Does the Apple TV need 1080p?
Notwithstanding (slightly dubious) recent rumours of a new video codec capable of pushing out 4096x2160, iTunes today can only offer high definition video in 720p. To move that to 1080p would require 2.25 times more disk space on the iTunes servers and the same increase in data bandwidth between those servers and the paying customers. Those are not cheap investments.
In turn, consumers would see a similar increase in streaming requirements. Xbox Live can stream 1080p video, but it requires 8-10meg broadband, which leaves an awful lot of people out in the cold. It has the option of downloading instead, but if you're out in the sticks on a 2meg stream you're looking at more than eight hours to download your film at 1080p. You'd best plan your Friday night viewing before leaving for work on Friday morning.
Would 1080p video be a significant upgrade for ordinary consumers compared to 720p? Probably not. At typical screen sizes and viewing distances (say, sitting eight feet from a 40" screen) the extra visual fidelity is quite subtle. I can certainly see it, and I get plenty of chance to do so as I move back and forth between Bluray content at 1080p and console games at 720p; but it's not the night-and-day step up that moving away from standard definition is. For most people with typical Internet connections, the extra pretties probably aren't worth the extra download time.
Would 1080p video attract more videophiles, though? Again, probably not. Let's assume a hypothetical iTunes 1080p format roughly equivalent to the Xbox 360 one, which weighs in at around 5-10Gb depending on the length of the film. This is still far short of the 20-30Gb that a Blu-ray disc will typically devote to the film itself, and with that comes a drop in visual quality -- again, one that's fairly subtle, but by definition if you target the videophiles you have to cater to some demanding customers.
So no, videophiles would continue to favour disk formats for their film watching. I certainly would, although my reason for preferring Blu-rays isn't because I'm some sort of gourmet movie watcher (I watch too many films with Jason Statham in to claim that title with a straight face) but is mostly because I have bitrate OCD and I am irrationally reassured by watching the best quality possible.
But what about other content? So far we've only talked on content coming from the iTunes store, rather than, say, content streamed over a network from a computer. Well, the plain fact is that Apple isn't making any money from that content. In fact, let's be honest with ourselves and admit many people with Boxee or XBMC on their Apple TVs are mostly streaming bootleg videos they've grabbed from BitTorrent; no-one's making any money off that. If Engadget's scoop is accurate, this new device will cost just $99; we're clearly in a razors-and-blades business model here and Apple will push iTunes purchases through this device as hard as possible. The company has no margin in supporting anything beyond that.
And finally, there's that price point of just $99; that's not very much. Processing 1080p instead of 720p needs more powerful processors which cost more to make. This is clearly a budget-conscious device and there can't be much wriggle room in that budget.
There's a lot of reasons Apple wouldn't want to bother with supporting 1080p, and very few reasons why it would.
UPDATE: commenter Jack Bauer has pointed out his current-model Apple TV offers a 1080i output mode. Whilst that's true, it causes the device to upscale the same old 720p content and doesn't actually increase picture quality at all -- in fact, introducing interlacing might well make it look worse. It's mostly there to maintain compatibility with older TVs that only support 1080i. In general you want any devices between your video content and your TV itself to pass the signal through without modification, so if you're watching HD iTunes content, you're better off setting your Apple TV to 720p.
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