How Apple Will Frustrate Music Subscription Moguls

CNN Money has a fairly thin story about how the CEO of INTENT MediaWorks believes Apple is preparing to offer a subscription music service within the next six months. In his own words:

I think Apple is seriously considering a subscription offering right now even though they will probably tell you otherwise,” he said.

But I think the real motivation behind the subscription idea isn't Apple, but the record companies, as analyst Phil Leigh of Inside Digital Media notes:

"Record labels would like a subscription service. They, like anyone else, like recurring revenue. Ringing the cash register every month is a beautiful way to run a business," Leigh said.

Just as the RIAA starts another round of lawsuits against its customers under the battlecry "Piracy!" every few months, the concept of subscriptions on iTunes appears about as perennially as weeds. But while some consumers may find the concept attractive in theory, for Apple, this strategy just doesn't work for three reasons:

1. Subscriptions require Digital Rights Management [DRM] that turns off consumers. How many times do people have to hear Steve Jobs oppose DRM before they believe him? A subscription music service doesn't work without DRM enforcement of the subscription terms. Jobs is on record as saying he'd like to get rid of the cost and complexity of rights-managed music, yet subscriptions would take the company back into that business model that he (and others including me) considers fundamentally flawed. And how would he explain Apple re-embracing DRM for subscriptions to EMI, who just signed up to provide music without DRM?

2. Labels would have little incentive to create good products. Once record labels start getting paid on the basis of subscribers to their entire catalog instead of purchases of songs, you can expect the quality of commercial music to drop from its already-low level. After all, why should they waste a million dollars signing a new artist when it won't directly affect their subscription revenue stream?

3. iTunes' existing subscriptions create more satisfaction. Contrary to popular belief, Apple already offers subscription services, both in the podcast area and in TV shows. And it has the capability to charge for these subscriptions, even though that ability hasn't been used yet for podcasts. But unlike the models put forth by Real Networks and Yahoo!, Apple's subscription policy is more like a magazine's or newspaper's: you pay to own the content, not to rent it. For consumers, that analogy to real-world products they know and understand creates significantly more satisfaction than one where your entire library disappears the moment you stop paying your subscription. And consumer satisfaction is one of the keys to Apple's overwhelming success.

I think this last point about consumer satisfaction is key. Subscription services where you sign up for an entire catalog of music sound attractive in theory, but place consumers squarely in the conundrum of the tyranny of too much choice. Suddenly playing music isn't about listening to things you like -- it becomes a chore of selecting, classifying, and often rejecting music on an ongoing basis. Consumers don't like chores and like paying for them even less. In my opinion, the day iTunes offers an all-you-can-eat music rental (as opposed to purchase) service is the day I'll be claiming that iTunes has peaked. Offering iTunes subscriptions would make iTunes a "me-too" music subscription site like Napster (NAP), Real Networks and Yahoo! Music (YHOO) -- and would throw away its unique differentiation in the market. Frankly, Steve Jobs is too smart to do that.

It's certainly possible for some startup to offer music subscriptions services and prove Apple's strategy wrong. That's what markets are for; consumers are pretty good about voting with their wallets. In addition to the three reasons I listed above, Apple's iTunes has about two billion revenue reasons this year to pursue its own course in music subscriptions and to reject "me too" rental services. Perhaps that's reason enough.

Disclosure: Author holds a position in AAPL

Comments

[brando:]

I have to disagree. First of all, we disagree on DRM being fundamentally flawed. Its flaws are technical in nature, but not fundamental. A product that may be so effortlessly copied and pirated must be managed in order to sustain any value. Music is intellectual property just like a painting or work of literature. Digital technology allows unmanaged IP to be copied in infinite quantity by mere novices without just compensation to the owner. If there is a fundamental flaw, it is here. No market for valuable goods can function without a just payment mechanism. Without just payment, goods cease to have value and the incentive to produce disappears. DRM must be modified to allow the music purchaser the flexibility of sharing music a limited number of times with consent and to move the music an unlimited number of times by its original owner to as many devices as the owner possesses. Microsoft is purportedly working on a new DRM called PlayReady that meets these needs. Secondly, DRM must be interoperable among all hardware brands. If these technical flaws in DRM were solved, consumers would receive the value bargained for and IP owners would receive just compensation. The chaos we have today has produced a generation of scofflaws, a dysfunctional market for music IP, and a dearth of new talent. DRM is necessary and can be implemented in a consumer friendly way, and it must be done very soon if the music industry is to regain its footing.
Thomas Sailors, CFA
Cloverdale Investments, LLC

2007 Apr 13 10:33 AM

[Alan Williams:]

Thomas,
You seem to forget that 80% of all music sold is on DRM free Compact Discs. Your argument falls apart when you consider that almost every music owner's entire collection can be ripped by a novice computer owner and distributed at will right now. Adding DRM to the other 20% of music sold is not going to change a thing.
Al Williams
Private Investor

2007 Apr 13 12:11 PM

[brando:]

Al,

No, I haven't forgotten. Perhaps you have not realized that music distribution is moving towards a fully digital delivery model. The 80% sold in CD form will be 20% approaching 100% at some point in the not very distant future. Just because an outdated technology facilitates piracy is no reason to set up the next generation of technology for the same problem. DRM, properly administered, is an issue only for people who want something for nothing. It doesn't take a PhD in economics to realize the something for nothing business model is a failure.

