A Beats acquisition could be big for Apple ‘hearables’

May 14, 2014, 5:27 PM UTC

FORTUNE — Last week, the Financial Times reported that Apple (AAPL) is in talks to acquire the trendy headphone and music streaming service Beats Electronics for $3.2 billion. The deal, which has yet to be confirmed by either party, drew both befuddlement and criticism from technology industry watchers.

For one, the acquisition would be Apple’s largest to date. And the logic of one revered brand buying another seemed broken, based on Apple’s history of acquiring smaller companies. New questions arrived quickly: Is this about reviving Apple’s cool factor? Is it about Apple’s reentry into the music-streaming race? Is it more about Beats co-founder Jimmy Iovine, a well-regarded music executive who could presumably take over Apple’s content strategy?

Or is the smaller company’s technology and approach best applied to Apple’s new product categories to which chief executive Tim Cook keeps alluding?

“I start from the assumption that Apple is a smart company,” Forrester analyst James McQuivey says. “That they wouldn’t be spending $3 billion for an accessories company or a music streaming business, but that they would spend it as part of a bigger plan to change our lives in the way that Apple has historically shown it likes to do and can do.”

The pressure is mounting on Cook, even as his company continues to be flush with cash. (Apple made $9.5 billion in profit last quarter.) The company arguably hasn’t introduced a pioneering new product since the iPad in 2010, instead focusing on refining its existing portfolio. Wearables seem to be the most promising new consumer technology, even as some analysts argue that margins for the ultra-portable devices are too thin for Apple’s taste.

But the evidence has begun to pile up. Last month, on the heels of various reports that Apple is quietly hiring experts from the fashion, fitness, and health industries, Nike CEO Mark Parker confirmed his company’s discontinuation of its FuelBand electronic wristband and exit from the category, at least as it pertains to hardware. Some suggest the move is an indication that Nike, a longtime Apple partner, plans to support an Apple wearable device. And in February, Apple was granted patents on devices that track performance metrics and amass biometric data through “headphones, earbuds or headsets.”

MORE: If you read one (more) thing about Apple buying Beats…

A so-called Apple iWatch has been rumored for years, especially after rival Samsung began selling its Galaxy Gear. But some analysts say that a “wearable” to Apple may rely on an entirely different body part. Much like Joaquin Phoenix in the futuristic film Her, some have hailed the idea of “hearables,” or wearables for your ear. Self-proclaimed “wireless evangelist” Nick Hunn writes that “hearables” could be worth more than $5 billion by 2018.

The ear presents an interesting environment for wireless sensors, says Atlas Wearables co-creator Peter Li. For one, biometric data is more accurately measured through the ear.

“You can certainly get much better biometrics from the ear,” Li says. “Especially from a heart rate perspective, it’s much easier to distinguish what your heart rate is without all the noise you get from the wrist. You also get much better resolution in terms of capillary in the ear.”

Today, Intel offers headphones that track a person’s heart rate and select music based on the user’s running pace and LG offers with its Lifeband Touch Activity Tracker headphones to track the user’s heart rate.

A formidable challenge for any wearable technology device is normalizing its use. Google’s (GOOG) Glass headset has been widely lampooned for how conspicuous it is; electronic wristbands have been more widely accepted. (Though it certainly helps that they are about 10% of the price of Glass.) But headphones are already a socially acceptable mainstay at the office, in transit, and during gym workouts. By most accounts, Beats controls about 70 percent of the high-end headphone market, and has helped accelerate a redefinition of studio-size, over-the-ear headphones as a lifestyle item.

“There’s not really any company [other than Beats] that Apple could acquire that could bring a pipeline of high-end products, and that they could potentially leverage into other wearable products that are already being developed by Apple,” says Tim Arcuri, an analyst at Cowen & Co.

MORE: The $3.2B Apple-Beats rumor: What the analysts are saying

Arcuri adds that the personalization engine at the heart of the Beats Music streaming music service, which blends recommendation algorithms with human curation, as further proof that the deal underscores the “humanization of data.” Beats Music launched earlier this year, and the company has mounted an aggressive campaign to thrust the service deep into the pool of music streaming competitors that include Pandora and Spotify. In short order, Beats partnered with AT&T (T) to offer family streaming plans and acquired Topspin Media, which helps musicians sell their music and merchandise to fans.

Connect the dots and it’s not unreasonable to see how Apple could make earphones or another wearable device that could serve up tracks based on the wearer’s heart rate, location, or mood. (It is not clear if Apple would have to renegotiate licensing terms with music labels for such a service.)

“I think Apple looks at it and say this could potentially change the paradigm around content delivery,” Arcuri says. “The way Beats looks at music delivery is an art, not a science. That’s how Apple thinks about things.”

And it plays into Apple’s cross-platform, user-centric approach to technology. “There’s a willingness,”  McQuivey says, “to give Apple permission to insert itself into our lives in a way that we don’t give to Microsoft or other companies.”

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