Apple (NASDAQ:AAPL) might be interested in producing original content for its upcoming streaming video service, according to recent industry rumors. Variety claims that the tech giant recently held talks with Hollywood executives to establish development and production units to better compete against Netflix (NASDAQ:NFLX).
This isn't the first time Apple has expressed interest in producing original content. Apple reportedly tried to hire the stars of BBC series Top Gear earlier this year, but eventually lost to a rival bid. Apple also hired top producers, stars, and DJs to create original content for its Beats1 radio station.
With over $200 billion in cash, Apple certainly has the resources to produce original content. But would it actually make sense as an extension of Apple's core business?
Why does Apple need original content?
Apple's biggest weakness is its dependence on the iPhone, which generated over 60% of its revenue last quarter. To diversify its top line, Apple needs its smaller businesses -- like Apple TV and iTunes -- to grow beyond single-digit percentages of its top line.
Apple previously expanded its iTunes music download model by renting or selling videos on an a la carte basis. However, users started favoring streaming solutions over downloads as Internet speeds improved. In response, Apple slowly pivoted the iTunes business toward streaming -- which it did on the audio side with iTunes Match, iTunes Radio, and Apple Music. On the video front, Apple is expected to update the Apple TV and use it as a launch pad for a new streaming video service.
However, licensing content from media networks isn't cheap. Netflix's streaming content obligations (the amount it promises to pay studios to license future content) rose 31% annually to $10.1 billion last quarter. But by producing more original content over the past year, those obligations only inched up 3% sequentially last quarter. It's also tough to raise prices to cover those costs, since competing services charge comparable fees. That's why Netflix only had net profit margin of 3% over the past 12 months.
A small slice of Apple users
Unlike Netflix, which charges $8 per month for unlimited streaming, Apple will reportedly launch a "skinny" streaming bundle of over two dozen cable channels for $40 per month. That business model targets basic cable packages, which cost an average of $55 per month in the U.S., according to research firm SNL Kagan.
Forty dollars per month might seem pricey for a streaming service, but it's comparable to Sony's (NYSE:SNE) PlayStation Vue, which offers similar streaming bundles of cable channels to PS hardware owners for $50 to $70 per month. However, both services require a broadband connection, which might be more expensive on a stand-alone basis than a TV/Internet bundle. If Apple's service is likewise shackled to the Apple TV or iOS devices, it will fail to reach a wider audience like Netflix, which can be streamed almost anywhere.
If Apple spends even more money to produce original content for its bundle, those costs might drive a $40 subscription price even higher. Since the appeal of Apple's streaming service could be throttled by hardware restrictions and a high price tag, it might be wasteful to produce original content for a limited audience.
Remember what happened to Microsoft
Before Apple treads down this path, it should recall what happened to Xbox Entertainment Studios, Microsoft's (NASDAQ:MSFT) ambitious attempt to create original content. Microsoft, wanting to expand "Xbox" as a media brand, tried to make original shows and movies for its Xbox 360 and Xbox One owners.
Unfortunately, Xbox Entertainment Studios had trouble securing partnerships with wary studios and creators who didn't see the appeal of producing content for a limited number of console owners. Microsoft addressed that problem by expanding the video network to Windows PCs, but it was largely ignored by PC users, who had plenty of other streaming video options to choose from.
If Apple only launches its streaming video service for Apple TV and iOS to reinforce its walled-garden strategy, its efforts to produce original content could suffer the same fate as Xbox Entertainment Studios.
Let's not get ahead of ourselves yet ...
For now, this is all pure speculation. Apple could simply be looking for ways to enhance Apple Music with more original content. It might be rattling its saber at studios to secure better prices for licensed content. So let's not jump to conclusions yet -- we'll probably know more when Apple unveils its new products and services at its special event on Sept. 9.
Leo Sun has no position in any stocks mentioned. The Motley Fool owns and recommends Apple and Netflix. The Motley Fool owns shares of Microsoft. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.