Lessons from Apple

Apple Computer recently opened an online store, iTunes, which allows Mac users to download songs for 99 cents. Consumers can now buy a single online and use it on their PC, iPod digital music player or CD burner. Fortune recently touted this service as the savior of the music industry. A record label executive stated, “I think the whole thing is a revolution” in the context of selling the same rights to download music to Yahoo, Amazon and MTV’s audiences (L.A. Times, 6/10/03). The good news is that eventually a Windows-compatible service may save me the hassle of uploading a CD onto my PC only to download it back onto my Nike digital music player. The bad news is that after three years of Congressional debate and battles between the technology industry and Hollywood, the digital music opportunity’s salvation is pay-per-downloads, currently available for 2-3% of PC users.

After hearing entrepreneurs also echo the digital music revolution four years ago, I remain skeptical since any ‘revolution’ that persists this long deserves to lose its “r.” It is hard to believe that there is a lot of substance behind the current hype. If I were the record label executive, I’d have the following concerns about this “r-evolution:”

1) The real rebels out there are in the form of Napster, KaZaA, Morpeus and Gnutella users. While Apple’s iTunes service may reach 10M downloads a month, the rebels are downloading billions of songs a month for free. The Recording Industry Association of America (RIAA) can only continue to sue college kids across America because pay-per-download sites will only pacify the rebels if they are more interesting and comprehensive than the illegal, free sites.

2) At best, these pay-per-download services resemble the CD single business and will likely cannibalize the CD business. According to the RIAA, the CD single business was a $19.6M business in 2002, declining from a $272M business in 1997. In contrast, CD sales were approximately $12B in 2002, down from a peak of $13B in 2000. This is no different than a captain on a sinking ship trying to save some jewels rather than fix the boat to stay afloat.

3) Finally, if the labels believed in a subscription business as a big opportunity last year, then why give up so soon? I have a subscription to NetFlix that costs $20 per month whether I order new DVDs each month or sit on the same three discs for many months. Subscription services offer predictable, recurring revenues to any industry that can capitalize on people who want consistency and convenience.

Does iTunes demonstrate that the tech and entertainment industries, if left alone for an era, can work out their own solutions as policy makers hoped? From a business perspective, I doubt the pay-per-download model is the big break for the industry. You can argue that 10 million downloads per month, assuming consistency, equals $120M per year, which is the same as 1 million subscriptions a year at $10 per month. Without a clear answer besides an instinct on subscriptions, I decided to test the pay-per-download theory by going to a real world 99 Cent store. There seemed to be no method to the madness of aisles and inventory, but somehow I spent $8 on things I had no need for like Gatorade, baking soda, marble notebooks, batteries, garbage bags and an ice cream sandwich (many 2 for 99cents). Later, I looked for the same items at my local supermarket – all much easier to find and 2x the price. The 99 Cent store is about high volume and low margins, compromising service and filling shelves with lots of inexpensive goods. The convenience and ease of use of the supermarket allow it to charge higher prices, which some consumers digest in their $50 a week basket. If the supermarket charged me a subscription for my membership with some discounts, delivery options, novelties, Zone meals, etc., then I would spend more not less. The record label executive should wonder if he is commoditizing his business by resorting to the “99 Cent pay-per-download store” rather than have many high-value sites also carry his product, allow them to package it differently, and charge premiums for ancillary content.

There are some good things that may come out of Apple’s foray into the online music business to teach us some digital music lessons. Lesson 1: We do not need a single security format decided by an industry consortium and the government as suggested last year in the Senator Hollings’ bill and painfully attempted by the Secure Digital Music Initiative (SDMI) in 1999. Rather, we need clarification of what fair use means for technology, e.g., no more than 10 CD burns of the same playlist. Apple launched its iTunes service with its own ‘homemade’ security to prohibit users from making unlimited copies of a specific playlist or album. Lesson 2: The technology and entertainment industries should specialize in what they do best. Both will benefit if they play within their strengths: the music industry finds, develops and creates great content, and the tech industry builds technology that encapsulates customer service, delivery of content in new ways and mechanisms to track usage to compensate parties. Apple did a good job of creating an easy to use consumer interface and simple service in contrast to label-backed services such as Pressplay and MusicNet that had technical difficulties, were expensive and had strict limitations on use of content. Lesson 3: Congress must take another look at copyright law and the processes of examining new technologies to protect and encourage the large and the small. Small companies and individual users have been beaten and bullied in court. We need guidelines for any technology company to innovate new and cost-effective digital media services so that it is not just the Apples and Microsofts of the world that are allowed to use their market power to play a tune.

The focus on the next column will be on copyright law and a case that never made it past a district court. Please email comments to diuliano@empower.org.