Apple blows a hole in the Mobile Music Landscape
At its recent MacWorld conference, Apple made three key changes to its iTunes music services offering: DRM free distribution, wireless downloads and variable pricing. A year ago, iTunes looked like a business under pressure. But these changes make the mobile operators' and Nokia's "Comes with Music" propositions look poor in comparison. In the article below we explore why this is the case and the significant new challenges faced by telcos involved in the content business.
Goodbye Sideloading and WiFi downloading...
Pre-MacWorld, Apple didn't have the permission to download music tracks to the iPhone via its partner mobile networks, either 2G or 3G. This was not because Apple didn't have the capability. After all Apple already sell games through the iTunes store to directly download to the handset. It was a licensing issue with the music labels.
Most users moved music onto their phone by synchronising with their iTunes library on their desktop. Purchases were possible over a WiFi network, direct downloading the music to their handsets. For an user, it must have always seemed strange that downloads weren't possible over the mobile network. More importantly, the ban on 2G/3G wireless downloads will have created a barrier for impulse purchases whilst on the move.
Although hard to quantify, the music labels knew they were losing revenue with the restrictions and Apple definitely knew the user-experience was less than perfect. Now, an iTunes user can buy music either at home, work or on the move and copy it onto whatever device they want - whether iPhone, iPod, desktop or laptop.
...Hello Dumb Pipe
Effectively, the mobile operator is reduced to just selling a data plan to the user. There is little difference between the mobile ISP role and the broadband provider role - they are just a dumb pipe and have been excluded from any potential upstream revenues.
Apple's mobile partners will struggle to recover from being just a dumb pipe. Even a really basic service like payments can be difficult to make attractive to iTunes. Apple already have 75m iTunes accounts with credit card details. Effectively the mobile operators' payment services are competing against credit card processing fees.
Music as a Zero Profit Service for Apple
In the early days, Apple claimed its music service was a zero margin game. These days very little is said. The previous assumption was that Apple made its profits by selling devices and the music itself could be sold not at a loss but at zero profit. Apple is now the biggest digital music retailer in the world selling over six billions songs since inception and one billion in the last five months. At current run rates (and 99 cents pricing) that is an annualised business with around US$2.4bn in revenues.
To put this in perspective, the total worldwide Music Retail revenues in 2007 was US$29.9bn, with digital accounting for US$2.9bn. In other words, Apple has a huge global market share and with that comes huge negotiating power.
The gross margins that Apple earns on its download store for third party application are public knowledge - 30% of gross revenues. Music margins are less public and more complicated because of the licensing, but we think it is fair to assume that Apple is aspiring towards music downloads as a profitable service in its own right.
Economic Rationality of Variable Pricing
Many commentators have said that Apple has made a huge concession to the music labels by introducing variable pricing. We see this as more market reality than a huge concession.
Apple itself already has variable pricing for its third party applications. It becomes a really hard sell to the music labels to say that Apple should set the price on music when it doesn't do it for third party applications.
But probably more important than this is the realities of the laws of supply and demand - you can charge a higher price for items in demand and lower the price of items with little demand to stimulate demand. Will Page, chief economist of the MCPS-PRS (artists' collecting society), recently revealed data that showed the majority of online catalogues had zero demand. It is merely rational behaviour to reduce the price of these items to try and stimulate demand.
It is interesting to see how Amazon is taking a different spin on this by promoting and reducing the price of albums. It has long been known that the rise of digital has broken the bundle of the album. So rather than selling ten tracks in the physical world, consumers only buy the one or two hits in the online world. Why not recreate the bundle, promote it and sell for as little as US$3?
The removable of DRM-protection from the Apple downloads was inevitable, once the major record labels had allowed Amazon to sell MP3 formats without protection. DRM-free downloads are a huge game changer, because they remove the tying of content to a particular device and we believe removes the incentive to cross-subsidise music, whether from contract bundles or device sales.
This blows a complete hole in the Nokia "Comes with Music" strategy - bundling music with the device and only allowing portability between Nokia devices. If music is DRM-free and portable, the attraction of buying another Nokia device in order to keep accessing your content is removed. Effectively, the customer retention rationale is removed.
Mobile Operators have a similar challenge when including music within a contact bundle. Music is not longer a retention tool if the consumer can still retain it at the end of a contract. There is still a large music opportunity within the prepaid market for the operators, but the operators will probably have to be extremely creative, including bundling postage (data usage) and possibly sponsorship to match the pricing of the largest music retailers (Apple & Amazon)
Challenging times for the rental model
We believe subscription services or a rental option are still attractive to a niche audience - especially parents worried about their children illegally downloading content. The technical challenge becomes how to protect content so that it only available for the rental period and plays on a wide range of devices and music players.
However, we believe that the preferred option for consumers will be to build a catalogue of owned music. The rental model will only work if the pricing is at a substantial discount to ownership.
In addition, the rise of streaming services such as Spotify offers a real alternative to operator-subscription services. It is only a matter of time, before these become available wirelessly as well as on fixed networks.
Ramifications of an increasingly OTT world
Mobile Operators have always included in their business plans revenues from upstream 3rd parties and value-added services to their customers. The Apple ecosystem offers a counterfactual to this theory and illustrates that the mobile internet could move in exactly the same direction as the fixed internet where "Over the Top" players gain a large chunk of the upstream revenues.
We believe that, just as in the physical world, the spoils are shared between the best retailers and best content producers - physical distribution is a very marginal business. Apple will be more frightened about the challenge from Amazon and Google than the network operators.
In addition, we see that the lines are blurring between fixed and wireless networks in the market for content. Both Apple and Amazon have set the expectation that the content price will be the same and that retailers will operate across multiple access networks and geographic footprints.
This means that there will be fewer (any?) protective barriers between the fixed (i-Tunes, Amazon) world and the mobile world. The mobility premium for content sales disappears.
Challenging times ahead for the networks...
[Ed. - these themes will be informing our research agenda for 2009 and will be explored at our next event on 6-7 May in Nice, co-located with the TM Forum's Management World]