2007 Apr 13 01:51 PM

[Alan Williams:]

Thomas,

The Major Labels have thrived on reselling the same content over and over again each time a new format comes along. 78's, 45's and LP's then cassettes and 8-tracks, then CD's and enhanced CD's and now digital downloads. How many times do they expect to sell the same horse to the same customer?
Selling unprotected CD's gave their customers a perpetual electronic file that is future proof. That horse is out of the barn now.

As soon as artists see the light and license their digital product directly to the online stores, the Major Labels are in big trouble. All of their back catalogue will be out there in unprotected form, due to their unprotected CD sales and their future product will be following the money into the realm of the digital downloads.

Bands have already begun to sell their own product online. Soon they will be doing their own deals with the major digital online stores. DRM is all but dead and the Major Labels may soon meet the same fate.

2007 Apr 13 04:33 PM

[brando:]

Well, I think you are a bit optimistic. It would be naive to think the record labels are just going to roll over and die. The law is on their side and they have time to make technology work for them as well. DRM is not "all but dead." The weakest of the four major labels is experimenting with a premium product in a last ditch effort to see what might save them. I suspect WMG will acquire them in the end and the DRM-free experiment at EMI will be dead. The record companies have every right to sell the same music to consumers over and over. That's what happens when new technology supplants old. The music business is no different than any other. Consumers have no right to take licensed intellectual property and engage in distribution on a massive scale, that's not what the "fair use doctrine" intended. I will not apologize for the major labels' inability to produce quality product anymore, that truly is a problem. But if one believes the product is bad today just imagine how bad it would be if there were no monetary incentive. It is not reasonable to assume artists can "go direct" by producing and distributing their own recordings any more than it would be to assume authors can have major success publishing thier own books. It takes a lot of money to compile a musical work in form and substance acceptable to today's market and even more money to promote the artist to the global public. Self production is a pipe dream. Perhaps the big four labels will fail, but if so, they will only be replaced by another set of distributors doing essentially the same things.

2007 Apr 13 05:29 PM

[Alan Williams:]

EMI will find widespread favor for their no DRM, higher quality initiative. Music users will vote with their wallets. The other Labels will see the economic incentive in giving the customer what they want and will follow suit in short order. Better quality and the ability to use the files on any device will win the day.

I could, as you say, 'compile a musical work in form and substance acceptable to today's market' on my Intel iMac, with the bundled Garageband software, if I had a creative bone in my body. The required technology and software, sans instruments, is in the five to six thousand dollar range. A figure that is within anyone's reach. I could get free publicity for my new music on a massive scale by posting my work on YouTube. I could create my own label, for a small incorporation fee and put my music up for sale on many online music stores.

A decent house band of singer-songwriters could self promote their way to stardom. Sure, a low talent, American Idol runner up needs a Major Studio for hype, payola and whatever else it takes to get ahead but a talented band, that has proved themselves on the local circuit, does not need to sign with the devil. It is now possible for them to do it on their own.

Investments should be made on the distribution end of things. The Major Labels are losing control of the distribution of music. They are all facing interesting times.

2007 Apr 14 11:31 AM

[brando:]

