Apple Inc. Could Crush the Over-the-Top TV Market

Source: Apple.

That Apple TV update people have been waiting for may still be a while in the making, but Apple fans received even better news this week. The Wall Street Journal reports Apple is in talks with television networks to provide a TV-streaming service similar to DISH Network's Sling TV.

Several other companies have expressed interest in providing a slim bundle of channels delivered over the Internet, but Apple holds one big advantage over all of them: Apple makes its money selling hardware, not services.

Welcome to the Apple familyWhen Apple announced that it would be an exclusive hardware partner to HBO for the launch of HBO Now, it also announced a price cut for Apple TV, from $99 to $69. That price cut makes Apple TV less expensive than comparable set-top boxes from Roku and others, and should give a boost to sales of a device that hasn't been updated in more than two years.

While many are clamoring for an Apple TV hardware update, this price cut makes perfect sense now in light of Apple's reported plans to launch an over-the-top television service. There are two factors that differentiate set-top boxes -- price and services. Apple rarely competes on price, but with a 2-year-old hardware design, it can certainly afford to do so.

On services, Apple lags well behind the competition, but an Apple television service could add something to the package that none of its competitors can offer. As a result, Apple stands to spike sales of its Apple TV device. Despite the lower margins on the device, Apple could make up for them with sales of its (undifferentiated) services like video and music downloads.

I wouldn't expect Apple to extend its streaming service to smartphones and tablets not called iPhone or iPad. It might allow non-Safari web browsers to access the service due to its less-dominant position in PCs and the longer upgrade cycle. Still, the service seems designed to lock consumers into the Apple ecosystem with the Apple TV being the gateway.

Breaking even on servicesApple is experienced in providing a service at near break-even profit margins. For years, its iTunes segment produced an estimated profit margin in the low single digits. That only changed after Apple added software and services to the segment, which typically carry a profit margin around 50%.

A television-streaming service is no different. Apple doesn't have to make a strong profit margin on the service for it to be a success because it will spur hardware sales, just as iTunes did last decade.

That's good news, too. While there's no hard data on the profit margins of Sling TV, it's a pretty good assumption that they're relatively low. With some of the most popular channels, including ESPN and it's $6 carriage fee, the content costs are likely in the $15 per-month range for the $20 per-month service. Add on top of that sales and marketing, content delivery costs, and customer service, and the profits start to dwindle away -- especially without scale.

Apple reportedly plans to have about twice as many channels as Sling TV, and would consequently charge a price 50% to 100% higher.Apple is much more efficient with its marketing dollars and already has scale for content delivery, which will cut down its operating expense.

Still, the less reliant Apple is on turning a profit with its streaming service, the more aggressive it can be on providing value and winning a spot in the growing number of broadband-only households.

Sling TV costs $20 a month. The Wall Street Journal reported that media executives say they think Apple is looking at a price around $30 to $40 a month. Unnamed sources are cited as saying Apple is looking to launch the service in September.

A good leadoff hitterA streaming service from Apple could help to diversify Apple away from its reliance on hitting the ball out of the park with every product release. Apple could generate a consistent and predictable revenue every month from subscriptions that would help smooth out Apple's seasonal revenue from its product-release cycle.

If Apple sees success in the United States, it might be able to extend a similar service internationally, creating a meaningful revenue stream for the company going forward. In the meantime, it would serve as a very strong incentive for consumers to make their next set-top box, smartphone, tablet, or laptop an Apple product.

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Adam Levy owns shares of Apple. The Motley Fool recommends Apple. The Motley Fool owns shares of Apple. 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.

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