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What Apple is really buying with Beats

First published on http://www.theverge.com/

All that was missing was the sound of a record needle scratch: Apple is doing what? But the Financial Times’ report Thursday evening that the company plans to buy Beats Electronics for $3.2 billion — giving it a billion-dollar electronics brand and a functional Spotify competitor — soon was matched by several other outlets, and then by Dr. Dre himself. Apple seemingly appears on the precipice of making its biggest acquisition ever. So, what exactly is it buying?

In the short term, Apple acquires a fast-growing brand whose ability to sell electronics at a high premium is rivaled only by Apple itself. Beats, a six-year-old company whose founders include Dr. Dre and record executive Jimmy Iovine, is reportedly profitable on revenues that were said to exceed $1 billion last year. Beats entered the market in 2008 with $350 headphones, and five years later commanded 59 percent of the market for headphones that cost more than $99, according to NPD Group. Its revenues quintupled between 2010 and 2012, according to The Wall Street Journal.

Along the way, Beats came to colonize the Apple Store, where its products dominate the headphone table. Though critics generally panned their ham-fisted sound reproduction, the company’s bold designs and the endorsement of Dr. Dre helped transform premium audio from a geeky obsession of audiophiles to an affordable luxury craved by the masses. The company also showed a genius for marketing — when Iovine served as a judge on American Idol from 2011 to 2013, a product-placement deal put Beats headphones on display in front of millions every week. Over time, the company’s lowercase “b” logo replaced Apple’s iconic white earbuds as a status symbol for music lovers.

Acquiring Beats lets Apple begin selling a range of high-end accessories to its own best-selling devices, earning profit margins that can exceed its own. (A $200 pair of Beats Headphones is said to cost the manufacturer as little as $14.) It gives Apple control over a powerful new music brand that has proven especially popular with younger people. And if the Beats brand survives, there would seemingly be a huge opportunity for Apple to grow it globally.

And in the longer term, the Beats acquisition could give Apple a music service to rival Spotify. Apple is still the dominant seller of digital music, but the 99-cent downloads that it pioneered are declining as more people turn to streaming services like Pandora and Spotify. Sales of individual songs have declined 12 percent in the past year, according to Nielsen SoundScan. Steve Jobs famously hated the subscription model of online music, but the growth of such services indicates an appetite that Apple may no longer have been able to ignore. ReCode reports that revenues from iTunes Match (a cloud music locker) and iTunes Radio (a Pandora clone) have disappointed the music industry. Meanwhile Beats Music, which launched its all-access music service in January, is said to have acquired fewer than 200,000 followers despite a massive marketing campaign and a number of friendly deals with cellular carriers.

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