…and it means it: the pictures below are of Deezer branded bus stops in rural Mauritius. With Spotify also having announced a bunch of new markets this week, and Apple and Nokia already having an extensive network of global digital stores, 2013 really is the year that digital music should start to see some meaningful ‘rest of world’ traction.
Subscriptions are still only a small share of the music market but their time is coming. That time is long over due (I and my former Jupiter colleagues David Card and Aram Sinnreich first started making the case for subscriptions back in 2000) and a slew of big players are getting ready to play ball now that subscription look ready for primetime. But they will find it far from plain sailing.
Spotify, Deezer, Rhapsody, Muve, Rdio, WiMP etc. have done much get the market moving and although there are still major challenges ahead (e.g. 9.99 not being a mass market price point) a host of new entrants are poised to make their moves. The much mooted / touted (delete as appropriate) Daisy is one of the more eagerly anticipated ones (see my take here) but focus has recently turned to potential moves from big players like Amazon and Google, while Apple’s arrival in the subscription market is becoming Godot-esque.
All of these companies bring fantastic assets to the subscription market –scale being the most important – but they will all find the subscription transition difficult. However good their technology assets, however big their marketing spend, however big their customer base, none of these companies have subscriptions running through the DNA of their products nor, most importantly, their customers. Here are the key challenges each will face:
- Apple: Apple was the music industry’s digital beachhead but now Apple has a problem. Downloads were a transition strategy with one foot in the digital future and one foot in the analogue past. Apple has built a paid content customer base founded on ownership, a la carte transactions and downloads. Meanwhile it tiers its hardware pricing by hard-drive capacity. In some ways this latter point matters most: in the streaming era consumers download less which means there is less need for higher capacity devices, which in turn means that demand for the higher priced, higher capacity devices tails off. Apple can use subscriptions to address this issue by creating bundles e.g. iPad Gold, a $200 price premium with device-lifetime access to an iTunes music, video and Apps subscription. This sort of tactic will be crucial for Apple because the concept of digital content subscriptions is alien to the vast majority of its 400 million iTunes customers. If anyone can make subscriptions work, it is Apple – and I believe they will – but currently its customer base, hardware pricing and content offerings (iMatch and movie rentals excepted) are simply not the right foundations for building a subscription service on. A lot needs to change before Apple and its customers are ready for subscriptions.
- Amazon: Amazon’s content-device strategy is the mirror opposite of Apple’s: Amazon is selling devices to help sell content. Amazon needs to be a key player in the music and video business because these low price point items are the bottom rung on the purchase ladder that Amazon hooks new customers in with. Subscriptions though, are high consideration items. Amazon is hoping it can nudge customers up to monthly subscriptions in the same way it can nudge customers from a CD to a laptop. But it isn’t the same transition. Most Amazon customers have a lot of one-night stands with the retailer rather than a relationship: it is where they go to get stuff, not to immerse themselves in experiences. Of course Amazon is trying to change that – particularly with video – but it requires a fundamental change in the relationship with its customers. As with Apple, a device / subscription bundle strategy will deliver best near-term results.
- Google: Google has the most diverse set of assets at its disposal. In YouTube it has the most successful streaming music service on the planet and in Google Play it has, well, not the most successful digital content store on the planet. Launching a subscription service on YouTube is an obvious option and the sheer scale of YouTube means that even with highly modest conversion rate it can easily become a major player very quickly. But the fact that YouTube is free is core to why it is so popular, so the vast majority of its users have little interest in paying fees. Thus Google will have to ‘think different’ to make subscriptions work on YouTube. But where Google could really make the subscription play work is, well, on Play. Not Play by itself though but instead as a tightly integrated subscription – device ecosystem with Motorola. A while ago I wrote that Google ‘needs to do an Apple with Motorola’. It still does, but it should do so in a manner fit for the cloud era by hard bundling a Play subscription service into Motorola handsets. (You should be spotting the theme by now).
