Apple TV Channels Is a Big Change to Apple's Subscription Model

Apple (NASDAQ: AAPL) unveiled a new way to subscribe to premium video-on-demand services at its event earlier this week. Instead of downloading individual apps for HBO, Showtime, or a couple dozen other services, users can subscribe to and watch those services within the Apple TV app with just a couple of taps. Apple handles billing and everything else behind the scenes. The new service is called Apple TV Channels, and it's very similar to Amazon's Prime Video Channels.

There are a couple of important things for investors to note about Apple TV Channels, especially in comparison to Apple's App Store subscription model or Prime Video Channels.

Apple is making wholesale agreements

A report from The Wall Street Journal (subscription required) before Apple announced Apple TV Channels suggested that Apple could sell HBO, Showtime, and Starz for $9.99 per month each. That price would be below what HBO and Showtime charge for standard stand-alone subscriptions. (Apple didn't announce Channel pricing at the event.)

Apple could offer those prices to subscribers because, as Recode points out, it's operating under a wholesale-retail agreement for Apple TV Channels. That means Apple sets the prices instead of the media companies. Apple just pays each service a certain amount for every subscriber it signs up. If there's anything left over after that fee, Apple keeps it. This is the same model traditional TV distributors use with premium cable networks. (And it's why cable companies are able to offer three free months of HBO, Showtime, and Starz.)

This business model is in stark contrast to the revenue-splitting agreements that Apple has for App Store subscriptions. Currently, Apple takes 30% of all in-app subscription revenue for the first year and 15% thereafter. Apple has no control over how much content providers charge.

Amazon Prime Video Channels also operates on a revenue-splitting model. Smaller content providers keep just 50% of net revenue while larger providers are able to negotiate better splits.

The ability to exercise more control over pricing could be key to attracting consumers to the Apple TV app. Apple could offer bundled discounts for consumers subscribing to multiple streaming services, or it could offer promotional pricing for a limited period of time for new subscribers. It can even use pricing for other services as a tool to sell more Apple TV+ subscriptions.

The wholesale-retail relationship gives Apple the best opportunity to maximize the long-term profits of its new TV service.

Owning the customer relationship

Another important change in the Apple TV Channels model is that Apple is in complete control of the customer relationship. Not only is Apple responsible for billing customers, it's also in charge of hosting content on its servers and delivering it to viewers' devices.

That means Apple will be the only company with access to viewer data. Previously, only the content provider had access to viewer data.

What Apple decides to do with viewer data is up to the company, but considering its emphasis on keeping its user data private, it will be limited in its ability to use viewership data. Apple should still be able to make better content recommendations and point customers toward new services they might be interested in without requiring users to upload their data to a central server. It outlined a similar recommendation model for its News+ service. But Apple likely won't be able to use viewer data to inform its own content decisions for Apple TV+ while keeping user data private.

Controlling the customer relationship should help Apple solve some of the biggest customer frustrations with streaming-video services.

These two big differences between App Store subscriptions and Apple TV Channels subscriptions are important to understand. The new business model gives Apple a lot of opportunities to grow the business using pricing and data to increase total subscribers and engagement. It could produce lower gross margin in the short term as Apple invests in those areas, but in the long run it ought to produce greater overall gross profits for the company as it gets customers to take multiple subscriptions -- including its own TV+ service.

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