Pundits, bloggers, Apple watchers and “experts” are falling all over themselves in a race to decry Apple’s putative acquisition of Beats, the company best known for its colorful co-founder Dr. Dre and its near iconic headphones. Gordon Kelly, here at Forbes, embodies this belief when he accuses Apple of “missing the plot.” It seems, instead that the critics have perhaps simply chosen to the ignore the big picture because — once again — it doesn’t fit their idea of a good story.
The vision thing
Now, I should clarify, there seems to be little truly inspired about buying Beats. It’s not as if Apple will gain amazing technology or a chance to enter radical new markets. Instead, what it will gain is a company that dominates a market in a manner that can only be described as “Apple-esque.” Beats headphones are much like the original iPod: a premium-priced product critics felt would have no chance of success, never mind dominant market share. (It’s estimated Beats sell more than half of all premium headphones in the world; Apple once sold 70% of all MP3 players.)
The company may have done as much as $1.5 billion in business last year and doubtless commands high profit margins. It appears to have doubled sales in 2012 and perhaps again in 2013. This from a category that essentially did not exist before Beats invented it. Yes, you absolutely could buy headphones from dozens of companies before Dr. Dre and Jimmy Iovine created Beats, but nearly no one spent any money doing so.
Burritos, not tortillas
The idea that Apple was better off buying Monster Cable, whose primary business is selling overpriced wiring to unsuspecting customers who believe the nonsense printed on the package, simply because it used to manufacture Beats’ hardware is nonsense. If you want to own Chipotle, you don’t buy the farm that grows wheat for its flour tortillas, you buy Chipotle. You also don’t buy the corner burrito stand, no matter how delicious your lunch there may be when you indulge on Thursdays. And that’s why every suggestion to buy some other tiny headphone maker instead of Beats is equally foolish. If you want to own Chipotle, you buy Chipotle.
Over at Forrester, the research firm, they appear baffled by Apple’s decision to do this. ”I cannot do the math on the offer,” said James McQuivey, as quoted in the Los Angeles Times. “Nothing that I can compute adds up to $3 billion.” That’s odd. Here’s a company that at a bare minimum — the lowest estimates of Beats revenue are north of $1 billion — has tripled in size in two years and McQuivey can’t see why someone would pay $3 billion for that? Of course, Forrester has become a laughably anti-Apple “trend spotter” of later. Last year, it claimed 200 million people wanted Windows tablets, but not Apple iPads. Since then, Apple has sold 70 million more iPads. Microsoft has not sold 1/10 that many Surface tablets. (Forrester also thought Kindle could seriously challenge iPad. It hasn’t.)
Om Mailk, the founder of GigaOm and now venture capitalist, also hates the deal. He tweeted: “Google spends $3.2 billion to buy the future & data. Apple buys bad headphones & a junk-service from music promoters. Worse use of corp $$$s” Which brings up a great point, although perhaps not the one Mailk was seeking. Apple likely bought Beats for a combination of reasons (1) A hugely successful brand, especially among young people (2) It’s streaming music service, which will allow Apple to launch the Spotify competitor they should have offered 5+ years ago when it would’ve been called a Rhapsody competitor and (3) Because the deal will actually pay for itself.
If Beats under Apple continues to grow at all, it will likely spin off enough income — that’s profit, the stuff on the bottom line — to cover the $3.2 billion Apple is rumored to be spending. Beats is likely selling fewer than 10 million pairs of headphones per year; Apple sells more than 15 times that many iPhones and competitors sell another 5-6 times more than Apple. All are not candidates for $100-400 headphones, but many are. Benedict Evans wisely tweeted: “As mobile phones have become boring rectangles, headphones have replaced them as a place for self-expression.”
Not like the other
That desire to differentiate, especially in a country where 42% of smartphones in use are iPhones, is strong. The ideas that Apple will fail to export the brand and that it will somehow lose all of its Android customers both seem like odd criticisms. Perhaps, instead, Beats will grow into a $5 billion business with 3-4 years. Further, it could become the brand under which Apple launches a cheaper iOS phone, as Evans mused later. Keep the Apple brand for the premium product at twice the price and use Beats, an Apple company, to sell colorful, less costly models targeted at emerging markets and price sensitive customers.
