Why Apple Should Avoid Internet Radio

Apple (NAS: AAPL) made waves recently when it announced plans to enter the Internet radio market. Two weeks ago, the tech titan revealed it had started negotiating licensing agreements for its own streaming service. The market responded by sending shares of Pandora (NYS: P) down 17% that day, apparently saying, "What Apple wants, Apple gets."

But the move seems like a bit strange for the Cupertino Colossus. While Apple helped remake the music industry with the iPod and iTunes, Internet radio is very different racket than the iTunes model, with most revenue coming from advertising. Unlike rival Google (NAS: GOOG) , for example, advertising has never been a major part of Apple's repertoire, and making inroads in local advertising, as Pandora is doing, requires the boots on the ground -- not one of Apple's immediate strengths.

More important, though, no company, not Pandora or its European cousin Spotify, has yet to prove that Internet radio can actually be a profitable business. Spotify lost $57 million last year, while Pandora posted a $5.4 million loss in its most recent quarter, which was considered a success. Since its founding in 2000, Pandora has lost over $100 million.

Despite Apple's brand strength, size, and cash hoard, it's hard to see what exactly its advantage in this area would be. Perhaps it could leverage better licensing arrangements, as content costs have made the financial equation difficult for these streaming services; but the record labels will likely want to encourage competition, which means they'd be unlikely to give Apple a sweetheart deal, especially considering its size.

Despite their lack of profitability, Pandora and Spotify are well-liked by fans. Switching costs could be higher than they appear. Pandora listeners, which now number 55 million, have put in time and effort to customize their own list of stations, and some have signed up for full-year subscriptions. Spotify devotees have made similar commitments. In terms of quality, the bar has been set high by these two companies.

Finally, this move seems to represent a step away from Apple's strengths in hardware. The company has risen to dominance by creating innovative and top-of-the-line products, starting with the iPod, and continuing with the iPhone and iPad. Investors should be hoping to see more groundbreaking gadgets, such as Apple TV or the iPad Mini, as opposed to growth from acquisitions or tangential revenue streams like Internet radio. Pandora, the industry leader, still has a market cap of under $2 billion, mere pennies in Apple's world.

The streaming service could serve as a feature in a bundling package to help sell more iPads or iPhones, but it also smacks a bit of the overreach critics have charged the company with in jettisoning Google Maps in favor of its own mapping service.

For now, any introduction of an Apple streaming service is likely months away, and the company's decision to avoid it during its iPhone 5 presentation may indicate that it's trying to downplay the move. Regardless, this will be a closely-watched development in the digital music space, even if it won't move Apple's bottom line.

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Fool contributorJeremy Bowmanowns shares of Apple. The Motley Fool owns shares of Apple and Google. Motley Fool newsletter services have recommended buying shares of Google and Apple. Motley Fool newsletter services have also recommended creating a bull call spread position in Apple. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.

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