Wednesday, June 15, 2011

iTunes Not a "Cash Cow" for Apple

This is certainly news to me. As reported by CNET, Apple is estimated to spend approximately $1.3 billion per year (that's $113 million per month) to run its iTunes and App Store portals. While that is a staggering operating expense, I always thought Apple makes many times that in revenues back. Looks like this may not be the case.

The cost estimation of $1.3 billion was computed by the market research firm Asymco, using the numbers provided at the most recent Worldwide Developers Conference, or WDC (quick recap here). Asymco concluded that given the price of songs and apps that Apple charges, the company runs both services at just "slightly above the breakeven point". This analysis is collaborated by the opinion of other analysts, who have stated in the past that the App Store has never been a source of huge profits for Apple. Piper Jaffray analyst Gene Munster estimated a year ago that the App Store only nets profits of $189 million since launch for Apple.

Now, how can this be? How could the two most popular music and application portals not contribute significantly to Apple's bottom line? I for one thought that their overwhelming usage alone (this is a no-brainer, as much as I like Amazon's stores, Apple's is just more popular) would translate into colossal profits. In wake of this news, it seems like the operating expenses are much higher than before. After all, the success of both services is contingent on Apple's ability to streamline payment processes, data transfers, and preparing capacity. All these can be expensive -- unlike Microsoft's cash cow "Office" or "Windows, or Google's ubiquitous search engine, Apple's iTunes and App Store require constant hands-on management. (Google probably has significant expenses to its search engine, but this is more than offset by advertising revenue.)

What is interesting about this news is that it points Apple's business model: maximize hardware revenue. While Apple's software may be adored by millions, new releases like OSX Lion and iOS5 are not for the express purpose of being innovative. Instead, they are to attract customers to its hardware like MacBooks and iPhones -- which (obviously) run exclusively on Apple's own hardware. The main point of software including App Store and iTunes is to differentiate Apple from the competition. This makes sense given the oft-ridiculous markup of Apple's various gadgets: because this is how the company makes the bulk of its profits. In economic speak, the profit margin is much much higher in hardware than in software. No wonder iTunes runs so sluggishly on my ThinkPad!

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