Apple TV is Dead; Long Live Apple TV

Over the last few months, there’ve been several articles written about the possibility of a future update to the Apple TV based on iOS, the operating system used in iPhone, iPod touch and iPad. These rumors have taken on a life of their own on the Internet, in large part because everyone desperately wants them to be true.

The iTunes Store is a Dead End for Video

Apple (s aapl) sits in an enviable position in the smartphone market, has pushed the tablet category into the mainstream consciousness, and its Mac lineup is selling like hotcakes. It’s the king of music retailing as well, but movies and TV have been somewhat anemic. The iTunes store does not have the dominant position with video content that it does with music. The slow buildup of the video category has led Steve Jobs to refer to the Apple TV as a hobby: something for Apple to continue to dabble in while the market matures.

[inline-ad align=”right”]So why has it been so slow? Because Apple was able to reach the top music retailer spot so quickly, media companies have been reluctant to concede control of electronic distribution to Apple. They feared the same fate as the record labels: their electronic plans dominated by a powerful distribution partner. NBC Universal even pulled its content from the iTunes store for a time during a public spat with Apple. NBC eventually returned, but the industry has still been slow to move on ideas like subscription services or lower pricing through iTunes. The pricing model for video content in the iTunes store has been static for years, and it’s not working.

The entire model for iTunes Store is based on owning the content you purchase. Unfortunately, the video content on the iTunes store is lower quality than what you can buy for the same price elsewhere. Why would anyone want to own mediocre quality content? The future is streaming for convenience and ownership for full HD.

How the iPhone Changes Everything

The explosive growth of the iOS platform (iPhone, iPod touch, and now iPad) has the potential to change Apple’s relationship to media partners. While there has been little change in the iTunes Store, there have been some innovative efforts in providing television shows and movies over the Internet.

iPhone apps provide a way to bring together these two worlds. Media companies can develop apps to bring their properties to consumers, while still retaining control over pricing and establishing a direct relationship with the consumer. The Hulu and Netflix (s nflx) apps are free in the App Store, but require a paid subscription to the respective service to access content. Of no small significance is the fact that Apple does not get one penny from these subscription services. And Hulu and Netflix know exactly who their customers are and how to reach them. App Store developers will be quick to tell you that one frustration is that they have no idea who is buying their apps, and no way to respond to people who complain in App Store reviews. Apple simply does not provide that information to developers.

You can see why media companies would be far more eager to pursue this path where they control pricing and have direct contact with their customers.

An End Run on the iTunes Store

In this scenario, Apple will miss out on a percentage of video content sales. It would be convenient to leap to the conclusion that this would upset Apple and it might take steps to prevent this from happening, but content sales isn’t what Apple is after.

I think the more likely scenario is that Apple continues to view the iTunes Store as the means to an end: selling more iOS devices. While the iTunes store contributed $1.2B to Apple’s revenue this past quarter, I suspect only a small portion of that number comes from video content. In comparison, Apple pulled in $2.17B on the iPad in the same quarter. I would bet that the margins are a lot better on the iPad than the iTunes Store as well, contributing far more to earnings than content sales. Apple will willingly give up growth in content sales in order to make sure that the App Store remains the preferred software distribution channel and iOS devices are the preferred hardware platform for media companies.

Great for Media Companies, Great for Consumers

The big media companies obviously win in this scenario. I think it also opens the stage for small media companies and startups to grow, because the App Store is a pretty level playing field.

Consumers also benefit. More choice, more pricing models, more innovation, more content. The opportunity provided by apps, multitasking in iOS 4, and remote control devices like the iPhone, iPod touch, and the new Magic Trackpad will create a great platform for developers and media companies to deliver existing content and innovative new features. Think Chopper 2 on the TV, controlled by an iPhone, and Scrabble on the big screen with iPod touch tile racks, and new apps that are designed to be controlled by a remote or Magic Trackpad. Maybe someone will finally figure out how to create compelling interactive content for movies that does not get in the way of actually watching the movie. Wouldn’t that be amazing!

Apple TV is Dead, Long Live Apple TV

The current Apple TV, a device where you buy and manage all your video content through the iTunes Store, is dead. But the next Apple TV, where media companies can produce apps to deliver their content to consumers, will be huge because it opens the marketplace back up to innovation again. I can’t predict if Hulu and Netflix will continue to ride the wave and hold their leading position, but I can guarantee that in an open market, someone will figure out a model that works for consumers. And Apple will be there waiting with the best devices for consumers to access that content.

Related GigaOM Pro Research: TV Apps Market to Hit $1.9 Billion by 2015