It’s the end of the year, and this is generally the time when journalists will put out sensationalist headlines about their predictions for the upcoming year, decade, millennium, etc.

Well, I’m not a journalist.  But I do have a blog.  So let me indulge here in at least one crazy projection that might actually make strategic sense.

Is 2008 the year that Apple decides to become a studio?

This might sound far-fetched.  After all, Apple is a technology company, not an entertainment company.  But I’ll argue that the same forces that pulled HBO into the innovative strategy of creating original content, now being emulated by every cable network from Showtime to FX, could also apply extremely well to Apple.

Let’s walk through this carefully.

First, can Apple move in the direction of producing original content? 

The answer here is clearly yes.  Apple now has the most important asset in entertainment – wide-spread, inexpensive distribution.  Apple has tens of millions of iTunes customers who have proven themselves more than willing to download content, even at a price.

Right now, roughly 2/3 of the cost of Apple’s service is actually royalty payments to the content providers.  If Apple produced their own content, those costs are replaced with actual production costs. HBO began their original content push with documentaries and short, 1/2 hour episodic comedies.

Apple currently has $16B in cash, and a market cap of $170B.  HBO put $30M into its 2-season run of Rome.  Apple could easily afford those budgets, and offset their costs with free distribution through iTunes.   The question is how much is a premium content brand worth?  The answer is billions, and Apple has the capital to invest against that opportunity.

Second, should Apple become a studio?

I’ll argue yes here, but with a number of caveats.

First, like HBO, they’ll have to walk a tight line between the need to license content from other major studios, and their own competitive efforts.  HBO managed to use original content to differentiate their offering, and Apple could do the same thing with iTunes.  HBO established itself as a premium brand and experience with their content and series, and Apple has similar brand elements.  HBO, however, had initial success with licensing movies from most studios before moving to original content – Apple right now is only tight with Disney.

Second, Apple has to be careful with pricing.  If their content is free, or cheaply priced, it might upset the difficult negotiations Apple continues to have around flat pricing on both the music and video sides.  You could argue that Apple would offer studios the same deal – cut your licensing fee and we’ll cut the price, but it’s a problematic area for Apple given their position on pricing.

Third, Apple has to watch out for their broad demographic.  HBO has a particular demographic – adult, high income, educated.  They used their platform (paid cable, commercial free) to produce content that better met the needs of that audience.  iTunes is completely mass market at this point, so it’s unclear what type of content Apple would build – maybe they would need multiple “studios” to address different markets.

Despite those caveats, the advantages of leveraging their lead with the iTunes distribution channel into a premium content play is extremely appealing, economically.  Just like in-house brands are economically too valuable to be ignored for a retailer, the huge fees paid to the content houses for video are extremely attractive when you own the distribution channel.

A quicker path for Apple would be to potentially buy HBO off of the ailing Time Warner, or possibly even NBC from GE.  That last option would have the added benefit of letting Steve relieve the current NBC executive staff of their current, difficult salaried positions.  🙂

Like the iPod/iTunes combination, unique Apple content that can only be accessed through iTunes could potentially boost the value of iTunes, and boost the potential success of the content by special access to the iTunes channel.

So, file this away in your bookmarks for crazy Apple predictions.  We’ll see what happens.