Record Companies Starting to Shun iTunes

Includes: AAPL, WMG
by: Markham Lee

The following relates to my previous article on how digital music is drastically changing the economics of the music business in such a way that it's hurting profitably:

(From the WSJ): "...a growing number of record companies are trying to steer clear of Apple Inc.'s (NASDAQ:AAPL) behemoth music store, because they say selling single songs on iTunes in some cases is crimping overall music sales.

Kid Rock's "Rock 'n Roll Jesus" album was kept off iTunes' virtual shelves. It has nonetheless sold 1.7 million copies in the U.S. since its release last year -- a sizable number for the depressed music industry. Sales of the album have increased in 19 of the past 22 weeks, according to Nielsen SoundScan, vaulting it to No. 3 on the Billboard 200 sales chart. After witnessing the album's performance, his label, Warner Music Group Corp.'s (NYSE:WMG) Atlantic Records, last week yanked an album by R&B singer Estelle from the iTunes Store, four months after it went on sale there -- and the same week that one of its songs entered the top-10-selling tracks on Apple's download service...

...Label executives, managers and artists chafe against the iTunes policy that prevents them from selling an album only. ITunes, with few exceptions, requires that songs be made available separately. Consumers strongly prefer that, though Apple also typically offers a special price for buyers who purchase all the songs on an album...

...The launch of Apple's iTunes service in 2003 was hailed as a potential savior for the industry: It allows consumers an easy, legal way to buy music online, while still cutting record companies in on a portion of the sales. But iTunes' rapid growth has turned it into a Goliath, music executives complain. It often asks for exclusive sales rights for songs in exchange for prominent placement on its home page. (full article here)

The problem here is that Album sales generate significantly more revenue than a digital download (the $10 wholesale cost of a CD vs. $0.70 per download), in the case of Katy Perry she (and her record company) made more from the sale of the CD ($2.8 Million) then from the digital download ($1.54 Million). Even when you factor in manufacturing costs CD sales are still way more profitable, because manufacturing costs are in the range of $0.30-$0.50/CD if not lower. Say what you will about record companies, their prices, attacks on downloaders, etc, but it's not a favorable model for them (or the artist) when the sale of a CD that is barely 1/2 way to gold generates more revenue than 2.2 million downloads.

While the commonly expressed risk for artists that shun iTunes is that it will push consumers to just download the song illegally, rip their friend's CD, etc, I wonder if the risk is worth it if it results in more CD sales/higher profit transactions. For the answer to that question take a look at the analysis below:

*The CD sale % is the % of digital downloads that would be translated to CD sales if the artist wasn't on iTunes.

Based on the above it's actually worth it if 85% of your former "iTunes single track" download customers elect to download your music illegally/not buy it all, because if the remaining 15% buy your CD you wind up doubling your revenue. When the numbers shake out like the above you really can't blame the record companies for deciding to shun iTunes, or at the very least being wary of working with them.

Moving forward the question offered is: what kind of model can be put in place that will allow the record companies to continue to survive, yet offer the digital music the consumer wants at the prices they're used to paying? After all if the iTunes model is hurting the record company's chances of survival, it's also hurting the production of the product (pop music) that people want to purchase/listen to. A quick look at the top ten songs on iTunes reveals that most of the songs are "pop songs" that benefit greatly from the record company marketing machine, so what happens to those artists (and the music most people like) when that machine goes away or has far fewer dollars to work with?

You can read more on the subject here.


The WSJ:"More Artists Steer Clear of iTunes" -- Ethan Smith and Nick Wingfield, August 28, 2008

Disclosure: At the time of publishing the author didn't own a position in any of the companies mentioned in this article.