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The $3 Billion Question: Why Did Apple Buy Beats?

Apple did not forget about Dre. But was it worth it? A look at why Apple splurged on Beats.
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In the post-Jobs era, did Apple just drop $3 billion on cool?

That's the ticket price on the company's purchase of Beats Electronics and Beats Music, it was announced on Wednesday at the Code Conference in Los Angeles. And yes, Dr. Dre himself and Beats co-founder and music industry bigwig Jimmy Iovine will be brought into the fold as official Apple employees, lending some street cred to a company that, despite its ubiquity, can still get a tad nerdy.

Apple's got plenty of cash to burn, and every incentive to ward off the "square" label that's been attached to companies like Microsoft and Blackberry. Still, not everyone's sold on the deal. Critics have complained that brightly colored Beats headphones clash with Apple’s clean, understated design philosophy. And really, couldn't Apple, with the past success of iTunes, have developed a streaming service on its own? Why spend $3 billion?

(Hint: It has something to do with celebrities).

Streaming is the Future

Before the purchase was final, analysts speculated that Apple was more interested in streaming music than headphones.

Look all the way back to 2003, when the iTunes store seemed revolutionary. Over the following decade, music downloads climbed as CD sales dropped. But last year, for the first time since iTunes was launched, digital album sales actually dropped along with CD sales.

"Music is dying in the way that we've known it," Eddy Cue, Apple’s senior vice president of Internet software, told a crowd at Code Conference. "It hasn't been growing in the way that we all want it to."

Meanwhile, streaming is on the rise. Last year, digital track sales fell by 6 percent, while streaming music consumption skyrocketed by 32 percent, according to a report from venture capital firm Kleiner Perkins Caufield & Byers.

The biggest player in the subscription streaming game is Spotify, which recently announced it had 10 million paying subscribers. Industry estimates put the number of Beats Music subscribers at 250,000.

Of course, if Apple wanted to build its own Spotify competitor, it probably could. In fact, Apple CEO Tim Cook told Re/Code that the company "could build about anything that you could dream of," adding that acquiring Beats would give them a "head start" and add "kindred spirits" to company. To outsiders, however, $3 billion seems like a lot to spend for a couple cool dudes and a fraction of Spotify's subscriber numbers.

Headphones That Stand Out

Beats Electronics makes headphones. They are not exactly the most well-reviewed headphones, or the cheapest. But Beats sells a lot of them and makes a killing in the process.

They can cost as much as $450, yet only cost $14 to make, according to the New York Times. That profit margin has helped Beats rake in $11 billion in revenue last year. According to a report from the NPD Group, a marketing research firm, Beats owns 57 percent of the "premium" market of headphones that cost over $99.

Still, Apple has always prided itself on putting out sleek products that don't sacrifice functionality for flash. Beats has been lampooned for doing the exact opposite.

Star Power

Apple has three times as much cash on-hand as the U.S. Treasury. Its lead designer, Jonathan Ive, was knighted at Buckingham Palace.

So, yes, Apple could probably make waves in both the music subscription and premium headphone markets on its own. But Beats is very, very good at being cool.

Apple is not just interested in Jimmy Iovine, who started his career bringing John Lennon his tea, and Dr. Dre, one of the most famous hip-hop artists of all time. (Their official titles at Apple: "Jimmy" and "Dre.")

Specific celebrities go in and out of style all of the time.

"I think what Beats will bring is not just the Dr. Dre endorsement, but the discipline to develop a portfolio of celebrity endorsements," Sam Rosen, practice director at ABI Research, told NBC News.

Pop stars Lady Gaga and Nicki Minaj have released their own Beats headphones. Athletes like Richard Sherman, the superstar cornerback for the Seattle Seahawks, created a lot of buzz for Beats with a defiant commercial released shortly after he was criticized for trash-talking 49ers wide receiver Michael Crabtree after the NFC Championship game.

Everyone from Usher to Vampire Weekend have made playlists for Beats Music. In a crowded market, where streaming services and premium headphones have similar features, "you really have to focus on branding and celebrity endorsements," said Rosen.

"It will be a learning experience for them. It can provide a new brand halo that speaks to other consumers," he said. "I doubt Apple will regret it."