There is no doubt EMI will find widespread favor for thier no DRM, higher quality initiative. It remains to be seen, however, if the other labels will see the economic benefit of forever losing any hope of having control over their IP. I think cooler heads will prevail and they will give the consumer what he wants without giving away the store. Yes, the consumer wants, and deserves, interoperability across all hardware platforms and devices. Thanks to Steve Jobs' penchant for control they don't have that now. All he would have to do is license FairPlay to the online record stores such as Napster, Rhapsody, Yahoo Music, eMusic, etc. and one very large step in the right direction would have been taken. That was not to his benefit however during the time he was building market share with his superior player. The iTunes music store is not a profit driver at Apple. It is more akin to a loss leader in support of iPod sales. Now that the iPod has achieved success (probably even beyond Jobs' expectations) and competition will soon start nipping away, it behooves Jobs to consider opening his device so that it can play more than just iTunes music (and of course pirated music - estimated to be as much as 97% of all music collectively stored on iPods today!). But instead of taking the logical step of licensing FairPlay Jobs cleverly (some might say sinisterly) positioned himself as the music messiah by advocating DRM-free music and muscling EMI into taking a highly risky maneuver in an effort to retain relevance. Interoperable DRM would benefit consumers AND Apple as the iPod would be able to play music from anywhere. But DRM-free music would be even better for Apple as it would accomplish this AND position Apple as the consumer friendly king maker in the music industry - an invaluable marketing ploy. This time Jobs may have overplayed his hand, however. No one in the music industry wants a single player to have as much control as Apple is trying to position itself to have. I project that forces will align to assure this does not happen. Secondly, as stated above, it is not in the labels' interest to temporarily juice digital sales by dropping DRM only to soon realize they gave away the store. To use an old analogy it would be like a farmer feeding out his seed corn during the winter. Sure, the hogs will enjoy it, but come spring time there will be nothing to plant and nothing to harvest in fall. Consumers who advocate a DRM-free world are acting like the farmer's whining, greedy, pigs squealing for more corn. P2P piracy has temporarily conditioned consumers to believe music should be free and that the record labels are the greedy ones. Perhaps the labels have not conducted themselves in perfect fashion, but as I said above, the law is on thier side. Futhermore, if you think it's so easy to self produce, market and distribute a platinum release then please tell me why it's not happening right and left already. The technology has been available for years and the built up animosity toward the recored companies has been there as well. I don't think I have to spell out the answer to the self production theory - but I will - it's just a little bit harder to pull off than it looks. Interoperable DRM that allows the consumer to do with the music files as he sees fit within the confines of IP law will solve the current problem. It's really that simple. But to completely abandon DRM altogether, the only hope IP owners will ever have of keeping up with piracy technology, would be seed corn suicide.

2007 Apr 15 06:48 PM

[Alan Williams:]

Ripping your own CD collection to put the music on your MP3 player is fair use, not piracy. 60 to 70% of the music on iPods is from personal CD collections. Only an employee of the Major Labels would say that any tune on an iPod, that was not purchased at one of the iTunes stores, was pirated.

Apple controls everything they can on their hardware. That is why their user experience is the best in the electronics industry and why their stock has performed so well over the last 5 years.

The logical step for Apple is to continue to use open standards and control it's own destiny. iPod users do not wish to have music mobility. They already have it. It is easy, using iTunes, to strip the DRM from your music files and change them to MP3 files.

Apple's iPod and iTunes Store competitors are the ones that want music mobility so they can sell music to iPod users and get iPod users with music collections to switch to off brand MP3 players. Why should Apple want to help their competition by licensing FairPlay?

If The Labels want to help Apple's competition and take some of the power away from Apple then it is up to The Labels to come up with a music mobility solution. The simplest way for them to do this is with DRM free files. The other Labels will see this and join EMI or they will concede the Music distribution business to one or two online music retailers.

I think the Labels will eventually remove the DRM from the last 20% of their music. At 2 billion files a year from iTunes alone, at $0.30 more per file for DRM free, higher quality files, that's an extra $600,000,000 per year to split up amongst themselves. No record executive would walk away from that much money.

Besides, 256 kbps is the tipping point for the sale of digital music files. At 256 kbps, digital music files are just as good as CD music for human ears. In fact, 160 kbps is good enough for 90% of all human ears. So, online music purchases, at the new higher quality, will rapidly increase.

The Labels make a lot more money on a $1.30 single or a $9.99 online album sale than a $13.00 physical CD sale. EMI has shown the other Labels the pot of gold at the end of the online rainbow. The Labels will bitch and moan and see EMI's increased revenue and jump on the bandwagon.

2007 Apr 16 07:15 PM

[brando:]

My head is still spinning from your BS.

When you pull your head out...into the sunshine...perhaps we can have a conversation about the music business. On second thought, I'm growing bored with your intransigent, religous fervor in favor of Apple and disrespect for the law. Enjoy your investment or employment at Apple whichever it is.

Most of the non iTunes music on iPods is not ripped directly from CDs. It's from P2P, i.e. pirated. Everyone knows this, including Jobs. Did you hear him stumble all over his himself when discussing this point in the EMI conference call announcing the DRM experiment?

And BTW, I'm not an employee of the music industry, an investor in WMG or any other label. I just think the public would be well served to know the facts...and to realize the limitations of the iPod's closed system. It's a cute little product, but it isn't the world changer so many dreamers think it is. When all digital music is interoperable across all hardware devices, including one's home and car stereo systems, within the confines of the law, then we will have something to go wild over. Right now we have managed chaos with one very clever player nimble enough to temporarily exploit it while simultaneously hoodwinking the consumer into thinking he has done them a great service. People who think they actually "own" something with those files purchased from iTunes are in for a little surprise when the technology passes them by or they realize the files are only playable on an iPod. That's why I subscribe to Napster. Unlimited access to 3mm tracks and no technology obsolescence issues. I like the service so much I did a Victor Kiam -- own the stock. I recommend you do the same.

2007 Apr 17 01:10 AM