By Brett L. Sappington, Director of Research

On Thursday, The Wall Street Journal published an article reporting rumors that Apple was in discussions with pay-TV providers about the possibility of an Apple-branded set-top box (STB) that would carry live and on-demand content. According to the article, Apple proposed to provide the hardware and have pay-TV providers deliver the linear and on-demand content.

For Apple, which has made a strong business by leveraging content to sell hardware, this approach makes great sense. Studios and networks are greatly aware of the stranglehold that iTunes has had on the digital music market and are determined to not let Apple have too much sway in the video world. By partnering with pay-TV providers, Apple can avoid the thorny content negotiations process, leaving that unpleasant task to the pay-TV experts that can bring extensive purchasing power to bear at negotiation time. A partnership with pay-TV providers also allies Apple with the companies most likely to be strong, bitter rivals in a fight over video consumers.

While pay-TV providers may be wary of Apple, an Apple-branded STB is potentially mana from heaven for the TV service folks. Here is why:

-- Apple offers pay-TV providers a way out of the STB hardware business. Dealing with STB development, deployment, and support issues is a major expense for pay-TV providers. Many have made noise about wanting to eliminate the cost associated with STB hardware, but few viable alternatives (that are popular with consumers) have surfaced in the market. An Apple-branded STB could change the equation. With cloud-based delivery of the EPG and interactive services, pay-TV providers could still maintain their branding within the Apple box.

-- A hardware battle in the living room could help with subscriber numbers and OTT service alternatives. What is better than selling your own services? Why, having everyone else do it for you. If Apple does go this route, know that Microsoft (through their Xbox 360), Sony (via their Playstation 3), and other companies with designs on the living room will not fade quietly into the background. Instead, demand for partnerships with pay-TV providers should jump as everyone tries to get the biggest kids on the block on their team. Increased competition will lead to increased promotion for those devices (and for the content within those devices) -- all to the good for the companies providing the content service. As the primary content provider for the STB, pay-TV services could potentially bump the apps for Netflix and other OTT services from their spot as leading video apps on TV-connected platforms.

Ultimately, some challenges remain. Will pay-TV providers be willing to give up STB rental revenues? Will Apple and pay-TV providers be able to agree on which company controls which parts of the interface (and branding)? What type of revenue cut will Apple demand from pay-TV providers? However, for pay-TV providers, Apple provides an interesting and powerful ally at a time when innovation and transition are pulling at the edges of the TV services market.