- Samsung / HTC / Nokia et al. By this stage any readers from a non-Apple and non-Motorola handset business might be beginning to wonder how on earth their companies are going able to squeeze themselves into the subscription equation. It is a very good question. Most mobile handset companies are at a crucial juncture, they now face the same problem as ISPs did in the mid-2000’s: unless something changes mobile handset companies are going to become ‘dumb devices’ just as ISPs ‘became dumb pipes’. Nokia recognized this earlier than most but got the solution wrong – or at least the implementation – with Ovi and is slowly clawing its way back. But all of them have a huge task ahead them if they are to avoid becoming helpless observers as other companies build robust digital businesses on the back of their hardware. If they can harness the carrier billing relationship then they have a truly unique asset for building a music subscription market, but that is much, much easier said then done (remember Comes With Music?).
All of these business have the potential to be successful subscription businesses but none of them will find it an easy transition and none of them are guaranteed success. Not only will they have to transform their products, pricing and customer bases, but they will also have to develop entirely new business practices. To some degree or another, all of these companies have to make the transition from being retail businesses to being subscription businesses. Being in the subscription business is all about managing churn. It doesn’t matter how good a job you do of acquiring customers if you can’t keep hold of them. These are the skillsets that Rhapsody has been quietly perfecting for years and that Spotify is quickly learning. A successful subscription business can appear like a duck, slow moving above the water line, but feet moving furiously fast below.
The Churn Killer: Device Subscription Bundles
Any business that is new to subscriptions – whatever they may say to the contrary and whatever talent they might hire in – is going to be learning the ropes. Which is another reason why hard-bundling subscriptions with hardware makes so much sense for these new entrants. Besides the consumer benefits of turning an ethereal subscription into a tangible product, they allow the providers to plan for 12 to 24 months worth of customer life time value rather than worrying about subscribers churning out after just a month or two.
Even though downloads and CDs will still dominate global music revenues by the end of 2013, it is going to be a big year for subscriptions. Whether the new entrants can help turn that into a big decade remains to be seen.
Note: this post has been updated to reflect some clarifications provided by IFPI. Thank you to Gabi Lopes IFPI for the guidance. Changes are noted below.
The IFPI today announced that for the first time ever growth in digital trade music revenues outpaced the decline in physical trade revenue. (The emphasis on ‘trade’ is important as we’re talking about revenue to the industry rather than consumer spending and so can include income such as advances paid by services in anticipation of sales.) That caveat aside, this is clearly a key industry milestone that has been a long time coming and is a sign of a digital market that is beginning to reach some degree of maturity. However this is a long way from mission accomplished, here’s why:
- 57% of music revenues still come from physical (see figure). With the exception of the US the few other markets that have surpassed the 50% digital mark (e.g. Sweden, India) are minor music markets in revenue terms. The simple fact is that the majority of music buyers still buy CDs. And to be clear, I said the majority of ‘music buyers’ still buy CDs, not the majority of ‘people’. So even forgetting for a moment the consumers lost to the music industry through piracy and other means, the majority of its core customers have still not seen reason enough to go 100% digital. And the interesting additional factor here is that the vast majority of people who are buying digital still buy some music on CD. So even among the vanguard of digital customers, the CD’s embrace is a lingering one.
- CD sales decline will likely accelerate. Among the top 10 largest music markets in the world CD revenue decline will likely accelerate markedly in the next few years. In France and the UK leading high street retailers are on their last legs while in Germany and Japan the vast majority (more than 70%) of sales are still physical. So the challenge for digital is can it grow as quickly as the CD in those markets will decline?
But there is hope. Streaming services present meaningful opportunity and despite the fact 9.99 is far from a mainstream price point (it is in the entire monthly spend of the top 10% of music buyers) it is a great way to deliver disproportionately high revenue from a small base of consumers. If that model can be effectively transitioned to the mass market via more telco partnerships like Telia Sonera and Cricket then we may just have a mass-market digital music proposition on our hands.
The Continued Dominance of Apple
But while premium streaming offers future potential, it is expected to total no more than 10% of 2012 digital revenues. By contrast, Apple is the here and now.
