Apple is expected to bid for Beats Electronics this week. Is this a signal that Tim Cook is floundering? Or is this the beginning of a new strategy for Apple – create value by making synergistic acquisitions? Beats Electronics appears to have two assets – its headphones businesss and its experience with streaming music.
Lets use the three frameworks from “Strategy for the Corporate Level” Jossey Bass May 2014 to look at this deal. First is the business attractiveness framework. How attractive are these two businesses? The headphones business seems to be very attractive. Beats Electronics has a strong position in a luxury niche. Margins must be high. Fashion could swing against them but this is a good business. The streaming business on the other hand is not that exciting. The market is growing fast from 7% of music sales to 20% in a few years but there is little money in it at the moment. Like so many new internet offers low pricing is used to gain share on the assumption that there will be ways to monetize the traffic later. Also Beats Electronics is not a market leader: it has no source of advantage. So one small attractive business and one large unattractive business. To justify paying $3 billion for this Apple will have to add a lot of value. This brings us to the next framework – what extra value can be created from the combination and will Apple be a good owner of this kind of business? Apple is already selling Beats Electronics’ headphones. It is not obvious that branding these headphones as Apple products will add value. In fact using the Apple brand is more likely to subtract value. Moreover the Apple team has no experience with luxury products. So where is the synergy? Maybe the synergy is in the streaming business. Apple probably needs to get into the streaming business. But does it need to pay $3 billion to do so? Why not hire some experts? Why not buy the market leader? Also what is Apple bringing to the party? Apple can bring extra traffic. But streaming sales cannibalize download sales – and streaming is much less profitable than downloads. Unless Apple believes it can raise prices and still sell streaming it is hard to see the added value. Maybe Apple believes that it will be better able to monetize Beats Electronics’ traffic. This would certainly add value. So when Apple makes the announcement we should be looking closely into the words used to see if there is clarity about where the added value lies… and how big it is. The third framework is about the capital markets. Are the capital markets under or over valuing assets like headphones businesses or streaming businesses? Making a judgement about market valuations is inherently hard. Moreover someone who is good at making these judgments can get very rich without the hard toil of making products or providing services. So this framework needs to be used with caution. That said we can probably be confident that the market is unlikely to miss-value the headphones business. These kinds of luxury/fashion products are well understood and Beats Electronics has a track record. If there is a miss-valuation it will be in the streaming business. We know that new technology businesses go through cycles of over valuation followed by under valuation followed by over valuation until the future becomes clearer. Where is streaming in this cycle at the moment? Probably on the over valuation side: growth is high hope is high there is plenty of hype about internet businesses: maybe not as much as in 2000 but… definitely on the upswing rather than the down swing of the cycle. This implies that Apple should at least consider keeping its powder dry for a day when market prices are more reasonable unless Tim Cook is confident that the combination of Apple and Beats will create so much extra value that paying over the odds today is easily covered by the extra value he can create before the cycle turns. In conclusion Tim Cook is probably floundering unless he is able to give a convincing explanation about the extra value that will be created by the combination of Apple and Beats in the streaming business. He probably needs to be able to articulate at least $1 or $2 billion of extra value from higher prices or better monetization of traffic or …. some other source of value I have not thought about.