Regardless of whether the latter comes to pass, perhaps Apple should get one given how little it spent. Malik loved Google’s Nest deal because it’s “buying the future” (For the same price Apple is paying for “junk” headphones, if the final figure on the Beats deal is $3.2 billion). That future apparently is one with expensive thermostats and ludicrously priced (yet still disposable) smoke detectors! Again, this isn’t criticism. The thermostat is great, but right now it’s a product for the early adopters, high-disposable income types and those that get it free or cheap from a utility company in exchange for giving up some control over their home’s temperature. The future might be in 1% of U.S. homes by now; it’s sure taking its time getting here.
Nest was allegedly on pace to do $300 million this year, making the deal at least 10 times revenues. There are serious questions as to what Google intends to do with the existing products — it has in the past shut down product lines of acquired companies and redeployed the personnel to other initiatives and rumors have suggested the Nest team’s future is not in thermostats. For all we don’t know, we can be sure the deal won’t reap financial rewards commensurate with its price anytime soon.
Seeing the future
Yes, it’s more farsighted than buying a headphone / streaming music company, but at the end of the day, these companies are supposed to make money. Did Google buy a property worth $3.2 billion? We might not be able to tell till the next decade, if ever. Of course, compared to Facebook, Google is frugal.
The social networking site has stunned outsiders recently with two acquisitions. In one, it spent a “mere” $2 billion on Oculus VR, the company behind a next-generation set of virtual-reality goggles called the Rift that are flat out amazing. Oculus to date has sold a few developer kits and ultimately wants to license technology, not sell goggles. Because of the potential in gaming and simulation, there are certainly markets where the Oculus Rift should be a big hit. Whether it ever goes mainstream, though, is a question we are likely to answer even farther into the future than the one about Google’s return on investment from Nest. And what this has to do with being a ubiquitous social network focused on smartphones is a question Facebook didn’t persuasively answer when it bought Oculus, either.
Yet Facebook is seen as visionary for this deal because it maybe bought a piece of “someday” if that day ever arrives and if Oculus is the market leader. It should be noted that Sony has its own virtual-reality tech coming soon for the PS4. Forrester’s boss 2 years ago said Apple was doomed to wind up like Sony. Presumably he meant the Sony that’s losing money selling TV, not the one that has a “worthy competitor” to the Rift, at least according to The Verge.
We need to chat….
But we’d be remiss if we didn’t talk about the elephant in the room, er Silicon Valley. Facebook spent $19 billion buying WhatsApp, a nifty product that replicates a core messaging feature built into Facebook itself and whose 500 million users are largely already on Facebook. This was a defensive play that Facebook would like you to believe is about reaching “the next billion users.” You know, the ones it wants on Facebook. WhatsApp charges $1 for a year of use after your first year, but didn’t do that from the beginning. For that reason, it won’t make Facebook hundreds of millions until at least 2015. But it might well be very profitable, given the remarkably lean team WhatsApp manages to run its huge service with. Whether $19 billion will ever be reasonable for the income stream WhatsApp will generate, though, is beyond the unknowable.
Apple, in short, spent next to nothing — the deal will cost it less than a month’s profits — to buy something that might extend its reach ever so slightly into new places. Given the size of the iPhone maker, Beats could never move the needle on overall revenue, but it can nudge it in the right direction. In the meantime, Apple can market an all-you-can-eat streaming service at last. Everyone who is anyone now finally agrees streaming is the future of the music business, accounting for 21% of U.S. music revenue last year. For the hardware and software sides of Apple, this deal offered at least something and it cost little.
I like the Oculus, WhatsApp and Nest deals all to varying degrees and think they are all a bit crazy, too. Part of what makes Larry Page and Mark Zuckerberg so successful is that craziness. In its history, Apple has never been a fan of the splashy acquisition. History is mostly on its side. Ask Yahoo how it feels about Geocities or Broadcast.com. Ask Microsoft about aQuantive. Talk to Page about Motorola. Or don’t.
But Google has shown that you can buy totally outside your wheelhouse as it did with Android, and create a dynamo. It figured out how to make YouTube a giant success with an ad model somewhat more familiar to its DNA. And it’s done well with DoubleClick, selling display ads even closer to home. It’s acquisition record, in fact, is probably the best in Silicon Valley history. And that’s, incidentally, with dozens of deals that have been complete failures.
For Tim Cook and Apple, this is new territory. I believe the company should spend 10, 20, even 30 times what it’s buying Beats for on other companies. But to say it doesn’t know how to do that successfully would hardly be an exaggeration. In the next post on this topic, I’ll provide a shopping list for Cook and some idea on how to solve the integration problem that usually makes such spending sprees worthless.