Downloads meanwhile are close to half of all digital revenues with about $3 billion. (The remaining 40% of digital revenue is a mixed bag, including ring tones, advertising and probably advances.) So with downloads by far the largest single digital revenue source Apple is the here and now – though we have to do some forensic work to find out just how big a role it plays…
The IFPI reports that the total number of paid downloads for 2012 was 4.3 billion units. (The IFPI have clarified that albums are counted as single units are not counted as total number of tracks). Earlier this month Apple reported reaching the milestone of 25 billion songs sold, with the previous reported number being 16 billion in November 2011. Allowing for January 2013 being a particularly strong month (following all those Christmas iPad and iPhone sales) that gives an annual sales number of about 6.6 billion. This translates translates to $3.9 billion which is about 70% of all digital revenues.
Which is still 2.3 billion more than the global total reported by the IFPI. The most likely explanation is that Apple’s February press release headline “iTunes Store Sets New Record with 25 Billion Songs Sold” was misleadingly incorrect – just as I suggested in fact at the end of this blog post – and that the actual numbers instead actually refer to ‘purchased and downloaded’ (i.e. a mix of the two).
Apple remains the biggest and most important game in town. And even without Apple getting into the streaming game this is still good new for the music industry. As I posted a few weeks ago, Apple’s growth in iPad and iPhone sales has driven an upsurge in iTunes downloads, which coupled with iTunes’ expansion into multiple new emerging markets will bring even further digital growth.
Finally, for some additional perspective, if you add Apple’s $2.6 billion to the $10.9 billion in CD sales, Apple and the CD combined accounted for 90% of music industry revenue in 2012. So for all the talk of streaming and new service innovation, in 2012 the CD and Apple remained the bedrock of music sales.
Yesterday Apple announced that it had reached the milestone of 25 billion songs sold.* The number is impressive by any means and brings yet more important context to the current scale of streaming versus downloading. But of course music downloads are just one part of Apple’s business, and not a hugely important one at that. Apple sells downloads to improve its device proposition. As I have written before, it is effectively monetized CRM, and interestingly in these days of increased investor scrutiny, music sales are actually a low margin revenue stream for a company which prides itself on high margins. Which means the better that music sales do, the more they dent Apple’s profit margins.
But the really interesting trend that the 25 billion downloads reveals is that the surge in iPhone and iPad sales has brought a very significant boost to iTunes sales (see figure). This has major implications for the music industry. In 2008 digital music sales fell off a cliff when iPod sales started their long term decline (see my previous chart here). But now, following an inter-product cycle lull, music sales are up again. The impact of Apple’s device sales on music sales is huge. When declining iPod sales started pulling digital downloads growth down I wrote that ‘when Apple sneezes the music industry gets a cold’. Now it is also clear that when Apple smiles, the music industry grins from ear to ear.
There are other factors at play too (such as the impact of all those new Apple stores coming on stream in markets such as Russia and India). But the data does show that we are some way yet from streaming denting download sales. Largely because downloads are a much more natural entry point for new digital music consumers.
For some final context though, as significant as the surge in iPhone and iPad sales has been on music sales, it has had an even more marked impact on App downloads. Which is a timely reminder that these devices are built for multimedia, interactive, visual experiences. While the music industry’s main product for iPhones and iPads remains a static audio file. That problem needs fixing fast.
*For long term Apple watchers the use of the word ‘sold’ is significant. The language Apple usually uses is that in the opening paragraph of the release ‘bought and download’ which has long been assumed to be worded to capture free downloads also. The interesting question now is whether the use of the word ‘sold’ in the release headline is a clarification of terms, or an over eager copy editor.
Perhaps the greater surprise is how long UK high street media retailer HMV has been able to hang on rather than the fact HMV today formally announced it was calling in the administrators. HMV of course has been on borrowed time, with suppliers having come to its aid a year ago, pumping in cash and taking an equity stake in return. HMV’s group revenues have been in decline since 2009 but its music sales have been tumbling since long before that. And despite belated revenue diversification strategies such as moving into the live sector, taking a smart strategic investment in 7 Digital, and some other recent smart initiatives, HMV has been unable to halt the inevitable.
Of course HMV’s problems are far from unique. Retailers across the globe have struggled to come to terms with the transition from the distribution era of selling physical units of stuff to the consumption age in which consumers value access to digital experiences. Even the most innovative retailers have found it difficult: just look at the travails of France’s Virgin Mega, arguably the single most innovative and ambitious of high street retailers couldn’t make it work. But for every Virgin Mega who tried to seize the digital bull by the horn there are ten Fnac’s (the other leading French media retailer) who did far too little too late. In fact, somewhat depressingly, one could argue that if the end result is the same, why bother expending all that strategic effort trying to change?
