Apple (AAPL 0.61%) scrapped its plans for a smart TV last year, according to a recent report in The Wall Street Journal. During the planning stages, Apple considered installing sensor-equipped cameras for FaceTime chats on a 4K display, but it ultimately couldn't find enough "compelling" reasons to launch its own branded TV.
Source: Apple.
That report dashed hopes that Apple would disrupt the TV market in the same way that it turned the smartphone and tablet markets upside down. But in my opinion, it was definitely the right play.
Why some people are upset
To understand why it was smart for Apple to kill its TV plans, we should first discuss why people thought it was a good idea.
Activist investor Carl Icahn, who owns about $6.8 billion in Apple stock, has been an outspoken supporter of Apple-branded smart TVs. In an open letter to CEO Tim Cook, Icahn claims that Apple could sell 10 million 55" and 65" 4K TVs at an average price of $1,500 in fiscal 2016, which would generate $15 billion in revenues. In 2017, he expects shipments to reach 25 million units and generate $37.5 billion in revenues.
Piper Jaffray analyst Gene Munster also expected Apple to launch a TV. Like Icahn, Munster claimed that Apple would start selling TVs for $1,500 each in fiscal 2016. Munster originally predicted that an Apple smart TV's combination of Siri, FaceTime, a TV app store, and a PrimeSense-based motion control device would set it apart from competing devices.
But it's not just about top line growth
Projections by Icahn, Munster, and others mainly focus on the revenue that could be generated by an Apple smart TV. But the problem with the TV business is the bottom line.
Margins in the TV market are so low that major players like Philips and Panasonic have respectively exited and scaled down their TV businesses. Even Sony spun off its TV business as a separate operating unit last year.
South Korean companies Samsung (NASDAQOTH: SSNLF) and LG, which accounted for 40% of the global smart TV market last year, notably fared better. Unlike Japanese manufacturers, which use components from multiple suppliers, Samsung and LG mainly use their own components to produce cheaper TV sets. By selling cheaper sets and undercutting their Japanese rivals, both companies took advantage of economies of scale -- meaning that the cost of unit production declined as more units were produced.
The commoditization of 4K smart TVs
However, most HDTVs are still sold at low single-digit margins. To boost those margins, TV manufacturers are upgrading the resolution to 4K and charging higher prices for comparable sized screens. They're also piling on smart TV features for media streaming, games, and web browsing.
However, prices for 4K smart TVs are already tumbling. In April, Vizio started selling 43" 4K smart TVs for $600, and 55" units for just $1,000. Xiaomi, the second largest smartphone maker in China, launched a 55" smart TV for $800 in March.
Xiaomi's $800 smart TV. Source: Xiaomi.
Meanwhile, customers who don't want to buy a new smart TV just to use Netflix or Hulu can buy cheap streaming devices like Amazon's Fire TV Stick, Google Chromecast, Roku set-top boxes, or Apple's $69 Apple TV set-top box.
Why Apple investors should be relieved
There's simply no reason for Apple to jump into the crowded low-margin battlefield of smart TVs when it can sell its hardware at gross margins exceeding 40%. Steve Jobs reportedly once told employees, "TV is a terrible business. They don't turn over and the margins suck."
Perhaps Icahn will argue that Apple's brand appeal could convince people to buy $1,500 4K TVs. But in my opinion, TVs don't belong in the same category as smartphones or tablets. Plunging prices across the market indicate that customers favor big screens with low price tags, and the upgrade cycle for TVs is much longer than the one for smartphones and tablets.
In addition, Apple already has a decent foothold in the connected TV market with Apple TV, which accounted for 17% of all streaming media devices in the U.S. last year, according to Parks Associates. That makes it a decent platform for delivering iTunes, its upcoming streaming TV service, and other digital content to customers.
Apple TV. Source: Apple.
The key takeaways
As a long-term Apple shareholder, I'm glad the company scrapped its plans for a 4K smart TV. There's no reason for Apple to ruin its margins by diving headfirst into a heavily commoditized market. Instead, Apple TV represents a more elegant and low-risk way for Apple to profit from the growth of the streaming media market.
