An iTunes Subscription Could Subsidize the Apple Tablet

| About: Apple Inc. (AAPL)
This article is now exclusive for PRO subscribers.

The unknown variable concerning Apple’s (NASDAQ:AAPL) rumored iTouch Tablet is how this device will connect to the Internet. Will it be Wi-Fi? Will it be 3G in 2009? Will it be Verizon’s (NYSE:VZ) 4G in 2010? With all the unknowns, the only thing investors can do is speculate based on what we do know. We know that Apple has benefited from the subsidized iPhone pricing model to the tune of approximately 60% margins. We know that the first release of the iPhone didn’t generate the demand that Apple wanted so they lowered the price points down to $99, $199 and $299. Consumers are obviously uneasy about paying $499 or $599 for an electronic device that isn’t a laptop. That price point doesn’t seem to be in our cultural DNA. We also know that consumers need a phone and they need a computer but they don’t need a Tablet. Anyone who owns a Tablet will still rely on a computer and a phone. The opportunity for a subsidized pricing model on the Tablet will be determined by its mode of connectivity.

My opinion is that built-in 3G through a single carrier like AT&T (NYSE:T) is not in Apple’s plans. The company seems to desire an expansion of its mobile customers to include others such as Verizon (here in the U.S.). The problem with this kind of expansion is that Verizon’s 3G network requires a different format than AT&T’s. Apple isn’t going to produce a unique Tablet for each carrier so it seems that the 3G connection between multiple carriers isn’t going to happen. Perhaps Apple waits until 2010 to release the Tablet in conjunction with Verizon’s launch of 4G, if they do this they will be alienating their loyal iPhone customers still at AT&T who would then be forced to open a second wireless account with Verizon. Distributing the Tablet through multiple wireless carriers would be a major headache and hassle to say the least. I don’t anticipate this will happen.

The other alternative is to connect the Tablet via Wi-Fi. This allows Verizon customers to utilize their Mi-Fi mobile technology while AT&T customers, along with most other international iPhone users, could use the tethering capability of the iPhone to connect the Tablet. This mode of connectivity allows the Tablet to be widely available across all carriers and it places a premium of relevancy on the iPhone as it becomes your Internet access point for the Tablet and other devices as well. This is a simple solution for the Tablet connection but the problem for Apple is that it presents a limited opportunity to subsidize the cost of the Tablet. A $50/month tethering charge from AT&T or a $50 a month Mi-Fi charge through Verizon won’t put much of a dent in the rumored $800 price tag on the Tablet.

This leads us at the Economic Weather Station to reason that Apple may tap into their $32 billion of cash to subsidize the Tablet by themselves. What if they offer buyers a two year iTunes subscription that provides all the necessary content for the Tablet to be a success? Tablet users are going to want access to newspaper subscriptions, magazine subscriptions, books, movies, apps, video games, etc... Apple could sell the Tablet for $399 along with the two year iTunes subscription and they would end up making more than the $800 for the Tablet. I find it hard to believe that Apple would ever want to abandon the subsidy model after experiencing the profits of the iPhone. iTunes has never been a profit generator for Apple and it has been the cause of much debate among content providers. A monthly payment works for the cable television industry so why can't it work for iTunes? It seems like a great alternative for the newspapers and magazines who don't know what to do about their declining advertising and subscription revenue and it seems like a great way for Apple to sell more hardware. A Tablet owner with access to all of the iTunes store content would be in media heaven. It will be very interesting to see how Steve Jobs brings this new space together.

Disclosure: Long AAPL