On paper, the ultra-exclusionary business model championed by Apple Inc—keeping competitors at arm’s length while pumping up its vast inventory of proprietary apps—should have given investors and consumers cause to reassess the way they buy music. However, on the day it launched its latest technological marvel, the new iPad third-generation tablet, shares of the Cupertino, California-based company were trading in the vicinity of $600, roughly double last summer’s stock price.
Numerous market watchers maintained a solid ‘buy’ rating, some even calling the stock ‘underpriced’ at current levels. Apple could move more than 65m iPads this year alone, according to some analysts.
In fact, the rapid deployment of handheld devices such as the iPad, combined with the steady growth of emerging digital-music models, have helped breathe life into a record industry hobbled by years of sagging revenues.
While Apple and its league-leading iTunes Music Store continues to dominate (holding down an estimated 70% of digital music sales), “all-you-can-eat” subscription services such as UK-based Spotify and France’s Deezer themselves attracted some 13m paying customers last year. This is a 60% increase over 2010, according to UK’s International Federation of the Phonographic Industry (IFPI).
Music downloading has also been helped in no small part by ‘in-the-cloud’ services; those that use a central network infrastructure, rather than a home-computer application, among them Amazon’s Cloud Drive and Apple’s newly launched iTunes Match.
All told, digital-music revenues rose 8% in 2011, according to IFPI, the first year-over-year growth increase since 2004. Providing music to users wherever and whenever they want appears to be the lynchpin going forward. By 2016, an estimated 161m subscribers worldwide are expected to access music from a mobile device, up from less than 6m in 2011. Frances Moore, chief executive for UK-based International Federation of the Phonographic Industry (IFPI), agrees that consumer choice “has been revolutionised…as new models for consuming and accessing music are rolled out in new and existing markets.”
Has the long-suffering music industry finally found its feet as a result of this technological convergence? And if the turnaround is at hand, where do investors go to rock and roll?
Hear today—gone tomorrow
Back in 1999 the record industry was sitting pretty—that year, 847m CDs were sold, according to the Record Industry Association of America (RIAA). By that time, intense consolidation from the Telecommunications Act of 1996—which enabled a handful of conglomerates to secure majority stakes in numerous media markets—had turned the airwaves into an increasingly exclusive club.
Eventually, listeners began seeking alternative sources online—some of them legit, many of them not. As faster connection speeds accelerated the trend toward peer-to-peer file sharing, recording artists began flocking to upstart venues such as MySpace, YouTube and Facebook (and, more recently, Bandcamp and Soundcloud), bypassing traditional distribution channels in the process. As the online phenomenon reached new heights, sales of physical media were suddenly in free fall; by last year, CDs hit an all-time low of 223.5m units sold.
Of course it is hardly the first time the music establishment has been forced to re-group in response to a major cultural backlash. But despite the potential to attract millions of newcomers, for years record executives have bristled at the idea of unfettered digital access, and have leaned on companies to push premium-pricing plans in an effort to optimize revenue.
However, after years of waging war over no-charge music streaming, record companies are now beginning to see the benefits of ‘freemium’ services—which, say analysts, are used by providers mainly as an acquisition strategy, roughly 15% of Spotify’s paid subscribers for instance consist of former ‘freemium’ users drawn to premium-level benefits such as higher-quality downloads and no intrusive banner advertising. Spotify chief executive officer Daniel Ek argues that his service has helped the music business enter a "golden age," as people who share music online are more likely to buy more tracks and albums.
“Even though labels worried about the impact of free Internet radio, music social networks, and other streaming services like Pandora and Spotify, it looks as if those services are having the same effect that radio did back during the height of its viability,” notes Anthony John Agnello in financial news site InvestorPlace.com. “Free Internet music broadcasts appear to be encouraging digital music sales,” he says.
Looking for a leader
The speed with which the digital-download business has evolved has turned more than a few would-be sure-shots into eventual also-rans. One notable casualty was (former) digital-music provider Napster, which went head-to-head with Apple back in 2005 on the assumption that its Napster To Go portable subscription service—which gave customers access to over a million songs for a mere $15 a month—would help revolutionise the music-listening experience.
In 2008, however, a floundering Napster was acquired by retailer Best Buy on the cheap, and last year its remaining assets were sold to rival subscription service Rhapsody. By then, Rhapsody itself was feeling the heat from new arrivals such as Pandora. “There are a lot of bodies on the road leading to success with a digital music service,” muses Tim Schaaff, chief executive officer of Sony Network Entertainment.
As such, betting on who will be tomorrow’s music-delivery heroes is no easy task. While up-and-comers such as Spotify are certainly attractive at the moment, it’s tough to argue with the proven track records and 25% profit margins of behemoths Apple and Google. Despite the lure of all-you-can-eat plans such as Rhapsody, Apple’s iTunes ownership model shows no signs of weakening.
During the final quarter of 2011, iTunes users downloaded estimated 16bn songs, good for approximately $1.5bn in revenue. Not to be outdone by the cloud crowd, Apple now offers its ITunes Match, a service that wirelessly syncs users’ iTunes music library between Apple devices using a cloud-based personal storage locker.
