The Rise of the Apple TV: What should be Apple's next step?

Frost & Sullivan recently reported that Apple TV made up more than half of the streaming device market for 2012, beating competitors like Roku and TiVo. Not bad for something that Steve Jobs once referred to as "a hobby" for the company. What should be Apple's next step for the little black box?

First, let's put that news into some context. The Apple TV is the most popular streaming box out there, according to this report - and that's a device that Apple doesn't separately report in its quarterly revenue figures. In fact, the Apple TV's contribution to Apple's balance sheet this past quarter is buried in the "Accessories" portion of its quarterly statement, which for the most recently reported quarter was $1.18 billion (out of $35.23 billion in total revenue).

Compared to the gargantuan revenues of the iPhone ($18.15 billion), the sizable revenues of the iPad ($6.37 billion), or even the Mac ($4.89 billion), that Accessories number is pretty small - especially when you consider that it includes all other Apple-branded hardware peripherals, and accessories made for iPhone, iPad and iPod touch.

But Tim Cook did offer details earlier this year that may give some insight about the success of the Apple TV. In May, Cook said that Apple has sold 13 million Apple TVs to date. About half of those were sold within the previous year, Cook revealed.

That's an average of almost 1.63 million Apple TVs sold each quarter. At $100 a piece, that's $163 million in Apple's coffers from Apple TV each quarter. Some quick back of the envelope math suggests that Apple TV is contributing a little less than 14 percent to Apple's overall "Accessories" revenue numbers. Small potatoes for Apple's balance sheets, perhaps, but if Frost & Sullivan's analysis is correct, a huge chunk of the streaming box market. Apple's biggest competitor, Roku, grabs less than half the remaining pie, according to the report. Other competitors divide what remains into even smaller slivers.

The Apple TV has been around for six years and is already in its third hardware generation. Apple doubling its installed base of Apple TVs in the last twelve months certainly indicates that public momentum for the device is picking up.

But the overall small numbers demonstrate just how nascent the streaming box market really is. While many of us Apple enthusiasts have bought Apple TV, there are still a huge number of consumers who don't find the device particularly useful or interesting, or feel that their TV viewing needs are serviced well enough by cable TV, DVRs and other set-top devices.

Apple's gobbled up a huge piece of a very small pie. But that small market is growing.

Where does Apple go from here?

The second and third generation Apple TV - the small black box - lacks any sort of local storage capability, but makes up for it by being more programmable than its predecessor. Not only is it easily updatable with firmware improvements and other enhancements, but it can be programmed with entirely new apps.

In mid June, Apple rolled out an update for the Apple TV that added support for several new content services including ESPN, HBO, subscription-based anime service Crunchyroll and more.

Some analysts and pundits hope to see the Apple TV become a disruptive technology for television watching - something that people could use in place of cable television altogether. And indeed, some Apple TV users find the content from iTunes, Netflix, Hulu and the other services the Apple TV supports to be sufficient for their viewing habits.

But it's clear that Apple is taking a more iterative approach with the device - an approach that requires customers to have other media at their disposal. Take HBO Go, for example. The app works the same way on the Apple TV that it does on the iPhone and iPad - you can stream HBO content, including current and archived TV series, but it requires you to validate by entering your cable service provider account information first. You can't subscribe to the service a la carte, as it were.

Tim Cook describes a "grand vision" for the Apple TV and calls television itself an "area of intense interest" for the company, but so far he hasn't publicly articulated what that vision is.

According to Frost & Sullivan, the secret to the Apple TV's success is AirPlay, which enables iOS devices and Macs to stream audio and video content to the Apple TV. AirPlay is the killer app for the Apple TV, because it enhances the experience of users of other Apple products by making it easier for them to share content on their television.

Apple implicitly understands this - the company's executives have spoken for years about the "halo effect" of people buying one Apple product and having a great experience with it, then that driving their purchase of more Apple hardware. To that end, AirPlay is getting a big boost in OS X Mavericks, due out later this year. Apple TV owners can already mirror the Mac's display to their television. But with Mavericks' improved Multiple Display support, Mac users will be able to use an Apple TV-connected television as a completely independent display.

The television question

Analysts like Gene Munster have long prognosticated that Apple will build an actual television, but the economics of doing so don't make a lot of sense, at least not right now. Flat panel TVs are an increasingly commodity-drive market, with inexpensive Chinese manufacturers flooding the market with cheap sets you can buy at Walmart and Target.

There may be a window for some new brands to be established in the Ultra HDTV market - the new 4K sets that are coming out. Apple could leverage its legendary supply line muscle with Chinese manufacturers to produce 4K televisions.

And Apple does appear to be making a play for 4K on some of its hardware, like the new Mac Pro, which will feature Thunderbolt 2 interfaces capable of driving 4K resolution displays. But that's a technology that is squarely focused on the high end of Apple's Mac line at the moment, and for the Mac Pro that makes a lot of sense: it's a machine that's historically had a high penetration in the professional digital video and film editing market.

But what, ultimately, would an actual Apple television - 4K or otherwise - gain Apple in the long run? It could establish itself as a niche player - a high end boutique brand, perhaps, but could it muscle itself onto store shelves the same way that competitors like Samsung, LG and Vizio, or long-time players in the field like Sony and Panasonic, have?

Stay the course

It's a smarter play for Apple to continue to to refine the black box with software updates, then roll out a new generation as it makes sense with new features like UHDTV support as it becomes something more consumers are looking for.

While more and more televisions are coming from the factory with "smart" capabilities like connecting to the Internet and to services like Netflix, many consumers continue to use them as simple dumb terminals for their set top boxes and their streaming devices.

For as long as that's the case, Apple's best strategy for the Apple TV remains building a black box that can connect to any of them, instead of building its own branded television. Compared to a television, the Apple TV is almost an impulse buy, and it capitalizes on the halo effect that continues to drive consumers to new Apple products.

Would you buy an Apple-branded television if they make one? Is the Apple TV a better solution? Or is the whole thing stupid? Tell me what you think in the comments.

Peter Cohen