A year or so ago, I started writing a post thinking through the AppleTV business, and how it related to the iPod business. I never finished the post, and I never felt like I quite had a hold on all the pieces.

One thing I did conclude though, was that the margins on the AppleTV would improve significantly in the space of a year or so. My rationale was that the hardware requirements of the AppleTV were largely tied to the demands of HD video playback, which given the dynamics of the consumer electronics industry, were pretty much fixed. As a result, Apple wouldn’t feel much pressure to upgrade the hardware, other than the storage, and so they could ride Moore’s law on down as the CPU and video chips declined in cost and then merged into a single chip.

My other thought was that Apple would also have the option of giving up some of their improving margins in order to improve the graphics capabilities of the AppleTV and make it a platform for more interactive entertainment, like video games. This is, of course, a tough market to enter, but its something Apple will likely have to confront at some point since the both Sony and Microsoft have other ambitions for the living room beyond high-end console gaming. A reasonably capable AppleTV would be capable of running a lot of existing Mac games, and might persuade more developers to do Mac versions of games.

I was reminded of all of this because of a recent rumor that Apple was planning on releasing a line of network-capable flat panel TVs with AppleTV functionality. I hadn’t considered this before, but in retrospect, its a natural progression that takes advantage of the declining costs of AppleTV hardware, Apple’s existing relationships with flat panel manufacturers, and the strength of their position in the entertainment market with the combination of the iPod and iTunes.

We’ll see if it turns out to be true.