Apple Will Continue To Dominate Set-Top Boxes

| About: Apple Inc. (AAPL)


In 2013, Apple TV dominated the market for under-$100 set-top boxes.

Despite competitive pressures from Roku, Google, and now Amazon, Apple will continue to dominate in 2014 with a next generation Apple TV.

Key to this new Apple TV will be Apple's patented 3D remote, which will enable a full iOS experience on TV.

Amazon's (NASDAQ:AMZN) entry into the Internet-connected set-top box market this week with the Fire TV underscored the growing importance of Internet based video delivery. The group of under-$100 boxes is a space that Apple (NASDAQ:AAPL) dominated in 2013 with $1 billion in sales of Apple TVs and related content for its fiscal year. With competition from Roku, Google (NASDAQ:GOOG), (NASDAQ:GOOGL) Chromecast, and Amazon Fire TV, will Apple lose its leadership position? No. Using exclusive patented technology, Apple's next generation Apple TV, which may be introduced as early as June, will keep it ahead of the pack.

A Hobby Grown Up

As Cook acknowledged recently at the annual shareholders conference, Apple TV can't be called a hobby anymore. With more and more people using mobile devices for video content delivery, as well as cutting the cable at home, Apple's competitors have realized what a growth market this is.

Apple's competitors trail it in unit sales. As of the middle of 2013, Apple had sold a total of 13 million units. Roku had sold 8 million units as of February 2014. Google's Sundar Pichai announced at SXSW 2014 that "millions" of Chromecasts had been sold.

By way of acknowledging the growing importance of Internet video delivery, Microsoft (NASDAQ:MSFT) and Sony (NYSE:SNE) both included streaming video apps such as Netflix and Hulu+ in their new consoles, but the consoles are in a different price category, and are focused mainly on immersive gaming, which requires more capable and expensive processing and video hardware.

The $100 set-top boxes are in a different hardware as well as price class, being powered by mobile ARM (NASDAQ:ARMH) processors. For Apple in particular, Apple TV, from the second generation on, represented a way to realize a bit more economy of scale for its mobile offerings. The current generation Apple TV uses a single core version of Apple's A5 processor, which is offered in dual core form in the iPod Touch and the iPhone 4s. The Apple TV OS is also based on iOS.

Innovative Competition

While Apple has focused on increasing the variety of content on Apple TV, Apple's competitors have gone beyond video content to interactive entertainment (games). Roku 3 offers a library of games playable via a motion sensing remote. Likewise, Amazon's Fire TV will also offer games playable by a separate wireless game controller.

Of course, Apple TV offers a broader array of app and game capability through Airplay video mirroring. With Airplay, an iPhone or iPad can send video over Wi-Fi at a fast enough rate that games are playable. Some games even take advantage of Airplay to create a second video output on the mobile device for controls and other info.

Like Airplay, Chromecast primarily relies on the mobile device as a source of video. By using the smarts already built into smartphones and tablets, Google was able to field a device that is the least expensive in this space.

Airplay also works well to provide large screen output for presentations or for just getting a bigger screen view of the app, but Airplay has disadvantages. With video mirroring, you have to look down at your device in order to enter any input. It feels clumsy. Game play is very sensitive to the speed of your Wi-Fi network and isn't always workable because frame rates are too low. Because of these limitations, Airplay isn't really a replacement for resident in-the-box apps.

Addressing the Limitations

Although very useful, Airplay represents a very imperfect solution to the problem of putting mobile app video on a large screen TV. For this reason, many have assumed that a future Apple TV would have the ability to run full iOS apps. This is what I expect as well, as discussed in "Sifting the Apple Rumors: Television."

In that article, I left for another time the problem of conversion of iOS apps to Apple TV. iOS apps require numerous touch and gesture inputs, which a non-touch screen television wouldn't be able to provide. As you might expect, this has been a significant area of research for Apple. On April 1, 2014, Apple's research efforts were rewarded with U.S. patent 8,689,145.

The patent is for a "3D Remote Control System." This has been in the works for a couple of years, and this new patent is actually a refinement of another patent granted to Apple in 2012. The 3D remote basically solves the problem of providing user inputs to a TV that substitute for touch inputs in iOS. The system measures very precisely where the remote is relative to the TV, as well as where the remote is pointing. With it, someone sitting on their sofa can point to an icon on a screen and press a button to select it. A cursor or other highlighting mechanism shows you where the remote is pointing.

The 3D remote can do other things, such as allow swipe gestures and zooming. Compared to Apple's current Apple TV remote, it's light years ahead. But the important thing is that with it, you'll be able to interact with a full TV-based iOS system without having to take your eyes off the screen.

The underlying mechanism for the 3D remote is very simply and requires only very basic calculations. It's much less sophisticated than Microsoft's Kinect gesture recognition system, but I'm convinced it will also be more reliable. Although the evidence is merely anecdotal, I've read plenty of complaints about the Xbox gesture recognition system, and Microsoft did eventually provide users with a means to control basic functions using only a game controller.

Likewise, it will also be more reliable than voice control. Part of the problem with voice recognition systems of all types is that they're very susceptible to background noise. For this reason, shouting from across the room at the Xbox was bound to have problems. The new Amazon system partially addresses this by putting the microphone in the remote control. This was a good move, but I doubt it will be enough. With a movie or music playing, the voice recognition system is still going to have a tough time.

The Advantage of Simplicity

By focusing on a simple, low cost solution, Apple has found the sweet spot for a more capable remote control system. By patenting this solution, Apple has gained a competitive advantage. Apple's next Apple TV will be a much more capable device with a much more capable remote. By bringing the full ecosystem of apps to the living room TV, including the multitude of games that are available on iOS, Apple will achieve a huge lead over its competitors.

The recent change in the Apple Store, where Apple TV was accorded new status as a separate product category, suggested to many observers that a new Apple TV would arrive soon. It will, and probably both the 3rd and 4th gen Apple TVs will be available in a broadened product line.

The ability to run full iOS apps natively on an HD screen will be immense, especially considering the convenience of iCloud app and content synchronization. If Apple announces the new Apple TV at WWDC in June, I expect sales of both generations to be 25% higher than they were in Apple's fiscal 2013.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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