Apple began selling snowboard action video “That” for $1.99 on its iTunes store, which is distributed by Indie producer Forum Snowboards. FFA outlined 5 reasons why Apple may be preparing to begin to distribute music in its strategic analysis published February 17th.

Perhaps the most surprising part of the Apple TV announcements in January was the fact that an HD TV (or at least ED) is a prerequisite for ownership. This is more than a little unusual given that the media that can be purchased from Apple today is at best near DVD quality when in a 4:3 format and lower still when in the HD standard 16:9 format. That makes it look kind of okay on an iMac but is likely to disappoint once viewed in the living room.

In fact the highest quality content you are likely to easily get via iTunes is MacBreak, Leo Laporte’s 1080p video podcast netcast!

FFA believes that Apple will announce the availability of at least some 480p or 720p content simultaneously with the shipping of Apple TV scheduled for February 28th. Although there is little direct evidence of this, support for the notion comes, rather ironically, from the iTunes on Vista debacle. Given the importance of the Windows platform to Apple in terms of sheer number of customers, the very slow solution Apple offers to Vista sufferers (basically wait till we update iTunes soon) doesn’t feel right….unless.

Unless, the update is more significant than simply adding an Apple TV tab so that your Apple TV can be synched to appropriate media just like an iPod. The Apple TV product only really makes sense if it can deliver HD content to your living room in a compelling and easy enough way to begin to suggest that you don’t really need that tedious cable / satellite service. Until that happens, Apple TV is simply the world’s biggest iPod!

It is usual practice for corporations to conduct market research for new products. In the case of the iPhone, the extreme need for secrecy may have minimized the amount of work conducted prior to January’s announcement. Companies have cause for concern about confidentiality especially when using on-line methodologies such as that utilized by PineCone Research. Although most vendors utilize various technologies to make it difficult for respondents to capture the contents of the survey for later unauthorized distribution, the old Print Screen trick or Command-Shift-3 is usually still effective. PineCone has, as recently as November 2006, updated its terms of service to show the following at the end of each survey:-

“As a reminder, you have agreed to maintain the confidentiality of the information that you saw within this interview which includes the description of the product idea. This means you are not allowed to describe this survey content to others outside of your immediate household. You may not post this information online in chat rooms or blogs, print, download or otherwise copy this information without breaching this agreement. Sharing outside any information related to this survey is grounds for legal action.”

This is what has seemed to have happened this time. A few screen shots have been provided to a rumor site to set tongues wagging.

The poor quality of the sample advertisement is typical in this type of research which isn’t actually testing the image or copy but the nature of the offer. In these case, amateur looking mock-ups are par for the course. As for the reduced pricing, we are likely seeing very selective leaking. There were probably various price points being tested in the research in order to provide Apple / Cingular with a basic feel for price sensitivity and some idea of price elasticity of demand. This could be achieved by simply showing respondents different versions of the advert, differing only in iPhone price, whilst asking the same battery of questions after each iteration. FFA’s guess is that the respondent who leaked the screen-shots deliberately chose only one of the lower price point options. For this reason the pricing shown is most likely unrelated to the final pricing we will see in June.

1) The Road is cleared for Apple to be in the music business

The recently announced settlement of the long running Apple Inc and Beatle’s parent Apple Corps has resulted in all trademark rights to the Apple name now belonging to Apple Inc (with some rights licensed back to Apple Corps). Most commentary has been on the implied clearing of the way for the Beatle’s back catalogue to become available on the iTunes store, however FFA is far more interested in the now allowed for possibility of Apple being able to get into the ‘record’ business, the subject of the ongoing but now resolved dispute.

2) The iTunes store is a significant and fast growing revenue engine but does not yet contribute to the bottom line

With over 1 billion songs sold in 2006 , the fast growing iTunes store already makes up around 5% of the the company’s revenue in 2006. Yet little profit is made as it is estimated that only a few cents of each 99 cent download stay with Apple as the vast majority are returned (predominantly) to the big 4 music companies Universal, Sony BMG, Warner and EMI. Is there a way for Apple to turn this revenue stream into a profit center?

3) The iTunes store is now the 4th largest music retailer in the USA

At MacWorld, Steve Jobs announced that Apple is now the 4th largest music retailer in the USA, having passed Amazon during 2006. Only Walmart, Best Buy and Target are larger, all of whom sell music via CD. This is a significant achievement as it cements Apple as a must have customer for the large music companies. This development clears the way for Apple to have the opportunity to follow its own path into the future without the threat of music supply being cut-off.

4) Steve Jobs publishes “Thoughts on Music”Apple CEO Steve Job’s open letter “Thoughts on Music” is supposed by many to relate to the growing pressure from Europe to open up Apple’s DRM Fairplay system to other parties. And in part it surely is, providing a nice distraction by putting the blame squarely at the feet of the music companies that mandated DRM as one of the prices to pay for making their catalogues available for on-line distribution and sale. It should be noted, however, that with one or two exceptions it is the music companies not the artists who favor DRM. Many indie labels already make their music available unencumbered by DRM on sites such as eMusic. Seen in this light Steve Job’s letter can equally be seen as an overture to artists.

5) The Ipod / iTunes hegemony is secure

Despite the launch of the Microsoft Zune, the Apple Ipod /iTunes vertically integrated system is powerfully cemented as market leader. Apple is both the price leader from its scale and supply chain strength and the design leader with its continuous stream of product enhancements and innovations. Having built up this lead with the assistance of a DRM based closed system, there is little risk now for Apple to opening it up.
Synthesis

FFA believes that Apple plans to enter the music publishing business in order to turn its growing iTunes store revenue into a profit center for the company. A direct relationship with artists should lead to at least a similar profit margin to the rest of its business if the music companies were disintermediated! The new settlement with the Apple Corps allows for Apple to enter this business.

The present focus on closed distribution systems is likely to be increasingly tested in the European courts. In addition, digital music distribution unencumbered by overly restrictive DRM remains an impediment to continued growth of this sales channel. The predictable RIAA response to Job’s open letter only acts to position Job’s and Apple as on the side of artists and consumers, a strong place to be. Although undoubtedly the closed nature of the iTunes / Ipod system has played a role in the strong growth and market share of iTunes / iPod, the relaxation of DRM now is more likely to be net positive for Apple in terms of increasing sales of digitally distributed music and devices to play it on.

Since an existing supply of DRM free music already exists, Apple could heed the call to begin distributing such music DRM free for now, even while it maintains DRM on the big 4′s catalogues. The iTunes store’s position as the number 4 retailer of music in the USA ensures that any backlash from the big 4 is likely to be only rhetorical in nature. Continued growth of the store will make it easier still for Apple to entertain direct publishing of artists’ material, DRM free, for a substantially greater share of the 99 cent per track revenue and to the delight of artists and consumers alike.

Such a development would of course revolutionize the music industry and further cement Apple’s transition from a pure computer company. Apple would be an originator (publisher), distributor and enabler (via the Ipod franchise) of digital music. Apple in your living room indeed.