Don't Rule Out Apple Ruling Your Living Room

Apple's (AAPL) decade-long run of iPod-, iPhone-, and iPad-fueled prosperity has featured only one notable dud. Introduced in 2006, Apple TV is a set-top box used to play movies and other digital fare on a TV via iTunes on a Mac or PC. Apple has sold fewer than 3 million of them, estimates Kaufman Bros. analyst Shaw Wu. The company sold that many iPads in three months.

And yet, at a Sept. 1 event in San Francisco, Steve Jobs announced that Apple is bringing out a less-than-revolutionary upgrade. The new Apple TV looks different—it's black, not white, and at 3.9 inches square, is 75 percent smaller than the old one—and you now rent rather than buy movies and TV shows. (The price has also fallen, from $229 to $99.) Otherwise, its function is mostly unchanged. "You're still looking at a product for the Apple fanatics," says technology marketing consultant David Clarke of BGT Partners.

So why bother? Even Jobs concedes the device is mainly for tech hobbyists, and most of the Sept. 1 event was dedicated to the revelation of a new line of iPods and a social networking feature that works within iTunes. What Jobs didn't say is that Apple wants to become king of the living room. He tells Bloomberg Businessweek that when the time is right, Apple could open an App Store for the TV that could do for television sets what all those apps have done for the iPhone. Asked if the iPad could evolve into the TV of tomorrow, Jobs shrugs and says, "That's how I do most of my TV watching today."

Rights Obstacle

Still, the timing for such an evolution isn't upon us, Jobs says. Apple's biggest obstacle may be that it doesn't have the rights to sell shows the way it wants. Many studios, nervous about angering the cable companies that pay billions for their content, refused Apple's efforts late last year to put together a subscription service, say three media executives involved in the talks, who requested anonymity because they did not have approval to discuss the negotiations. Consumers would have been able to purchase only those shows they want in an a la carte model, rather than pay for hundreds of channels they never watch.

Apple gave up on that idea this past spring, say the executives. Rather than continue to fight a losing battle to replace the cable box, the company refocused on making it iPod-simple to watch shows across all of its devices. With a new software update coming in November, fans of the Fox show Glee, for example, will be able to rent an episode, start watching on their iPhones during the morning commute, watch some more on the PC during lunch, and finish up after work with the iPad or Apple TV.

Rather than seek drastic pricing changes from studios, Apple pressed for the right to rent their TV shows for 99¢ per episode, say the executives involved in the discussions. Apple already was selling many movies for $9.99 and TV shows for $1.99 ($2.99 for high-def) on iTunes. The new thinking: A flat 99¢ price per episode—$4.99 for movies—might spark a change in TV watchers' behavior, just as it did in music a decade ago. Apple executives, led by Internet services Vice-President Eddy Cue, argued that it could mean billions in incremental sales for the studios as 120 million Apple device owners rent missed episodes to watch on the grocery line or airplane, says one of the executives.

Even that proved to be a difficult victory. Studio chiefs are getting hit with new TV schemes from every direction. Netflix (NFLX), Yahoo! (YHOO), and (AMZN) have deals with mobile handset makers, TV set manufacturers, and other hardware companies. Google (GOOG) is coming out with its own offering, which will initially run on Sony (SNE) TVs and Logitech (LOGI) set-top boxes. In the end, only News Corp.'s (NWS) 20th Century Fox unit and Walt Disney's (DIS) ABC have agreed to provide shows for Apple to rent. In News Corp.'s case, the agreement is for a trial period. (Jobs is Disney's largest shareholder and sits on the company's board.)

A La Carte in the Future?

If Hollywood isn't ready to distribute TV as Jobs would like it, Apple is still well positioned to pull off an a la carte model in the future. All of its devices function easily together, tied by software that no other consumer technology company has been able to match for utility and style. "Today's announcements were just a stepping stone," says Michael Gartenberg, a partner at consulting firm Altimeter Group. "TV is too important for Apple to ignore." If Apple keeps growing the way it has, it may be too big for the media giants to ignore: Apple has 160 million credit-card numbers on file thanks to iTunes, while Comcast (CMCSA) has 23 million.

A big question will be whether Apple opens an App Store for Apple TV. If it does that, and history repeats itself, thousands of developers might then race to create programs suited to the TV. Tim Westergren, chief executive officer of the streaming music service Pandora, is already dreaming of the possibilities for his business. "When I was a kid, I used to stare at album covers for hours," he says. "This could be a big, interactive album cover."

None of this will come cheap for Apple. The company is putting the finishing touches on a $1 billion, 500,000-square-foot data center set off a two-lane road in rural Maiden, N.C., population 3,200. If you stand by the cemetery behind Cedar Grove Baptist Church, you can get a pretty good look at the site through the trees. Code-named Project Dolphin by local officials, Apple's facility could be used for storing your iTunes music and video, or to take on Facebook in a bigger way. Apple isn't saying. Whatever the company is cooking up, it'll be big, says David J. Cappuccio, an analyst with Gartner (IT): "Any company that is investing a billion dollars must have some serious plans."

The bottom line: The Apple TV update won't wow consumers, but it's a long-term bet on Apple's place in the living room.

    Before it's here, it's on the Bloomberg Terminal.