profitability of iTMS

Per Coolfer:

In the New York Times’ Bits blog, Saul Hansell makes a case that iTunes may be Apple’s best business segment.

Last year, PacificCrest analyst Andy Hargreaves estimated iTunes’ operating margin to be 10% and possibly as high as 15% (it would be better today due to the increases in volume). Earlier this year, Billboard’s Ed Christman estimated $161 million to $390 million of operating profit on revenue of $1.9 billion. That comes out to an operating margin of 8.5 to 20%.

Whatever the true operating margin, we can safely assume iTunes is making money hand over fist. Steve Jobs might downplay its success, but we shouldn’t.

I’ll buy Hansell’s argument that the iTunes music store is contributing a nice chunk of $$$ to the bottom line, but I want to point out that operating margin isn’t the only part of the equation: opportunity cost matters. If Apple could earn more by investing that same money in, for example, a search engine, it’s losing money by accepting the lower rate of return.

Also, I want to point out the subtext of the conversation. Coolfer is generally a conservative on music industry issues, and Hansell’s argument would tend to support the conservative perspective. The trad recording industry is deeply committed to per-piece unit sales as their main line of business. They’re seeing the internet as a new distribution channel for download sales, not as a way to upsell concerts, merch, and whatever an advertiser thinks they can move.

I’ve argued in the past that ad-sponsored streaming is the way it’s all going, and that downloads will become a profitable but small part of the market. I’m supporting that view by not fully accepting Hansell’s argument. (And my perspective is what the tech industry wants to hear, because big internet companies are all about advertising).

While I’m pointing out who has what axe to grind, it’s important to know that Billboard is more or less the house organ of the big record and movie companies. If they’re estimating X profit margin for Apple, and the record companies are feeling bilked, X is probably high. iTMS gross revenues probably reached a big enough scale last year that the proportion of fixed cost to marginal cost probably went to zero; that proportion doesn’t keep improving once the fixed cost is a negligible part of the whole.

On the whole, though, I do buy the argument that the iTunes Music Store is a decent if not great business.