The fact that Apple has managed to maintain download supremacy through the creation of must-have proprietary devices (such as the iPad, iPhone and iPod) is obviously not lost on rival Google, which has already announced its intentions to move into the hardware market.
Earlier this year, Google got the green light to acquire Motorola Mobility––part of its ongoing effort to boost production of Android-based smartphones. Currently 40% of smartphones utilise the Android operating system, the Linux-based, Google-owned rival to Apple’s iOS 5 mobile OS. Additionally, the Mountain View, California-based company is said to be developing a proprietary wireless music-streaming system for the home that can be operated from an Android-based handheld device.
In with the in-cloud
While not nearly as competitive on an earnings-per-share basis as Apple or Google, Amazon’s standing as the industry’s overall download sales king makes it a strong contender going forward. Last year, the Seattle-based online retailing giant announced the premier of its Cloud Drive, a music-backup service that allows Amazon customers to store music in the cloud, using a “digital locker” hosted on the company’s servers, with the ability to access personal libraries from any location and on any computer.
Providing a more practical means of accessing users’ personal media libraries appears to be at the heart of Amazon’s cloud-based model, notes Frank Gillett, vice president and principal analyst for Forrester Research, called the move a “first salvo in a series of steps that will lead Amazon to compete directly for the primary computing platform for individuals, as an online platform, as a device operating system, and as a maker of branded tablets,” says Gillett.
In-the-cloud music plans, which typically offer users the choice of a free, advertising-supported plan, or a premium paid-for option, are fast becoming the medium of choice on the increasingly crowded digital-music frontlines. Compared to portable subscription plans of the past that only worked with a limited number of devices, emerging cloud providers have addressed compatibility issues by allowing users to access music through apps on smartphones and other connected devices. “This has vastly improved the quality and level of the consumer experience,” notes IFPI.
Live streaming music
One of the more visible cloud-based proponents of late has been Spotify, which allows users to live-stream music from the vast libraries of companies such as Sony, EMI and Universal. Like rival Rhapsody, Spotify users rent their music on a monthly basis by accessing tracks through an internet connection; premium members may also listen offline by downloading and storing music to a smart phone or similar portable device.
Where iTunes currently charges $1.29 to own a single track, Spotify users who don’t mind viewing the occasional banner ad may stream tracks free of charge (or pay $15 a month for music without any advertising).
Debuting in the states last summer, Spotify has since signed up some 2m US users, more than a quarter of which are paid subscribers. Spotify also became the first subscription service that enabled users to share personal playlists through a Facebook link, thereby turning conventional music streaming into a social experience. “Spotify has always had a keen sense of how to coexist in the broader ecosystem, rather than try to do everything itself,” says digital-media analyst Mark Mulligan. By integrating with Facebook, Spotify has found a way to simply the learning curve for its new users, suggests Mulligan.
Also joining the ranks of the cloud crowd is Sony Corp and its Music Unlimited Powered by Qriocity service, which links content across Sony-manufactured devices such as its Playstation 3 as well as Android-equipped smartphones. Google too has unveiled its own Google Music streaming/storage service that will allow users to access online music from a variety of devices, and share music through a social network (Google’s own Google+).
Equally important in the resurgence of the music trade has been the ramp-up in smartphone and tablet sales. In areas with higher-than-normal handheld uptake, subscription plans have fared unusually well. In Spotify’s native country, Sweden, for instance, subscription services accounted for some 84% of digital revenues through the end of last year.
Manufacturers of connected devices will continue to expand their reach, say experts, with sales of tablet computers expected to set the pace over the next several years. Research firm Gartner estimates that tablet revenue could reach $326m by 2015, led by Apple, which has shipped an estimated 55m iPads since the product’s debut two years ago. Meanwhile, sales of smartphones grew by 47% during Q4 of last year, reaching 149m units sold, according to Gartner. Apple’s iPhone accounts for nearly one-fourth of global smartphone sales, says Gartner, which expects smartphones to eclipse desktop computer sales over the neat term.
Own or access, or both?
As downloads continue to displace tangible media such as CDs and vinyl albums, for many the term digital has become synonymous with “disposable”—and for those users, subscription services that allow access rather than ownership remains the most logical choice. For that matter, it is the model that would appear to give iTunes a real run for its money.
Rather than battle for digital supremacy, however, subscription and ownership plans have managed to achieve profitability independent of one another. “The fact that these two models of consumption can co-exist speaks volumes about the future,” says Rob Wells, president, global digital business, Universal Music Group. “In fact, we have really only scratched the surface of digital music in the last decade—now we are starting the real mining, and on a global scale,” he says.
The bottom line: analysts and music executives alike believe that the current uptick in digital music sales is sustainable, and that the recent numbers reveal an industry on the cusp of a rebound. “We are still seeing healthy growth in the market for digital-music downloads,” observes Russ Crupnick, senior vice president of industry analysis at NPD Group.
Adds Stephen Bryan, executive vice president, digital strategy and business development, Warner Music Group, “There’s a race among the services to go global and plant the flag in new territories, and we’re seeing services that are generating revenues and growth. There is high engagement with these services. Consumers love them and spend hours using them.”