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It takes nearly $1 billion/yr to run iTunes

In recent articles I highlighted the acceleration in iTunes App downloads where the rate is approaching 18 million apps per day and the cumulative total apps which is about to overtake the cumulative songs downloaded.

We now turn our attention now to constructing the iTunes income statement: namely total sales, gross margins and deduce its operating budget.

Gross Sales

To obtain the top line (income) for iTunes we need to know the average selling price (ASP) for songs and for apps. Apps are easy, we received that info in June: $0.29 per app. For songs, it was easy before early last year: $0.99/song. After the selective price increase, the blended price needs to be estimated. I chose $1.10 for 2009 and $1.2 for 2010. These are just assumptions and can be adjusted but should give us a rough estimate:

I followed the convention of using income rate or $/month to show the history of sales. It shows that even with a price less than a third of the music product, apps are generating over half of the sales of music. In other words, apps are adding 50% to iTunes sales today. If the decline in music units continues and the app sales increase with the current trajectory then app sales value will overtake music sales next year, consistent with the cross-over of cumulative units sold.

Gross Margin

If we know how much Apple pays music licensors and developers (i.e. cost of goods sold) we can calculate how much it keeps for operations (gross margin). Apple’s app margin is 30 percent. The music margin was never official but the consensus has been 10 percent for a while.

Using these figures, we get the following chart:

This shows that what is left after paying the content license, Apple “keeps” about $50 million every month to run the App store (iTAS) and another $30 million to run the Music store (iTMS).

The Operating Budget

Apple has made a point of saying that both iTAS and iTMS are run at “break even” implying that the gross margin is used up in operating costs (CAPEX, R&D, SG&A). To be sure, the cost of bandwidth and the data center(s) needed must be considerable.

But the operating budget for the store is beginning to reach a level that may be beyond what can be spent reasonably. The amount left over for operations has increased from ~$30 million a month in 2009 to $75 million/month today.

In fact, if this burn rate is maintained (even though it’s increasing) the operating budget for iTunes is nearing $1 billion/yr.

I’m not an expert on the cost of operating data centers but $ 1billion a year seems like a lot. I would love to see an analysis of how this could be allocated.

Implications

I would also add that because of the increasing mix of apps, the overall gross margin percent is increasing. I estimate that to be a blended 17%–a healthy margin for a content store–and an increase from 10% before the app store came online.

Finally, one implication of the economics involved is that a budget like this may provide a significant barrier to entry for any competitors looking to take on the iTunes juggernaut. iTunes has reached content critical mass (12 million songs), user base (160 million users) and wide distribution (23 countries for songs and 80+ countries for apps).

These are non-trivial operational issues that even the best in the “cloud” business models will find challenging.

Footnote:

This discussion excludes video sales, rentals, book sales as we don’t have solid histories for these product lines. However, we can do a spot check on the cumulative totals:

  • 450 million TV episodes downloaded implies $1 billion in sales.
  • 100 million movies downloaded probably adds at least another $1 billion
  • 35 million books adds another 500 million.
  • Compare with 11.7 billion songs at ASP of $1 for about $12 billion in song sales and 6.5 billion apps at ASP of $0.29 or about $1.9 billion.

iTMS content downloads have generated $16.4 billion in sales to date.

  • Stu

    Just so I'm clear on what you're saying.

    It's not that Apple *is* spending ~$1B/yr on iTunes, but that based on past income & expenses (of apps & music only!), that's what they're budgeting to spend. And your premise is: That's beyond reasonable, so where is the excess cash going to go?

    Also, that because of these very high costs, other app/music stores are going to be difficult to maintain/implement.

    • http://www.asymco.com asymco

      You have to take Apple management at their word. If they are not telling the truth, they are personally liable to shareholder lawsuits. Therefore I am *obliged* to believe that they spend nearly $1 billion on iTunes infrastructure.

      Of course there is the possibility of being "creative" with the accounting of costs.

      To me, the numbers do point to something beyond what would normally be expected. I leave the explanation to others as I'm not an expert.

  • Rob Scott

    So Google will burn $1 billion to make create an iTunes equivalent so to make Android competitive with iPhone. And Google makes how much per device sold? Eric once suggested that $10 for a billion device will be $10 billion for Google.

    This Google venture look dicey every day.

    • http://www.asymco.com asymco

      All good business models are simple. Beware of complex business plans.

      • Steven Noyes

        It worked for Enron… I mean Freddi Mac… I mean Fannie Mae… Oh never mind.

        BTW: I love the work you do on this sight. It is so much more than a simple regurgitation of existing data.

