About Apple TV margins, and lessons learned

Over the past week, another teardown of the Apple TV took place, revealing the presumed costs of both the 40GB and 160GB models’ parts, and implicitly Apple’s profit margins for both devices. The conclusion reached by analysts: Apple is aggressively pricing Apple TV given what’s inside, and the 160GB version yields more profit than the 40GB version, even when Apple is buying the 160GB drives and installing them at the factory.

Once a teardown takes place, there’s little room for argument with knowledgeable analysts about the value of the components: Apple may be (and probably is) doing better on its bulk purchases than some analysts would assume, but it’s probably not doing so much better right now that the numbers matter all that much. Once you’ve added on the costs of packaging, direct and indirect marketing expenses, and some small fraction of the company’s R&D, PR, and executive expenses against the device, it’s obvious that Apple’s not making tons of money on Apple TV, which CEO Steve Jobs more or less confirmed by referring to it as a “hobby” rather than a core business for the company.

Having said all of that, it’s worth taking a step back and asking a couple of questions. First, did Apple make the right choice by pricing Apple TV at $299 and building it with features that made such a price tag appropriate? And second, since it’s obvious that the device hasn’t taken off quite yet, are there lessons to be learned from the experience?

My personal answers to those questions are “sort of” and “yes.” A $299 price tag for a device with Apple TV’s capabilities isn’t totally crazy; Apple’s only mistakes were announcing the price before fully revealing those capabilities, and releasing the device before fully taking advantage of them with software and content. From my perspective, those moves had a double impact on potential buyers: they were told that they’d be asked to pay around $100 more than they might have imagined was necessary without knowing why, then, when Apple TV was released, most people didn’t have immediate reasons to want or need it.

Based on what we now know about Apple TV’s components and capabilities, there’s an argument to be made that the device was over-engineered for what it currently does, and what consumers currently want.

If a battery-powered iPod can play back H.264 and MPEG-4 videos—the best ones Apple currently sells—on most peoples’ TV sets, it’s arguably unnecessary to have the equivalent of a low-grade Macintosh computer stuffed into Apple TV’s chassis. Under this philosophy, Apple would have been smarter to just add on-TV navigation to the video-ready iPod family, sell a SDTV (and/or HDTV)-ready dock, and make that its “living room” solution rather than trying to popularize a separate device. Many people, including us, would have cheered Apple for doing this: having tested the available on-TV menuing iPod docks, I think Apple is a far better interface developer than any third-party company producing iPod accessories, and really needs to offer such a feature in future iPods. Note that Microsoft’s doing this already, though not especially well, with its first-generation Zune.

But, and this is a big but, if you assume that people currently or will soon want high-definition (better than DVD-quality) videos, Apple TV and/or a much more powerful sixth-generation iPod become necessary. You don’t need something better than an iPod for current iTunes Store downloads, but if Apple wants to offer video downloads that are better than Netflix or Blockbuster rentals, Apple TV is ready for them. Mostly. They’ll require a lot of storage space, and may need a few extra minutes to cache, but the device can handle the playback.

Unfortunately, since there’s nothing yet that actually takes advantage of Apple TV in this way, save for self-encoded home videos (and transcoded, uh, “other videos” or more-hidden-cost HDTV transfers), this justification for Apple TV is ahead of its time for most people.

(An easy fix for this would be to add the sort of open-format video support any Mac with QuickTime can handle; suddenly, a wealth of downloadable content would become available to Apple TV owners, stimulating hardware sales and removing the need to painfully transcode everything just for this device. If the wisdom of this was debatable months ago, which it really wasn’t outside of Apple, it seems all the more prudent today.)

The other “but” is also future-focused. Apple has said that it plans to update Apple TV over the next two years to include new features, such as a YouTube browser. This is really great news for those of us who currently have Apple TVs, but until the new features start to become compelling, they’re not going to grow the device’s userbase. While the YouTube deal seems like a great strategic move for Apple as a company overall, and could well benefit iPod and iPhone users in the future, the value of free access to more low-res videos through Apple TV is questionable at best. It took Walt Mossberg mere moments to raise that issue when the announcement was made. I’ve been saying on Backstage for months that Nintendo was wise to add weather, news, web browsing and other widget-like features to its Wii console.