Today’s tech giants have grown to a point where they have the capability to build almost anything. However, a successful product also requires the capability to distribute the product at scale and, most importantly, the motivation to invest resources to create the best possible ecosystem. It is fairly easy to understand a company’s capabilities, but gauging motivations can be challenging. Understanding business models can give us great insight about motivations and, consequently, product strategy.
With this background, let’s attempt to compare the capabilities and motivations of Apple Inc. (NASDAQ:AAPL), Google Inc (NASDAQ:GOOGL) (NASDAQ:GOOG) and Amazon.com, Inc. (NASDAQ:AMZN) with respect to the living room.
Continued from part one... Q1 hedge fund letters, conference, scoops etc Abrams and his team want to understand the fundamental economics of every opportunity because, "It is easy to tell what has been, and it is easy to tell what is today, but the biggest deal for the investor is to . . . SORRY! Read More
Apple: Hardware Margins Reign Supreme
Apple’s business model is fairly easy to understand — Apple Inc. (NASDAQ:AAPL) makes money by selling high-margin devices and everything else exists to make their devices more attractive to consumers. In fact, iTunes and the Appstore make up less than 10% of Apple’s total revenues and an insignificant proportion of their profits (this is why I find it puzzling when industry observers discuss Apple profit potential from mobile payments).
Apple Inc. (NASDAQ:AAPL) has been a popular choice to disrupt the living room for some time now with an enhanced version of Apple TV (let’s call it Apple TV+). They certainly have the capabilities to build Apple TV+ and their distribution reach cannot be questioned. But do they have the motivation to invest in expanding the entertainment ecosystem for Apple TV+? I believe the following chart answers that question.
Apple makes a gross margin of ~$30-$35 on each Apple TV, as compared to hundreds of dollars on each iOS device. Even if the product is refreshed every other year, the gross margin increases to a measly ~$50 with a 10-15% BOM reduction. In other words, Apple would have to sell 3-4 Apple TVs to make the same gross profit as it does on a single iPad Mini (non-retina). That doesn’t seem like the greatest motivator.
But if this is the case, why does Apple TV even exist? The simple answer is that it isn’t a profit center, but a way to strengthen the Apple Inc. (NASDAQ:AAPL) ecosystem for their best customers. An integrated TV set would seem more attractive, but long refresh cycles make that a difficult business.
Google: The Road to Increased Advertising Revenues
What about Google Inc (NASDAQ:GOOGL) (NASDAQ:GOOG)? Are they motivated to invest in an ecosystem to invade the living room? Google’s business model is slightly more complex than Apple’s — their goal is to attract consumers to free services and make money on advertising. Cheap, effective hardware just makes it easier to attract these consumers. Is TV advertising an attractive market for Google? Again, the following charts should answer this question.
Clearly, TV still attracts a major chunk of advertising spend and it is expected to retain its position because of its hold over consumer attention. Today, Google is the leader in mobile, desktop and digital video advertising (although Facebook is catching up fast on mobile). TV advertising remains a vast, untapped opportunity, i.e. Google is highly motivated to find a way into the living room.
Google Inc (NASDAQ:GOOGL) (NASDAQ:GOOG) certainly has the motivations and capability to build a product/ecosystem to go after this opportunity, but distribution remains a challenge. Creating a modular ecosystem (like Android) is difficult at this time as OEMs are focused on building their own platforms (a modular ecosystem could still be a long-term play). Meanwhile, an integrated product would offer superior performance (at this point) and make product iteration easier. This would force Google to distribute the hardware as well, which isn’t a major strength for them.
Of course, Google Inc (NASDAQ:GOOGL) (NASDAQ:GOOG) could always wait for a winning platform to emerge and create over-the-top solutions/services that hijack the platform (similar to Chrome on PC), but that’s a longer game.
Amazon: In the Game for Content Revenues
This leaves Amazon.com, Inc. (NASDAQ:AMZN), which has already shown the capability to build an integrated product. With their e-commerce platform, they also have the ability to distribute hardware at scale. What about their motivations? Here’s an excerpt from my post about Amazon’s Fire TV:
23% – That figure alone explains Amazon.com, Inc. (NASDAQ:AMZN)’s goal for Fire TV. In 2013, it was estimated that the Kindle ecosystem was responsible for 11% of Amazon’s revenue, but 23% of its operating profit. However, the revenue numbers also include $4.5 billion in Kindle device sales (6% of Amazon’s revenue) which were sold at break-even. This means that 23% of Amazon’s operating profit came from a business that accounted for just 5% of its annual revenue.
Given the figures above, it is no surprise to see Amazon double down on its “razors and blades” strategy. By selling a low-cost ($99) box to consumers, Amazon gains access to a distribution channel for high-margin content sales. Amazon seems to have realized that this box would only appeal to consumers if it also provides access to third-party services like Netflix, Inc. (NASDAQ:NFLX), Hulu, etc. (much like Kindle Fire tablets and third party apps). But more importantly, they also seem to be expanding their presence in the digital content business via Amazon Game Studios. As Fire TV gets the Kindle ecosystem into living rooms, games become a natural extension for their business model. After all, games are typically one of the most popular and profitable segments within this business.
Based on this, Amazon.com, Inc. (NASDAQ:AMZN) is the most likely source of a disruption to the established TV/console paradigm. Of course, this analysis is only valid if we assume that this disruption requires dedicated TV-focused hardware. It’s entirely possible that smart mobile devices are already disrupting consoles. In this case, are devices like Apple TV and Fire TV limited to a niche market?