  • Jason

    I find it interesting to see the noticeable decline in music sales after the mixed pricing structure was implemented in iTunes. Another sign that the aging music labels simply don't "get it". While I doubt that Apple will be able to switch back to a flat 99¢ price for everything, it seems obvious to me that Apple relented in giving the labels enough rope to hang themselves.

    After another quarter or two when it is painfully clear how "well" the new mixed prices are going, it should give Apple plenty of clout to resist another cash grab attempt by the labels (no doubt when they start complaining that digital downloads are on the decline).

    • RattyUK

      Unfortunately you know how this will play out. The companies will insist on raising the prices to make up for the shortfall. Meanwhile bands will back out of deals and move towards dealing with Apple directly.

      • Jason

        That would be ideal – cut out the middle-man entirely. Granted, some artists do benefit from promotion and financial backing that some get from the labels, but hopefully someday soon we can get more of a direct connection to the artist – they create the music we want to hear, and we pay them for their valued work. Most artists don't make anything on CD or download sales anyway.

      • famousringo

        I found an infographic on what artists and labels get from various music sales:

        http://mashable.com/2010/04/15/music-artists-earn

        If accurate, it shows a couple of very interesting things:

        - Record labels make three times as much from a downloaded album as a retail album. What a shameless cash grab to demand that the consumer pay even more for music.

        - Artists could earn seven times as much money by dealing with Apple directly rather than through a label, assuming they can sell as many units.

        So how much is all that marketing clout the labels provide really worth to the artist? In a future where there might not be any content sold at retail, labels need to either sell 7 times more product than the artist can sell, or they need to give the artist a better slice.

    • Steven Noyes

      The drop in music consumption also corresponds with the sharp rise in increased consumption of applications. If we assume that people have a set amount of disposable income each month to twitter away (yes I know twitter is free) then as app purchases increased something else had to give.

      What this means is applications are the new media consumable. Great, that makes me a grade B actor/extra;-)

      • Jason

        That's an excellent point – I hadn't thought of that.

        One thing I will say from experience is that there is a definite psychological benefit to "under a buck" pricing than there is to anything over. When I peruse the App store, if I see a decent title that has a mid-range rating and is only a buck, I don't think much about purchasing it – whereas if it is 1.99 or over, I tend to prefer apps that have very solid (4-5 star) ratings and non-spammed reviews.

        I find the same effect at play when looking for new music. I find it much easier to "experiment" with music at 99¢ than with whole albums or $1.29 tracks (fortunately for me, a lot of music I like is 99¢ still).

    • iOSWeekly

      Music sales are significantly higher than they were just 24 months ago – and the average song price has increased – those figures are not exactly dismal for the music industry.

  • Vertti

    Apple is building a 1 Billion dollar data center in Maiden North Carolina.
    So I would asume that the money goes to ramping up the data center capacity.
    They need the money to expand the data centers at the same rate as their sales (iOs and Mac Os X) do.

  • JonathanU

    Asymco, v. useful analysis as ever.

    Just wanted to add one cost which I don't think you mention in the article, which is also fairly significant, is that of credit card processing fees. I am no expert on this either, but a credit card transaction for $.99 is fairly punchy. This also pushes up SG&A significantly alongside data centre capex and bandwith etc.

    I did see an article a few months back on Apple 2.0 from one of the investment banks – the analyst did an analysis on app store profitability. Will try and dig it out and post it here as it might be of use…

    • Vertti

      That is why Apple does not charge every 0.99 purchase separately. They bundle it up to something $20 or more. But you are right, it is an expensive part of the store. If I remember right they use American Express to do the transactions.

      • JonathanU

        Agreed – however this clearly depends on how much each person spends in the iTunes store and App Store per month (or per time period that they can bundle purchases together; I would venture it is shorter than one month, but I may be wrong). Similarly it stands to reason that a lot of apps are bought as a one off impulse buy every now and then, rather than a large number of purchases in a short space of time etc. Therefore there is probably not as much bundling of purchases together into each credit card transaction as you might expect.

    • JonathanU

      http://tech.fortune.cnn.com/2010/06/23/app-store-

      Found it – this is clearly just as much of a guess from Gene Munster as the next person, but it is at least some food for thought.

      • http://www.asymco.com asymco

        15% for CC processing seems enormous given the ability to aggregate purchases.

    • http://www.asymco.com asymco

      Right, though I'm sure that with billions of transactions, they are able to get a volume discount. The cost is not zero but I would put it at far less than 10%.

      • JonathanU

        Agreed – I don't see why credit card processing fees would be any more than the standard 1% to 2% like any other credit card transaction? All the blogs I have read on this subject never seem to drill down into this and always assume the CC processing fees would be high.

      • skips

        There are a number of problems with assuming that the credit card costs are minimal.

