means, if nothing else, Beats would be another diversified source of revenue for Apple, albeit small when put in the context of the rest of Apple’s business. But Apple, like other large companies, is up against the laws of large numbers, which means that maintaining double-digit growth becomes a significant challenge (for Apple, trying to grow by 20% means increasing revenue by about $35 billion, which is a huge leap). That kind of growth doesn’t come from home-runs anymore. It comes from additive revenue from different lines of business. It means building up entire companies that would have their own significant presence in the Fortune 500.

But Beats Electronics offers a few other attractive elements for Apple. First, it allows them to make beautifully designed Apple-branded headsets with decent sound quality. So far, Apple’s earbuds and follow-on EarPods have been a bit of a dud. Not everyone can wear ear buds comfortably (I certainly can’t) and the sound quality is adequate but not necessarily good. Beats has some skill in making headphones in a variety of form-factors, for recreational and professional use. Apple would gain access to that talent, and be able to sell “Beats by Apple” alongside the “Beats by Dr Dre”.

It would also give them control of Beats Audio, the technology that now appears in some HP laptops and in a few different makes of car. Apple has shown an interest in getting a presence in the automotive electronics world, both with their CarPlay initiative and their push for Siri eyes-free integration. Again, by including Beats in the picture, it gives Apple the design and technical talent they need, and a brand presence that speaks specifically to audio. Its another way to start a conversation with a car company that doesn’t require they take over the dashboard.

Beats Audio, though, would also allow them to improve the audio quality in their own products, specifically MacBooks. The audio quality from the built-in speakers is, again, adequate but not outstanding. The audio hardware on-board is pretty mainstream. Having the Beats brand, and their technology behind it, improves the story about Apple’s multimedia capability. Apple pushes their Mac and iPad/iPhone product line fairly hard as content creation tools, and having top-notch audio quality would improve that message.

Going Further

Going even further, it could allow Apple to explore other audio products, such as speakers and home theatre systems. There has been plenty of talk over the years about Apple making a television. This, I think, would be a mistake. However, building on their experience with the Apple TV, Apple could move up the rung and offer something that acts as home theatre receiver (to manage and route audio and video) that could double as a way to manage the actual content like the Apple TV does today. These are typically far less expensive than a full-on television, and if priced correctly, could be something that people would be willing to upgrade far more frequently than their TV and other ancillary devices like game consoles. The business of televisions is changing, and more and more “televisions” are really just “monitors and speakers” attached to PVRs, cable boxes, game consoles and such. The need for a tuner in the TV itself is slowly diminishing (I would happily buy a TV without one). Why get into that business? Worse, the myriad sizes needed to make a line of TV’s compelling is far, far larger than Apple typically offers (more akin to their darker days of the 1990’s, when there was a plethora of Macs available, and no single model selling well). It’s a messy, low-margin business. The important bit is content, including management, distribution and consumption. A box like an Apple TV-on-steroids might be a better way to go.

An Apple home entertainment device, acting as the central hub connected to other devices, but also providing its own deep and rich content and functionality, could be augmented by superior sound. Here is a device that, for some, could be their “all-in-one” for some kinds of consumption. It could offer a platform for Apple content, as well as 3rd-party providers like Netflix. That Apple content wouldn’t necessarily be just music, movies and TV. It could also include apps, if Apple makes the device an iOS-based machine as its foundation. Couple that with Beats Audio technology, it offers both content and superior audio and video. If the device allows people to start with simple stereo, and then upgrade over time to various SurroundSound configurations (by buying Apple/Beats speakers, of course), it would be a step up, and a bit of a simplification, for the home theatre. It means someone could start small and grow the environment over time. And it isn’t a television, with all the history and baggage, and outsized expectations that come along with it.

So Does Beats Fit?

When you consider Apple’s transformation from a pure technology company to a technology and content distribution company, Beats isn’t necessarily a bad idea. Beats fits their design aesthetics. It is a strong, premium brand with an upscale image, which fits Apple’s approach to branding and marketing. It would expand Apple’s footprint in content creation and consumption, while bolstering their rather weak presence on the audio side.

But Beats also gives them a brand and a service for offering streaming that could take it out from under the iTunes monolithic umbrella, and give it an image and presence of its own. By starting with a company with a small presence, Apple has the opportunity to build the brand and the service with fewer preconceived notions, and without worrying about alienating an existing, large customer base. Remember the iPod? Apple could have purchased someone with a bigger presence in the MP3 player market if all they wanted was market share. But it didn’t suit their long-term plans, and so they bought some tiny little company that had the right technology to build a powerhouse business that resulted in Apple being the largest retailer of music in the world (and owning the MP3 player market, with a peak of 85% of all devices sold). Apple doesn’t buy marketshare, they buy what they think is the right starting point to build it themselves (whether it truly is “right” is a different question). The Beats streaming service could be the starting point for that new business.

The last thing Beats gives Apple is another reason for car manufacturers to talk to them, and at least get their foot in the door. Not everyone will want CarPlay, or even Siri eyes-free integration. Adding in Apple/Beats audio capability is an easier first step, before allowing them further into the dashboard and the on-board infotainment system. Car manufacturers walk a fine (and somewhat weird) line between innovative and conservative, and starting conservatively isn’t the wrong way to approach a car company.

Altogether, Apple buying Beats isn’t a bad idea. Is it worth $3.2 billion? Possibly. If it allows them to build a successful streaming service, to continue to build and grow a top-quality audio product line, opens up a new product line for the home theatre, and gives them another way into the car, then it could pay for itself in a few years. A lot of “ifs”, but with where Apple is now (and with the cash they have), it isn’t exactly a huge risk either. They have some similarities (their attention to design, their premium brand image). It is something that might work out in the long-term.