Apple + Beats = Genius

Let's not over-think this. Beats instantly makes the iPhone a better product. And that's worth billions to a company that's only growing because of the iPhone.
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British DJ Ruth Flowers appreciates the power of Beats, too. (Reuters)

Tech reporters used to complain that Apple wasn't spending its $100+ billion in cash. Now we're complaining that Apple is spending too much. Journalists really are wretched people.

Apple is buying Beats—a headphones juggernaut with a promising but unpopular streaming service—for $3.2 billion (2.3% of its cash), its biggest acquisition ever. The high and low on Beats is that it controls 70 percent of the market for premium headphones, and its streaming service is just 5 percent the size of Spotify. Still, analysts and tech journalists are flabbergasted and confused. Is this deal all about acquiring the headphone hardware of today or the cloud-based software of tomorrow? It's an interesting question: Digital sales declined last year for the first time ever, and it seems inevitable that the future of music will be streamed. But rather than being about hardware vs. software, I think this deal is more about the value of small advantages in the smartphone market, which now accounts for all of Apple's revenue growth.

Samsung and Apple both make nearly-equally fantastic devices, but the vast majority of high-end smartphone users are buying one or the other. In a zero-sum game between remarkably similar devices, small differences can determine where a consumer spends hundreds of dollars right now — and where she spends hundreds of dollars on future services and hardware once she joins or leaves the Apple family.

When the distinguishing features of the new Samsung phone are "you can drop it in a toilet" and a crappy heart-monitor thingy, it’s fairly clear we’ve reached the micro-tweak period of smartphone evolution. Samsung keeps promising us that the Next Big Thing is here, when in fact the future of smartphone development is more about the Next Little Thing. Slightly longer battery life. Slightly wider screen. Slightly better water resistance.  

What’s iPhone's Next Little Thing? Why not: the most popular premium headphones in the world (plus a promising streaming service)?

Headphones? Sure, headphones. Besides clothes, there are five things on my person each time I step out of my apartment: keys, wallet, watch, phone, and headphones. Apple already makes a best-in-class phone and is working on a best-in-class connected watch. But for reasons I won't even guess, it makes weirdly fragile plastic headphones. Owning the most popular premium headphone manufacturer means Apple is an iWatch away from producing the top high-end version of just about everything I carry around with me when I walk, besides a wallet (which is going to the cloud anyway) and keys (which, who cares). The implications of dominating the high-end ambulatory consumer market in a world where everything is going to mobile seem profound.

But we don't even have to extrapolate into a sci-fi future to justify this deal. iPhone vs. Samsung is a close call for millions of consumers. If {iPhone+Beats} vs. Samsung converts even a fraction of the market (or locks in a larger portion of the market), that spills over into higher use of Apple services and Apple devices down the line. Maybe they'll convert because of the hardware today. Maybe they'll convert because of the streaming software tomorrow. Doesn't matter. The bottom line is that Beats clearly makes the iPhone a better product right now in ways that aren't easily replicable and that's invaluable to a company that's only growing because more people are buying its expensive phones. So Beats' value to Apple is significantly more than its value as an independent company.

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Derek Thompson is a senior editor at The Atlantic, where he writes about economics, labor markets, and the entertainment business.

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