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Will Apple Take a Cue From Netflix?

By Jamal Carnette, CFA - Sep 5, 2015 at 10:01AM

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The first transaction is always the hardest.

In addition to being a revenue driver in its own right, Apple Music could be an icebreaker for Apple's rumored video streaming subscription service. Image source: Apple.

Rumors about Apple's (AAPL -0.50%) streaming service have been circulating for some time, but the recent revelations have added more fuel to the fire. Initially, the service was considered to be competition to traditional subscription TV operators, as the service was compared to Dish Network's SlingTV -- a streaming-based skinny bundle for traditional TV delivery. In the beginning, the rumored $40 price point seemed high for a streaming delivery service, as it simply seemed another "me too" provider.

More recently, however, the service also seems to be taking heavy cues from streaming leader Netflix as rumors have centered on Apple moving into original programming. The impetus for those rumors were recent reports that Apple had bid for the Top Gear stars before losing out to Amazon. But according to a new report from The Information's Jessica Lessic, the Netflix analogy is apropos not only in terms of Apple's content plans but also for its billing and marketing policies.

The first transaction is always the hardest
For subscription-based business models, especially when the product is content, the first transaction is always the hardest. Keeping this high level, most sub-based businesses spend significant money on marketing to initially convince customers to try their product or service (a.k.a. customer acquisition costs); in many cases, this can be multiples of the initial transaction amount.

Although that may sound odd to spend more in marketing than you make on your first transaction, it's actually quite common. The goal is to spend less on these acquisition costs -- on a per-subscriber basis, or in aggregate -- than the business makes throughout the customer's subscription period, also called lifetime value. While keeping customers satisfied post-transaction is important to limit turnover (churn), the first transaction is always the hardest. Once a billing method is proffered and the initial transaction takes place, repetitive billing occurs and post-sale marketing for new (and generally more expensive) products become easier.

According to Lessic, Apple's already made the initial content-based subscriber transaction with over 10 million users: Apple Music. While the article thinks Apple will need 30 million subscribers in order to make its video service succeed, she likens the Apple Music fan base to Netflix's early DVD-by-mail subscribers that migrated over to its now more popular streaming video service.

The problem with that 10 million figure
Of course, there's a slight problem with using Apple's 10 million Apple Music subscribers as a positive catalyst for its potential subscription video service. Right now, these users are on their trial period and the first transaction hasn't actually occurred. We don't know what the percentage of these subscribers that will end their Apple Music subscriptions before the trial period ends, but it stands to reason there will be cancellations. Unlike Netflix, which was marketing to entrenched, paying customers, these 10 million "subscribers" can best be currently described as potentially interested parties.

Of course, even if all 10 million remain Apple Music subscribers, it would still be hard to convert all to this new video streaming service. If the article's estimate of 30 million subscribers is correct for viability, Apple will probably need to produce original content in order to grow its subscribers to that ambitious total, pulling Cupertino into a market share battle against Netflix's 65 million subscribers. Apple does have a great starting point with its iTunes accounts that now total more than 800 million, but the question is: How many of them can it convert to video subscribers?

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