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Apple Is Poised To Take Control Of The Music Streaming Business

|About: Apple Inc. (AAPL)
Summary

Apple introduced a new music streaming service called Apple Music.

In this article, I focus on the demand side of music professionals for streaming services.

Unlike competitors, Apple is willing to make deals and offer only paid subscriptions.

Apple Music's paid subscription service is also in line with music industry demand.

Overall, Apple Music fits perfectly with demand from the music industry and is poised for success.

Although many releases of last night's presentation were already leaked through several channels, analysts and investors looked forward to Apple (NASDAQ:AAPL) revealing its new music streaming service. Apple indeed introduced a new music service called Apple Music. The service will debut on June 30 and will cost $10 per month after a three months free trial period.

Apple also announced a new internet radio station called Beats 1 and an online platform for artists to share their latest work with their fans called Connect. Apple does not only want a big slice of the online streaming pie from competitors like Spotify and Tidal, it will also take on internet radio competitor Pandora (NYSE:P) and open source music platforms like the popular service Soundcloud.

At first sight, Apple seems to have developed a perfect strategy to face its competition in the online streaming business. With the entire iTunes music catalog at its disposal, Apple Music's subscribers will have a lot of titles to choose from. Considering the company's track record, the Apple Music app will be awesome and customer friendly at the same time as well. Combined with a very loyal customer base and a large cash pile to send on marketing, Apple Music should become an important streaming music business in the near future. How important Apple Music will be remains unclear.

First of all, the company is quite late in offering a music streaming service after dominating the market of music downloads for years. Apple's iTunes still generates significant income, but total downloads are slowing in favor of music streaming services. Spotify already has over 15 million paid subscribers worldwide and other well-funded U.S. companies like Amazon (NASDAQ:AMZN) and Google (GOOG, GOOGL) offer music streaming services as well. Therefore, Apple should prepare for a long fight to take control of the online streaming business.

In this article, I will discuss topics from within the music industry with respect to streaming services. It is important for investors to understand the ongoing discussion within the music industry, so that they can make a proper evaluation of Apple Music's prospects. In my opinion, this analyses has been underestimated by analysts and investors. Further, I will discuss Apple Music and its fit with demands from within the music industry. I find that Apple Music fits perfectly with the need for more transparency, a fair revenue split and higher royalty payments to music industry professionals.

Need for transparency

The industry can no longer afford to spend $5 collecting $1. The efficiency of AMRA is the future.

Willard Ahdritz, Kobalt (source: Music Business Worldwide)

One of the most important topics is the need for transparency. Industry professionals, including musicians, songwriters and producers just do not have a clue if their royalty statements are complete and correct. Royalties are normally collected by collecting agencies. These agencies pay the royalties received to record labels, after deduction of expenses of course. Then the record labels pay the royalties to the ultimate beneficial owner of the music rights.

Apart from all the actions required to get the royalties from the streaming company to the owner of the rights, royalty statements are almost unreadable. Just consider the statement by Elizabeth Moody, Vice-President licensing of Pandora below. Making a distinction between free streaming services and paid subscription services, like Spotify, does not help transparency either.

While artist do get paid, not all of them understand what happens.

Elizabeth Moody, VP licensing Pandora (source: Radio & Music)

Although several articles estimated the amount earned by every play (e.g. this article in the Wall Street Journal), there is still no transparent way to determine whether royalty statements are correct or not. In my opinion, this provides a major opportunity for Apple Music to benefit from the lack of transparency by other streaming service providers. If Apple Music enables a transparent way of reporting royalty payments and pay-per-stream data, record labels and collecting agencies are likely to prefer exclusive licensing deals with Apple Music. This could be a major blow to its competitors as an extensive music library is the most important thing for streaming services.

Fair revenue share and royalty income

The ad-funded part for the music ecosystem - that's on-demand, ad-funded - as I've said before, is not something that is particularly sustainable in the long term.

Lucian Grainge, Universal Music (source: Music Business Worldwide)

According to Universal Music boss Lucian Grainge, free streaming services are not sustainable in the long run. Grainge probably referred to the distinction between paid subscription royalty income and free streaming royalty income. The Wall Street Journalcalculated that artists earn $0.0068 for every single play by subscription users and just $0.0014 for every single play by free streaming users.

Naturally, it is a hard sell to industry professionals that royalty income from free streaming services is 80% lower than income from paid subscribers. Therefore, the statement by Mr. Grainge makes perfect sense. The New York Post reported that freemium (free streaming services) represented the smallest slice of the music revenue pie as well.

I'm not willing to contribute my life's work to an experiment that I don't feel fairy compensates the writers, producers, artists and creators of this music. And I just don't agree with perpetuating the perception that music has no value and should be free.

Taylor Swift, Artist (source: Inquisitr)

The music business prefers subscription-based services, because these services pay significantly more in royalties. As a result, labels and agencies are likely to sign direct deals with streaming service providers. Some good examples are the latest deal between Soundcloud and licensing agency Merlin as well as the licensing dealbetween Sony and Spotify. This is where Apple Music is likely to have a competitive advantage over free subscription services in the long run. Apple proved willing to make deals with record labels to come up with a fair revenue share.

Further, Apple only offers a paid subscription service. This will generate much more royalty income for artists. Like I mentioned before, I foresee that more artists will ban their music from free streaming services and sign exclusive deals with companies that offer only paid subscription services. In the end, this is much more profitable for them.

Apple Music

The first signs of transparency and fair revenue share are very positive for Apple Music. Apple Music offers a paid subscription service and no ad-funding freemium service. It is clear that paid subscription services pay higher royalties to artists. Further, the calculation of artists' revenue share is much more transparent for paid subscription services compared to freemium services. In theory, royalty income should be calculated as follows: total subscription revenue -/- Apple Music's revenue share * percentage of total plays.

I identified two major trends in the music business. First of all, industry professionals have the need for transparent revenue statements and calculations. Second, free streaming services do not pay enough to be sustainable in the future. Based on these trends, Apple Music has the potential to become the first transparent and subscription-only streaming service provider.

Investors should notice that this is an important competitive advantage for Apple Music compared to other streaming service providers. Because of this advantage, Apple Music should be able to sign exclusive content deals with artists and labels in the future. This draws additional subscriptions and limits the library potential of competitors. A win-win scenario for Apple.

Conclusion

Considering all of the above, Apple Music could convert its potential advantages into actual competitive advantages and take control of the music streaming business. However, competition is fierce and not likely to give up immediately. One big advantage is Apple's financial strength and its ability to take on competitors for a long period of time.

Disclosure: The author is long AAPL.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.