There is an opening for Apple to find success in paid video streaming. Letting others wage the content arms race, Apple will look to create a curated feed of compelling visual storytelling. Priced with sustainability in mind, Apple TV+ will be positioned as a way to push Apple’s broader video distribution platform forward. Combining Apple TV+ with other curated collections of content, Apple is developing a different kind of content consumption arm for hundreds of millions of highly engaged and loyal users. Apple TV+ has much higher odds of success than consensus assumes.

Content Distribution Arm

Apple has been in the business of distributing content to its users for decades. However, 2019 is shaping up to be the year of Apple reinvigorating its content distribution arm. To reflect the growing momentum found with subscriptions and to take advantage of certain ideals found with privacy and curation, Apple has been unveiling a revised content distribution arm that provides users access to human curated collections of media and entertainment. This content will be provided by both Apple (video) and third parties (news, video, music, games).

Apple News+ (human editors curating stories from hundreds of paid magazines)
Apple Music (human tastemakers creating playlists consisting of songs)
Apple Arcade (human editors developing a curated collection of games)
Apple TV+ (human producers creating a curated portfolio of visual stories)

Apple TV+ Details

Despite Apple remaining secretive and cagey about Apple TV+ details, we can have confidence in the service having a few key attributes.

Apple TV+ will be a paid service. Apple’s language at its March event implied that Apple TV+ would be tied to a subscription (i.e. not free). Last month, during the company’s 3Q19 earnings call, we received another major clue from Apple CFO Luca Maestri that Apple TV+ would be a paid service. Maestri said Apple TV+ will boost Apple Services revenue. Given that Apple had previously said Apple TV+ would be ad-free, the only way Apple TV+ could boost Services revenue is through paid subscriptions.
Apple TV+ will have a limited amount of content at launch. Apple TV+ will lack a back catalog of content at launch. Obtaining rights to an expensive back catalog would have led to a bidding war and plenty of leaks to the press. While the exact number of Apple TV+ shows that will be available at launch isn’t known, Apple highlighted five at its March event, and there are reportedly another 30 or so projects under development. Apple has shared four trailers for shows said to launch this fall (For All Mankind, Dickinson, The Morning Show, and Snoopy in Space).
Apple TV+ will have a free trial. Maestri disclosed on Apple’s 3Q19 earnings call that Apple TV+ will have a free trial. Such a trial would be unnecessary if Apple TV+ was available for free. In addition, the presence of a free trial may provide some clues as to how Apple plans on releasing new show episodes going forward. Apple has previously said that new series will be released on a monthly basis.

Early Skepticism

Consensus continues to struggle with some basic questions pertaining to Apple TV+. For example, the idea of Apple getting into original video in the first place still makes some people uncomfortable. However, much of the skepticism surrounding the service boils down to one thing: Apple is viewed as not having enough content to justify charging users.

One of the oddest criticisms that has been floating around is that there are now too many paid video bundles for consumers. This is a classic example of “the grass is greener on the other side.” The dream was for consumers to access their favorite TV channels a la carte. That vision is becoming a reality, but not quite in the way we expected. There are now ways to subscribe to individual “channels,” but they are large bundles of content fueled by content budgets in the billions of dollars per year. Nevertheless, some think that subscription fatigue will make it difficult for Apple TV+ to find a seat at the paid streaming table.

Strategy

Consensus thinks that if it wants to have a chance of Apple TV+ competing, Apple needs to dramatically increase its video content budget (likely around $2B per year) while keeping subscription pricing artificially low. The error found in such thinking is that Apple TV+ isn’t like other paid video bundles. Apple will look to fight a different battle.

Instead of competing in a content arms race or grabbing as much user attention as possible (both battles will be brutal), Apple will look to position Apple TV+ as a way to strengthen its broader video distribution platform.

Apple TV+ is positioned as an exclusive curated feed of content only available in the Apple TV app. Instead of paying to access a lot of mediocre video content that won’t be watched, for roughly the same price each month, subscribers will access a handful of exclusive stories that the entire family can watch together.

The Apple TV app, available on hundreds of millions of iPhones, iPads, Macs, Apple TV boxes, and various third-party smart TVs and streaming sticks / boxes, is designed to be a depository for a user’s video consumption. Success for Apple will be measured by the number of subscribers turning to the Apple TV app for video consumption. Similar to how Apple Card is leading users to become familiar with the Wallet app, Apple TV+ is a way to push the Apple TV app forward. As long as subscribers use the Apple TV app, Apple wins even if the subscriber watches content from HBO, Hulu, or Disney (since Apple earns revenue from those third-party subscriptions).

One problem for Apple is that the video streaming leaders, including Netflix, have no interest in playing ball when it comes to the Apple TV app. These companies want users to spend time on their own platforms, not Apple’s. This has resulted in the Apple TV app lacking the kind of deep integration with third-party content bundles that Apple management wanted. However, recent developments in the paid video industry are beginning to raise the question of whether or not the decision to bypass Apple’s home for various third-party video “channels” was the best business decision.

