Amazon's New MP3 Store No Threat To Apple's iTunes

Includes: AAPL, AMZN
by: Yankee Group

By Carl Howe

[Blackfriars projections of FY07-08 iTunes Store revenue. Click the image for a larger view, excerpted from our June report, Analyzing Apple: Waiting For The iPhone]

In a recent article, John Gruber of Daring Fireball takes on the launch of the Amazon music download store and dispells one of my favorite media falsehoods - that the iTunes Store is a loss-leading business:

So why Amazon is even bothering with a music download store, given that ‘everyone knows’ the iTunes Store is a loss-leader that Apple offers just to sell more iPods?

Because that’s bull****. Apple is making good money from the iTunes Store.

John estimates gross margin from iTunes at about $900 million from the 3 billion songs sold at the iTunes store to date. Our estimate just for FY07, which ends September 30, 2007 is that iTunes revenue just in this fiscal year is $2.1 billion, with gross margin of $630 million just in this fiscal year.

Just to put those numbers in perspective, it was only about three or four years ago that $600 million was a respectable gross margin number for Apple's entire business, Macs to iPods. And the $630 million in gross margin from the iTunes Store this year is about 1/4 of Amazon's gross profit for its entire business.

And the whole, "Amazon's DRM-free MP3s will give it an advantage over Apple's DRM-laden music," doesn't play either. 95% of consumers never experience Apple's DRM in any way shape or manner. They buy their music from the iTunes store, load them on their iPods, play them on their computers, and never give DRM a second thought. The convenience of one-stop impulse shopping from their iTunes music player vastly outweighs the lower prices and DRM-less features of the Amazon store. Further, Apple itself sells DRM-free music and will increasingly benefit from Amazon's negotiations for that format.
So while that vocal minority of music purists who insist on DRM-free music may flock to Amazon's new store, they will only be helping Apple maintain its music dominance with the vast majority iPod owners and music buyers.

The bottom line: Amazon's new MP3 store is great for everyone, and it lends choice to the digital music business. But don't make the mistake of thinking that Amazon's music business threatens iTunes dominance. Amazon's music business will simply put pressure on music labels to reduce their cut of the digital music distribution pie (since Amazon is undercutting Apple in price and can't do that indefinitely) while expanding choices for consumers. Meanwhile, the vast majority of consumers will continue one-stop shopping for their music, movies and TV shows in Apple's iTunes, preferring convenience over low-prices. Amazon will fight for the number two spot in digital downloads, while Apple's iTunes business will dominate digital music downloads -- and profits -- for years to come.

Disclosure: Author owns stock in AAPL