Is Apple buying Beats to fix iTunes?

Apple has put the rumours to rest and bought Beats Electronics, but just why the tech giant -- usually measured on how it spends its war chest -- has done so is still something of a mystery.

Is Beats Electronics’ nascent streaming service really worth $US3 billion? Evidently not -- The Wall Street Journal reports that Apple is paying slightly less than $500 million for the streaming service. So are the headphones and the rest of the audio gear good enough to warrant a $US2.5 billion tag?

Well, Beats’ headphones may not be the weapon of choice for audiophiles but they have undeniable mass market appeal, with 2013 sales totalling close to $1.3 billion. Beats knows how to make money from its gear. It understands the power of brands and star appeal.

That’s something Apple had in spades not that long ago, but the power of its brand, especially iTunes, has been on the wane of late. Weighed down by market expectations, Apple boss Tim Cook has decided to sign off on a deal that would have never happened under the tenure of his predecessor Steve Jobs.

But times have changed and the iTunes revolution ushered in by Apple is swiftly fading in the wake of streaming services like Spotify and Pandora. Buying Beats is Apple’s hedge against the upstarts and while Beats’ streaming-music service, launched in January, is small fry when compared to Spotify, that could all change quickly.

The service currently has 250,000 subscribers but analysts such as Trip Choudhury of Global Equities LLC reckon leveraging Apple’s powers of distribution could turn Beats into a dominant player in the streaming space, easily outstripping rivals.

What’s in it for Apple? Well, it propels Apple close to the top of a field that so far it has paid very little attention to, and while content is one thing, Piper Jaffray analyst Gene Munster says the Beats deal could be a template that Apple wants to follow as it opens its eyes to opportunities in the internet services space.

It’s important to remember that Beats isn’t a stranger to working with a phone maker -- it has a somewhat unusual history with Taiwan’s HTC. Beats was majority owned by HTC, which tried to leverage Beats’ value into its products without great success. Investment group Carlyle bought HTC out last September and between then and now the value of the company has tripled from $US1m to $3m.

Asymco analyst and noted Apple-watcher Horace Dediu says that Apple can do everything Beats does, but this might be all about Apple repositioning its brand.

Dediu says Beats has branding figured out: it started as a good idea by a music industry mogul -- Jimmy Iovine -- who figured out a way to outsource the technology for the hardware, attach a major celebrity (Dr Dre) and then position the product and sell it at a premium.

“It’s not a new thing for anyone in the apparel business, or the perfume business. Somebody comes up with a new brand and you can either slap on a name like Versace or a attach a celebrity to it,” Dediu says in the latest episode of the 5x5 podcast. "People want to buy something that has an affiliation with something that’s hip and cool.”

Dediu says this formula will also work in the rapidly evolving world of wearables -- a sentiment shared by Forrester Research’s James McQuivey, who expects Apple to tie Beats into a more comprehensive wearables strategy in the future.

“Beats has a brand that can get people to wear conspicuous gear without shame. Put the two together and you have a recipe for body-based product innovation,” McQuivey says.

“(It’s) as if Apple came to the wearables market, took one look at Google Glass and said, "We can do better than that."

But Apple’s spending a lot of money and Dediu adds that the move may be designed to fix the one brand within Apple that’s really in need of a tweak.

“There’s a brand that’s broken within Apple -- that’s iTunes,” he says.

Dediu speculates that Apple may use Beats to reinvigorate iTunes, not just pivot the model from downloads to streaming but also transform the entire platform into one that isn’t just about being a store but a community for music discovery, curation and culture.

Spending $3bn to make iTunes cool has to be one of the biggest bets made by Apple CEO Tim Cook and we’ll have to wait and see whether content is still the king in today’s ecosystem.