But what brought HMV and other retailers to their collective knees was a fatal combination of irresistible momentum and strategic error. Piracy, tumbling CD sales, and competition from new competitors (supermarkets, online retailing and Apple) all played their part. But even collectively they need not have added up to an HMV death sentence in 2013. Don’t get me wrong, I am not arguing that there is a long-term vibrant role for high street music retailing, but there could be at least a few good years left.
Despite Apple having been in the market for a decade, the CD remains the bedrock of music sales, and a very significant share of music buyers still buy music offline. For HMV, if it survives in some guise, perhaps half of its 230 odd stores will be able to eke out a solid enough business for another couple of years. The problem though is that those stores will be serving the lowest value part of the music buying population. HMV used to be the destination of the music aficionado now it is the last refuse of the mass market, tech-wary passive music buyer. These consumers are numerous but incredibly low value: the bottom 60% of UK music buyers account for just 18% of total UK music spending. But nonetheless it is a customer base there for someone to serve.
Unable to Kick the High Street CD Habit
Of course, HMV should never have let itself get into the position of relying on bottom feeder revenue. HMV reacted too slowly to the rise of digital, and in doing so was little different from most other music retailers. HMV did not recognize the seriousness of the threat of Amazon and Apple until it was too late. The irony of the piece is that there was a growing strategic awareness of the Apple threat but strategic paralysis prevented HMV from doing anything. While HMV busied itself rolling out ill fated digital stores and services it was unable to play the ace in its pack: deep integration with CD retailing in the high street. But because HMV’s digital revenues were a miniscule share of the total business, the digital team never won the argument against the main retail business who would have effectively been signing away their core proven revenues to an unproven internal upstart. HMV was deeply addicted to high street CD revenue and it was simply unable to kick the habit.
The Missed Digital Opportunity
Back in the mid-2000’s this could have helped transition a very meaningful share of still-physical-but-soon-to-be-digital customers to HMV digital rather than to iTunes. Of course HMV would have needed MP3 catalogue at this stage too, but they were strong enough to get this years before it actually happened, if only they’d been willing to expend political capital getting the licenses from the majors. MP3 mattered but simply wasn’t a big enough deal for HMV in 2005.
The dominant influence of the high street retail business had another unfortunate effect: just when HMV should have been battening down the hatches against Apple, it instead gave Apple a free pass to steal its customers by stocking iPod accessories and iTunes gift cards in its stores. Of course this all made absolute short-term revenue sense, but it was long-term strategic idiocy.
If HMV had acted early enough – i.e. 1999 /2000 – and used its political weight to get the right deals out of the labels and partnered with a good device manufacturer, then we might have been looking at a digital success story now. Even if HMV had missed that strategic-visionary boat, and had instead fought a proper rear guard action from the mid-2000’s then it would have a meaningful digital business by now. Instead HMV’s fortunes remain inextricably tied to the slow, painful demise of the CD.
Regrets, it’s had a few and, unfortunately, it did it its way.
If you are a journalist and would like to talk about this story please email me at mulligan_mark AT hotmail DOT COM
2012 has been a fantastic year for smartphones, with penetration pushing past the 50% mark in key markets such as the UK and US (some estimates even put US penetration as high as 70%). Apple’s iPhone is the leading smartphone in most key markets but Google’s Android Operating System (OS) has much larger market share: c. 70% compared to c. 20% for iOS (Gartner estimated global market shares to be 64% and 19% respectively back in Q2 2012). But these market share statistics can be misleading, particularly when it comes to understanding the digital content and services marketplaces.
Android Fragmentation Complicates Content Strategy
The fragmented nature of the Android landscape is well documented but close analysis of key metrics reveals some startling trends with significant implications for content providers (see figure):
- 60% of iOS devices are on the latest version of the OS (iOS 6) compared to just 3% of Android devices on the latest flavour of Android (Jellybean). Additionally, 88% of iOS devices are concentrated in 3 versions of iOS while Android devices are spread across 10 different versions of the OS, of which 54% are on a version that is 4 releases out of date (Gingerbread).