        1. The 1-2 percent number is correct for the discount that brick and mortar retailers pay for "card present" transactions. Larger retailers get the lower end of this range and smaller ones the higher end. "Card not present" transactions, which Apple must use, typically have discount rates 2-4 times larger due to the higher cost of fraudulent transactions.

        2. Credit card fees are based on the number of transactions and are not dependent on the total value. These costs dominate for transactions, which have a small value, ( and are the reason that some businesses will not accept credit cards for small value transactions). Typically the cross over point between these costs (discount verses fees) occurs around $5.00.

        3. Consolidation of transactions cannot be done between different accounts (i.e., credit card numbers) or between different nor between different reconciliation periods (normally 24 hours). Failing to reconcile transactions in a timely manner normally has significant penalties associated with it.

        4. Any "bonuses" or "perks" that are due to the card holder must be absorbed by the retailer and may not be passed on to the customer. If the card pays the cardholder a 1 percent reward, the retailer sees an additional 1 percent fee on the transaction.

        Because of these features of the credit card system, a retailer can see the cost of accepting a credit card be as high as 10 to 15 percent of a one dollar purchase.

  • http://www.ecolojic.com Joshua

    Personally, I hope they spend some of that $1B on the steaming pile that is iTunes the application – especially the Windows port.

    • Vertti

      Get a Mac. Problem solved.

    • Tom

      Or an iPad!

    • Rob Scott

      I don't know. I enjoy iTunes on Windows. If iTunes is that bad for you maybe you should use the bundled media player and only use iTunes to synch or buy tracks.

  • kevin

    Horace, where did you get the 10%? I haven't looked recently, but back when there were iTunes music store competitors, there were several articles that had Apple taking 30% (and giving the labels 70%). Apple's 30% was mostly used to run the store (bandwidth, storage, marketing, website/editorial, transaction fees, referrals, etc).

    • http://www.asymco.com asymco

      The 10% is after "variable costs" meaning transaction costs and most bandwidth costs.

      • Vertti

        Normal Visa is about 0,5% of the the revenue? So if there is a 100€ transaction the cost for the credit card is 0,50€. Can't remember the exact figure now so please correct me when I am wrong :)

  • Iphoned

    I posted this comment accidentally on the wrong blog post… reposting here…

    Horace – your chart shows about $310m revenue/month for iTunes or I suppose about $1.2b a year.

    Yet Apples earning releases report about $1.2b a quarter in “other music related products and services” which they clarify as ” iTunes Store sales, iPod services, and Apple-branded and third-party iPod accessories”.

    I assume that’s mostly iTunes downloads, and thus about $5b+ a year revenue.
    So that’s 4x your estimate.

    Thoughts?

    • http://www.asymco.com asymco

      Thanks for doing the loopback with Apple's financials. The "Music" line item in the income statement does say $1.2b in sales for Q2. My estimates are for Music and Apps which total about $485 million/mo in sales for June period. That seems a bit high ($1.46 billion if we assume 3xmonthly). However, the rate of downloads changes a lot during a given period of time which means the rate in Sept will be much higher and not comparable with what we saw on average March to June.

  • famousringo

    I don't think $0.99 was ever a good estimate for the ASP of an iTunes song. In addition to a lot of free promotional tracks which Apple may include when discussing song downloads, a lot of songs get bundled into album purchases. I've personally bought an album for $9.99 which included 30 tracks, and I'm sure they all get reported as paid downloads even though the ASP was only $0.33 per track.

    Things were messy even before variable song pricing showed up.

  • Pat Smellie

    Back in 2007 Pacific Crest did an estimate for songs. They estimated for a .99 song network fee .05, transaction fee .10,and store operating expenses of .05
    http://www.appleinsider.com/articles/07/04/23/itu

    • http://www.asymco.com asymco

      "Based on those cost estimates per song, Hargreaves arrived at the 10 percent margin estimate." That's about what I remembered. Let's keep in mind that there is always a margin of error.

      One thing about the model above is that the ASP and margin on music are the only significant assumptions. There are some time variances in the rates I used but I'm pretty confident in the conclusions and implications. Put another way, it rarely gets this clear-cut.

  • David Chu

    Is anyone an expert in data centers?

    One of the core assets of Google is their massive server farms which are designed as a distributed model (lots of cheap servers located in many locations). It would be interesting to see what kinds of advantages/disadvantages Google has versus Apple who has a centralized location.

    • don

      Akamai is a big part of Apple's content distribution network. Even with centralized data centers, Akamai allows localized servers in different regions to speed up distribution, especially when delivering downloads of purchased content. Apple reportedly owns over a billion dollars in Akamai stock and was rumored at one point to be interested in acquiring them.

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  • Vertti

    "6.5 billion apps at ASP of $0.29 or about $1.2 billion."

