How Netflix is Slowly Killing Apple’s TV Hobby

October 28th, 2008 at 3:00 PM - Columns and Opinions by John Martellaro

"Due to recent financial difficulties, the light at the end of the tunnel has been temporarily turned off."

-- Placard seen at Applebees Restaurant, Richland, Wash.

From time to time, Apple has made impressive sounding announcements about the success of its Apple TV, but the facts show that during the time that Apple has failed to work with Netflix, the DVD rental company has been slowly killing the Apple TV. The result is that the Apple TV will linger on, by Mr. Jobsi admission, as a hobby throughout 2009.

I have been keeping an eye on Netflix over at the iPod Observer ever since Netflix announced its partnership with LG electronics to deliver Netflix movies via the LG BD300 Blu-ray player. Last week, Netflix entered into a similar partnership with Samsung.

It was natural to ask why Apple wasnit partnering with Netflix so that Apple TV owners could also view movies streamed via their Netflix account. I chalked it up to the idea that with all the apparent success Apple was having with the Apple TV, thanks to Appleis powerful marketing efforts, that Apple doesnit need to work with Netflix.

So I did the math, and I found out I was wrong.

Assumptions

The tale to be told of the Apple TV is in the numbers. Because Apple is shy about revealing sales of the Apple TV, one has to back out the numbers. Thatis not too hard to do with some simple assumptions, based on my own habits and those Iive observed of others.

The average Apple TV customer:

• Rents one movie per week.
• Buys one movie per month.
• Buys 20 TV shows per month (SD + HD)

Backing Out the Apple TV Sales Numbers

We can use Appleis own numbers to back out how many Apple TVis theyive sold. From Appleis press announcement of June, 2008, Apple said that they sell or rent 50,000 movies per day. From the assumptions, the average customer buys or rents five movie items per month. Hence:

      (# Apple TVs x 5 items/mo/atv x 12 months/yr)/(365 days/yr) = 50K/day

That gave me a number of about 304,000 Apple TVs in place. Next, Apple claimed recently that theyive sold 200 million TV shows, most of which were SD over the 19 months that the Apple TV has been shipping. Once again, we have:

       (# Apple TVs x 20 TV shows/mo x 19 months) = 200M

In that case, the number of Apple TVs works out to 526,000.

A good way to verify this number is to do a sanity check with a different algorithm. Every time I go into an Apple retail store, I innocently ask how the Apple TV sales are doing. The answer I typically get is that they sell about 2-3 per day. Colorado is probably on the low side compared to east and west coast cities, so Iill use the higher number.

      200 U.S. stores x 3 ATVis/day x 30.5 days/mo x 19 months = # Apple TVs

I get 348,000 with that method, which is in reasonable agreement with the estimates above. Iill use a final estimate, averaging all three methods, to obtain 393,000 Apple TVs sold in 19 months.

Whatis the Apple Revenue?

In order to stay on equal footing with Netflix, which Iill analyze later, Iill focus on total revenue. There is a useful story over at Gizmodo, based on an iSuppli Bill of Materials analysis, that shows how much money Apple makes on each Apple TV, and it isnit much. Even so, Iill stay with total revenue in this analysis. Iill use an average selling price (ASP) of $279. Then, pro-rating the 393,000 Apple TVs in 19 months, Apple generates about US$69M in revenue each year on the hardware.

A hobby indeed.

Next, because Apple hasnit revealed their percentage take on content sales (at least I couldnit find a reference), Iill assume that Apple takes 1/3 of the price of movies and TV shows. 126 million TV shows per year times $1.99 times 33 percent is $84M. Add to that 40,000 movie rentals per day, we get $14.6M. Finally, 10,000 movie purchases per day also amounts to about $14.6M per year. Even if my estimate of Appleis take is off significantly, the effect is small and the conclusions remain valid.

Independent of GAAP rules, Apple is generating a total, by my estimates, of about $182M per year in gross revenues from the hardware and content sales for the Apple TV product.

The Netflix Side

Based on a report obtained from Barclayis research, I collected the following numbers for Netflix.

• Annual Revenue, about US$1.36 billion.
• Total subscribers, about 8.7 million.
• Year/year growth in subscribers, about 23 percent.
• Year/year growth in revenue, about 16 percent.
• Estimated: Average monthly revenue per subscriber, about $13.07
• Estimated: Delivery of 1.1 million movies/day compared to Appleis 50,000.

In terms of a business vs. a hobby, Netflix is generating over seven times the annual revenue of Apple TV*. In addition, Netflix is vigorously creating new outlets for its content: Xbox 360, Roku box, PCs, Macs**, LG BD300 Blu-ray player and Samsung BD-P25xx series Blu-ray player. So when I ask myself whois in the driveris seat for the digital living room, Netflix is way ahead of Apple and pulling away.

Conclusions

Apple continues to regard Apple TV as a hobby and has curiously failed, so far, to secure an agreement with Netflix. Instead of getting an Apple TV into every Netflix subscriberis home, Microsoft, Roku, LG, and Samsung are, in Appleis absence, seizing the business opportunity, with likely others to come.

As a result, Apple has lost the chance to sell millions of Apple TVs and has instead settled for an estimated total of perhaps ~400,000 ±100,000 sold in a 19 month period.

Moreover, the subscription model, which Apple has used so effectively with Mobile Me, Pro Care, and (roughly) AppleCare, is being embarrassingly well exploited by Netflix to maintain healthy revenues. Apple, meanwhile, seems to have failed with the Apple TV to use content to sell hardware (like the iPod business model) because Hollywood is reluctant to let Apple have too many keys to the movie kingdom.

If Apple were in a monstrously profitable venture with the Apple TV, it wouldnit need to partner with anyone. However, my analysis suggests that Netflix is large, seven times larger than Appleis Apple TV venture, enjoying double digit growth and is solidifying itself to be the Internet movie rental company of the future. (Blockbuster is showing no signs of life.) Netflix is outmaneuvering Apple with hustle.

Eventually, DVDs mailed in paper envelopes will go away, and Apple will suddenly find that the Apple TV hobby needs to be retired. That is, unless the company, notorious for going its own way with the Mac and iPhone, can figure out how to bring its strengths to a partnership in the digital living room of the future.

* Netflix may be paying a royalty for each viewing over and above each DVD purchased by them. If so, that would reduce the ratio of 7x somewhat, but I doubt that it would negate the overall argument.

** Viewable only on the Mac -- in the near future -- because no Macs have HDMI/HDCP.

 

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John Martellaro is a senior scientist and author. A former U.S. Air Force officer, he has worked for NASA, White Sands Missile Range, Lockheed Martin Astronautics, the Oak Ridge National Laboratory and Apple Computer. During his five years at Apple, he worked as a Senior Marketing Manager for science and technology, Federal Account Executive, and High Performance Computing Manager. His interests include alpine skiing, SciFi, astronomy, and Perl. John lives in Denver, Colorado.

You can follow John on Twitter at twitter.com/jmartellaro.