What The iTunes Store Can Teach Investors About Apple TV's Possible "Tipping Point"

Source: Apple

I'm not the only one thinking Apple's (AAPL 0.51%) rumored over-the-top TV product will be a "game changer."

The possibility of Apple moving into the TV and/or content streaming business has surfaced intermittently for years, to little effect. However, these rumors have recently resurfaced anew.

The current climate feels eerily similar to the run-up to another seminal product for Apple -- the iTunes Store. I believe Apple's TV efforts have finally reached an iTunes-esque "tipping point," and that should be a very encouraging thing for its investors.

iTunes' development: a history
Apple launched iTunes and the iPod in 2001, but it wasn't until 2003 that Apple debuted the actual iTunes Store that allowed the purchase of albums and single songs. However, the behind-the-scenes wrangling required for Apple to get iTunes off the ground has since become legendary. 

As is the case in the cable industry today -- albeit for different reasons -- the music industry years ago was on the ropes. Around the turn of millennium, a new crop of file-sharing sites and programs like Napster, Kazaa, and others made illegally downloading music arguably the simplest way to get music for the nascent and highly fragmented world of MP3 players.

With the major record labels consistently refusing to cooperate with one another in hopes of establishing their own platform music sharing platforms, industrywide innovation effectively stalled. It took Apple and Jobs to present an attractive, turn-key solution in the iTunes Store to finally break the industrywide gridlock and help reduce the piracy that had threatened the industry for years at that point.

Like the cable industry today, the music industry is a relatively concentrated space with several large incumbents carrying a huge amount of power. And while piracy presented a huge threat to the record labels in the early 2000s, it still required extensive negotiations and back and forth to finally compel the labels to sign on to Apple's iTunes Store.

Present parallels
Fast forward to today, and plenty of parallels appear in Apple's rumored behind-the-scenes wrangling with the major cable networks. For starters, although cable networks are not faced with the same sharp declines in their businesses as the record labels in the early 2000s, "cord cutting" is starting to impact the industry.

After expanding from 40 million to 100 million cable subscribers in the U.S. over basically the past two decades, cable subscriptions declined for the first time in 2013. And last year, subscriptions fell once again, with nearly 130,000 households cutting the cord in 2014.

Piracy isn't driving this shift in the cable business as it was for the record labels years back, but it's not unreasonable to attribute this shift in media consumption that's threatening the cable industry to the Internet as well.

The Internet has enabled new forms of content and new offerings like Netflix, Amazon's Prime Instant Video, Google's YouTube, and Hulu (partially owned by Comcast) -- legitimate alternatives that typically cost less than the traditional cable bundle and cater to the increasingly mobile consumer. However, the cable industry, in fear of upsetting the proverbial apple cart, hasn't adapted to this brave new world.

As was also the case with the record labels in the past, the cartel-like makeup of the large cable network owners lends itself particularly well to a "critical mass" moment when large scale buy-in to a new service -- Apple's in this case -- happens.

There's a certain degree of brinksmanship in these situations. Judging from the pared-down nature of other over-the-top services like Sling TV and Sony's PlayStation Vue, an Apple TV service would most likely feature fewer channels than the 189 channels found in the average cable TV offering, of which consumers typically use only 17.

That might not alter the overall pricing in the service as high-demand networks like Disney's ESPN and Fox News command a disproportionately high percentage of affiliate fees. However, for a company like Comcast -- which will be by far the largest cable distributor in the US after its Time Warner Cable deal closes -- it could cause a dramatic shift in its business activities. Comcast also owns NBCUniversal, which controls much sought-after channels like CNBC or Bravo, and uses the leverage from these key properties to tack on less popular offerings like Syfy in typical cable bundles.

Source: Nielsen 

Slimming a cable bundle down from around 200 to, say, 40 channels might not have a huge impact on profit at the likes of Comcast since its lesser properties may or may not be profitable in their own right. However, between cutting out "filler" channels and removing other lucrative aspects of the cable subscription experience like cable box rental fees, the coming wave of over-the-top services could help roll back the average revenue per user at both the cable content companies and the cable operators.

The cable networks thus have an incentive to resist change -- until they don't. Why would they want to risk disrupting their current cash cow businesses? The cable industry rationally wouldn't, until the threat of missing a seminal shift in behavior becomes too great a risk. Apple is reportedly in discussions with most media heavyweights, including at least Disney, CBS, Fox, Viacom, and Discovery Communications. The largest holdout here is media titan Comcast. According to Comcast, it has yet to be approached by Apple, but there's reason to think that some or all of its competition joining forces with Apple's over-the-top product could compel Comcast to also get onboard. 

This isn't necessarily meant to imply that Apple will land all of these names for its widely expected TV content business. However, between the apparent slow erosion of the cable industry and the industry's cartel-like structure, I thought it might be useful to point out these happy coincidences between Apple's iTunes efforts and what may or may not be happening at Apple's negotiating table today. The iTunes store was pivotal in Apple's early 2000s renaissance, and I'm extremely excited to see what an over-the-top content service could do for Apple's future as well.