    $0,29*6500 000 000 is $1 885 000 000?

    Steve Jobs has several times said that Apple has already paid more than a billion dollars to the devolopers and when we remember that Apple keeps 30% and developers gets 70%… so the 1.2 billion dollar amount must be wrong by couble of hundred million. It should be over 1,4 billion.

    So what number is right? :)

    • Vertti

      This is the luxury with the Apple that we can toss a billion here and billion there almost like Steve Jobs & Co. You can't do that with Nokia :P

    • http://www.asymco.com asymco

      Fixed. What's a billion among friends…

      • Vertti

        Right :D
        Don't want to be picky, but now the numbers don't add up :(

        1 billion + 1 billion + 1/2 billion + 12 billion + 1.9 billion is 16.4 billion and not 15.7 billion :)

      • http://www.asymco.com asymco

        Do be picky. Thanks for pointing out errors.

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  • Vertti

    IMHO Apple is using significant amount of money to the "hard" infrastructure of the iTMS and iTAS. If you think about it is something that has to be done ASAP. iOS devices opened the "flood gates" and the new things like Ping eats data center capacity very quickly and the Maiden facility is not yet operational.
    100% jump in the sales means 100% jump in the server side.

    Have you noticed that Nokia is talking lots about services, but they are not building any infrastructure like Apple and Google are.

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  • http://2hphotography.ca hagen

    As you admit, you are not an expert, why even add the 'seems like a lot.'. That is unprofessional in an article where you are claiming to reconstruct op costs. And why not do the same for a server farm and have no ambiguity?

    Anyway, server costs are _massively_ expensive. The hi-tech company where I work spends $2M on electricity alone for 1000 people. 45% of that is for the servers. So say $1000 per person. Assume 1 person's emails, file management etc is equivalent to 1000 itunes customers. Using the 160 itunes accounts you mentioned, that's $160M just in electricity. Add in facility costs, server costs (completely replace every three years), staff (a very expensive part)…$1B is realistic.

    Another way to check figures: how much does it cost to run google: they are entirely driven by server costs: they've a depreciation of $530M, $731M in capital, and $1B in SG&A. So $1B for itunes? Sure why not, seems reasonable

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  • AA

    Horace,

    Great analysis. I've been lurking for a while here, and I'm impressed with the quality and level of analysis. Great job.

    One point though. You point out:
    QUOTE
    But the operating budget for the store is beginning to reach a level that may be beyond what can be spent reasonably. The amount left over for operations has increased from ~$30 million a month in 2009 to $75 million/month today.
    In fact, if this burn rate is maintained (even though it’s increasing) the operating budget for iTunes is nearing $1 billion/yr. /END QUOTE

    I'm not entirely sure that the opex for running the store / data center is linearly related to the # of downloads. In general, costs of bandwidth and data center capacity is a staggered function, not linear. Even if one assumes that it cost Apple $30M/month to run the store (on avg, in 2009), how likely is it that the cost will increase in direct/linear proportion to the # of app downloads? Both hardware (e.g. servers, network equipment) and bandwidth performance increases *more* than linearly for an equal increase in cost.

    I do agree with most of the implications.. that the Appstore / iTunes store erect formidable barriers for entry to anyone else. For competitors to respond, only those with comparable scale can respond meaningfully. Ergo, think Google, Microsoft. (and we know where both are going…).

    Thanks

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  • skips

    “If we know how much Apple pays music licensors and developers (i.e. cost of goods sold) we can calculate how much it keeps for operations (gross margin). Apple’s app margin is 30 percent. The music margin was never official but the consensus has been 10 percent for a while.”

    I do not believe that these statements are correct.
    1. Apple has clearly stated that it renumerates content providers with 70 percent of the revenue for both applications and music. If you read the provider information, it implies that this rate applies to all content.
    2. The cost of goods computation is effectively identical for both applications and music because these items differ only in how they are consumed by the user and not in how they are acquired by Apple.

    The cost of the transaction and delivery are operating expenses (at least my accountant treats them that way). To first order the "cost of goods" for aps and music should be the same.

    I suspect that the operating costs are similar with only one minor exception: the cost of the credit card transaction contains a component that is a percentage of the total value of the transaction. For large transactions, this component dominates and for small ones the fees, which are a fixed amount per transaction, dominate. It is true that Apple can consolidate transactions to minimize the fixed costs, however, the banks limit this consolidation to one credit card number and one 24 hour period. Multiple cards may not be consolidated and there are significant penalties for attempting to consolidate transactions that were made in separate 24 hour periods.

    All of these issues make attempts to determine the profitability of these stores rather difficult. None the less I would expect that at present the music sales are generating significantly more gross profit than the aps.

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