Industry Dynamics

There are five fundamental issues plaguing the paid video streaming market, and each one stands to be taken advantage of by Apple.

Subscription pricing is subsidized. Most companies are subsidizing paid bundle pricing in an effort to grab as many users (and their data) as possible. Given the amount of money being spent on content, a Netflix subscription in the U.S. probably should be more like $20 per month, not $13. Disney could have easily priced Disney+ at $15 to $20 per month rather than $7 given that a subscription includes access to the company’s evergreen library of content. This dynamic ends up helping new entrants like Apple as odds are good that consumers will subscribe to a few inexpensive bundles instead of one large expensive bundle.
User growth is prioritized too much. Companies are making questionable product and business strategy decisions in an effort to grow as quickly as possible. It’s time to start wondering if binge-watching, a development aimed at hooking people onto platforms for as long as possible, has actually been a positive development in the video space. The more bundles that embrace weekly release schedules for new shows, the more a central location such as the Apple TV app (where shows from various bundles appear when available) makes sense.
Mediocre content is becoming a problem. There is a finite amount of time each day. Companies are desperate to fill as much of it as possible with content. This battle for our time will lead to paid video bundles becoming bloated with mediocrity. This will result in users wanting more curating and filtering to focus on just the premium content - another tailwind for relying on something like the Apple TV app.
Data capture is a ticking time bomb. The degree to which video streaming companies are collecting viewer data has not received the attention it deserves. Data capture has been positioned as a selling point under the guise of something leading to better content recommendations. However, the failure found with “smart recommendations” represents a major hole in the claim that such data collection is even needed in the first place. Apple’s data privacy stance with its revised content distribution arm is being underestimated.
Value propositions are lacking. Not enough is being done to truly set paid video bundles apart from the competition. It is likely that churn will become a notable problem in the industry as consumers hop from bundle to bundle depending on which new shows are available. If this occurs, we will likely see more shows released on a weekly or even monthly schedule. While this will be done in an effort to reduce churn, it will likely lead many to crave a central depository for the newest shows.

The Difficult Truth

A harsh reality is unfolding in paid video streaming: There isn’t a sustainable business model for a standalone streaming service looking to compete in a content arms race. Netflix is trying to make a go at being a standalone paid video streaming service while also significantly ramping up content spend. It is noteworthy that Netflix has also taken actions to move away from Apple’s content distribution arm that include bypassing iTunes payment and not wanting much to do with the Apple TV app.

One way of assessing how Netflix’s business model is performing is to look at the company’s free cash flow. The situation doesn’t look good.

Exhibit 1: Netflix Free Cash Flow (Annual Totals on a Trailing Twelve Months Basis)

Netflix is burning through billions of dollars each year, and there is no light at the end of the tunnel. Netflix management will argue that negative free cash flow is merely a consequence of the company placing a huge bet on original content (higher costs up front). However, the company makes no attempt at suggesting free cash flow will turn positive anytime soon. Instead, Netflix plans on continuing to issue debt to fund its ballooning content budgets. This simply isn’t sustainable. Something has to give.

The $140 billion question facing Netflix is whether or not the company will be able to reduce its content spending and raise subscription pricing once it has achieved much of its user growth. There is reason to be skeptical. Competition for engagement is going to be brutal, and most companies playing in the paid video space are looking for other ways to monetize users and the intellectual property (IP) behind paid video streaming bundles. This will pressure Netflix’s ability to raise pricing.

Disney has three viable and profitable ways (movie tickets, theme parks, merchandise) to monetize the IP underpinning Disney+.
Amazon positions Prime Video as an add-on to a Prime subscription.
NBCUniversal is treating its upcoming ad-based video subscription service as another way to keep cable subscribers.

Given how easy it is to switch from paid video bundle to paid video bundle throughout the year, churn has the potential of ravaging the industry. Based on Netflix’s most recent earnings release, the churn effect is real, and we haven’t even seen genuine competition in the paid video streaming space. It is time to start wondering if Netflix would benefit from integrating into the Apple TV app and once again supporting iTunes for payment.

Long Game

Based on Disney’s aggressiveness with Disney+ (a $13 per month bundle consisting of Disney+, Hulu, and ESPN+ is going to make waves) and recent actions on the part of NBCUniversal and WarnerMedia to bring home the most valuable IP, it’s clear that companies are ready to wage war against the first-mover: Netflix.

Apple finds itself in a different situation as it both produces original video content and distributes third-party video bundles. From Apple’s perspective, competition in the paid video streaming space is a great thing. By having power move from one or two companies to a number of players, Apple’s strategy to become the “bundler of bundles” stands to benefit. It also doesn’t hurt to have an ecosystem of a billion users and 1.5 billion devices.

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