Although Beats Music had only 111,000 subscribers in March, the streaming service is the crucial centerpiece of Apple's $3 billion purchase Wednesday of its parent company, headphones giant Beats Electronics, according to a record-industry source familiar with the deal. "All you have to do is read their press release — all their messaging has been about the subscription service," says the source. "The headphones have really taken a back seat." Adds Syd Schwartz, a former EMI Music digital executive who now runs independent marketing company Linchpin Digital: "Apple had to address streaming."
Rumored for weeks, Apple's purchase of Beats Electronics includes three basic elements: the streaming service, the headphones company that brought in $1.1 billion in revenue last year as well as top executives Jimmy Iovine and Dr. Dre, who founded the company in 2006. "Music is such an important part of Apple’s DNA and always will be," Eddy Cue, Apple’s senior vice president of Internet software and services, said in a statement announcing the purchase. "The addition of Beats will make our music lineup even better, from free streaming with iTunes Radio to a world-class subscription service in Beats, and of course buying music from the iTunes Store as customers have loved to do for years."
Although Apple's Steve Jobs harshly criticized the music-subscription business, the market has changed dramatically since his death in 2011. Apple's iTunes remains the dominant music retailer, but track sales dropped 6 percent in 2013, according to Nielsen Soundscan, and are down 12 percent this year. (Album sales are down 15 percent.) Meanwhile, streaming revenue rose 39 percent, the Recording Industry Association of America reported. "No question, we are in the middle of a format transition," says the record-industry source. "We're going from one business model to another." With Beats Music, Apple will suddenly have the tools to compete with both Pandora and Spotify. "You now have Apple better positioned in the streaming space," Schwartz says.
The challenges in the streaming market are considerable; even successful companies such as Spotify have struggled to turn a profit, especially when music fans can find just about any free song they want via YouTube. But if Beats Music doesn't work out, Apple can fall back on Beats' core business, a market-leading headphones company and cash cow. "Here you have a company already driving $1 billion to $1.5 billion in annual revenues — just think about what happens when you have the Apple machine behind it, when you have the marketing machine and the retail outlets," says Peter Csathy, CEO of Manatt Digital Media and former president of Musicmatch, an iTunes Store precursor later purchased by Yahoo!
While it's easy to imagine Apple re-branding Beats headphones and stocking them next to iPhones and iPads, the ubiquitous audio equipment is better known for fashion than for sound quality. "At what point do Beats headphones become unfashionable, because all fashions go out? That's the key," says Guy Holmes, a veteran record executive who now advises tech and electronics companies, including Beats competitor Sennheiser.
In the end, the key to the Apple-Beats deal may be the company's founders, Iovine and Dre, who will join Apple as music executives with yet-to-be-decided roles. Iovine, 61, began his career in the music business as a recording engineer for stars such as Bruce Springsteen and Tom Petty. Dre, 49, was a member of gangsta rappers N.W.A (Until Wednesday, Iovine was also the head of Interscope Records — the company's owner, Universal Music, announced longtime label executive John Janick would replace him.) Neither is a technology expert, although some have compared Iovine to Jobs, a marketing genius who relied on Steve Wozniak's innovations in co-founding Apple Computer.
"Jimmy is a marketing guy and he is a visionary and he is very well connected in the music business," says Noel Lee, founder of Monster Inc., the cable-and-electronics company whose equipment was the centerpiece of Beats due to an early manufacturing partnership. "The rest of it, as far as building a consumer electronics company, or engineering technology, he's going to have to go out and hire that." But the record-label source suggests this won't be a problem: "Steve [Jobs] was the crazy creative guy at the center of the company. A guy like Jimmy is a lot more in [Apple's] DNA."