Apple: A New Business Model for iTunes?

| About: Apple Inc. (AAPL)

Apple (NASDAQ:AAPL) recently acquired an online music service called Lala that allows users to pay 10 cents for permanent access to songs that can be streamed via a Web browser but cannot be downloaded to a user's computer hard drive or to portable players like iPods. Lala has an inventory of over 8 million songs that can be streamed. We think Apple is positioning its iTunes business to benefit from trends that are making mobile data more readily available and decreasing the need for local storage of information.

Higher Mobile Bandwidth Makes Storage Redundant

Mobile phone technologies like 3G and 4G along with pervasive Wi-Fi are making high-speed mobile internet access a reality for many mobile phone users including those that don't own smartphones like Apple's iPhone.

Smartphones typically have gigabytes of storage space that allow users to store thousands of songs conveniently on their phones. By streaming music through the web, mobile phones with limited storage space have access to volumes of music they would otherwise not be able to store and listen to.

Streaming music means phone makers can offer cheaper smartphones with less memory and cheaper phones can lead to even more smartphone adoption. And memory can impact smartphone pricing significantly. Apple itself prices its iPhones in increments of $100 based primarily off of two criteria:

(i) the amount of memory offered (8, 16 or 32 GB)
(ii) the speed of the data connection (3G vs. 3GS)

Impact on iPhone Business

If memory diminishes in importance as driver of premium pricing, it will have negative consequences for Apple's Average iPhone Pricing, but could give a bigger than expected boost to Apple's iPhone Market Share.

Show iPhone Market Share Chart

Impact on iTunes Business

iTunes & iPhones apps together constitute about 5% of Apple's stock today. If a large percentage of users opt to pay 10 cents for streaming access to songs, average pricing of songs on iTunes will drop precipitously from about 96 cents today. However, the loss in revenue per song could be offset by higher demand for songs driven by both more songs per iPhone as well as more iPhones (remember the cheaper phones from above).

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