- There are 260 different Android phone and tablet models, compared to just 6 iOS tablet and phone models.
- There are more than 50 different official Android stores, but just one Apple App Store
Of course there are many mitigating factors, but that simply does not matter from a consumer perspective nor indeed from a content owner’s perspective. Both iOS and Android have got vast App catalogues (750k and 650k respectively) and both have vast numbers of apps downloaded (35 billion and 25 billion respectively). Both also have huge installed bases of devices: 450 million iOS devices and 600 million Android devices. But there is only one clear leader in paid content: Apple.
Looking just at music sales, Apple’s music annual music sales (based on the last reported 12 months) equate to approximately $4.00 per iOS device, compared to just 50 cents per Android device. Apple wins in part because of its longer presence in market, but more importantly because it exercises complete control of the user journey in a closed ecosystem.
The Importance of Closed Ecosystems
The success stories of paid content to date are closed ecosystems: iTunes / iOS, Playstation, xBox, Kindle. Though the controlled nature of these ecosystems may limit user freedom, they guarantee a quality of user experience. In these post-scarcity days of content, the quality of experience becomes a scarce experience which people are willing to pay for. Google simply cannot exercise that degree of control because of its pursuit of a less-closed (but not wholly open) ecosystem strategy. It depends upon device manufacturers to determine the user experience and also gives other value chain members much more control, such as allowing operators (Vodafone) and retailers (Amazon) to open their own Android stores, as well as, of course handset manufacturers (Sony).
Smartphones with Dumb Users
In a pure mobile handset analysis this doesn’t matter too much. But from a content strategy perspective it matters massively so. The problem is compounded by the fact that that as smartphones go mainstream the user base sophistication dilutes. With so many consumers increasingly buying smartphones because they are cheap and on a good tariff, rather than for their smartphone functionality we are ending up with a scenario of smartphones with dumb users. (I am indebted to my former Jupiter colleague Ian Fogg for this phrase). This factor arguably affects Android devices more than it does Apple devices because a) they are more mainstream b) they are often cheaper. This matters for content owners because the more engaged, more tech savvy smartphone owners are also the ones most likely to pay for content.
Google Needs to ‘Do An Apple’ and Not ‘A Microsoft’
With growth slowing in the digital music space, it is clear that new momentum is needed. Google is potentially the strongest opportunity to bring mass market traction to the digital music space, but currently its music strategy, and paid content strategy in general, is falling short due to all of the reasons outlined above.
Google does however have an incredibly strong set of assets at its disposal, in terms of installed based and growing adoption. If Google is serious about making its Play strategy a success then it needs to start putting itself first. Back in the early 2000’s Microsoft expected to be the dominant force in digital music because Windows Media Player was the #1 music player and Windows DRM was the industry standard rights protection. But instead of pushing ahead with a bold Microsoft music offering it relied upon its hardware and services partners to do it for them. Just as Google now is sensitive to the concerns of its commercial partners, so Microsoft was then. Of course Microsoft lost the battle and their softly-softly approach was powerless to fight off the rapid onslaught of iTunes. Microsoft eventually realized that it needed to go it alone, launching Zune, but it was too little, too late. Interestingly there wasn’t much of a backlash from commercial partners when it did so. Launching a standalone music strategy was actually compatible with being a platform partner.
Now Google has an opportunity to learn from both Microsoft’s mistakes and Apple’s success by turning its recently acquired asset Motorola into a closed Play ecosystem to rival iTunes. This doesn’t preclude Android partners from continuing to build their own devices and app stores, but it does create a paid content beachhead for Google, from which it can build a base of highly engaged digital consumers who will quickly learn to value the benefits of a high quality, unified content and device experience. In a Motorola ecosystem Google can truly allow Google+ and Play to become the glue that binds together its diverse set of valuable assets. Without it though, Play will continue to struggle for relevance in a fragmented and confusing Android user journey.
This week Apple and Colombia announced the arrival of another big digital holdout to the iTunes Store: AC/DC. Having grown up listening to AC/DC and playing Angus Young riffs such as the seminal ‘Whole Lotta Rosie’ in my high school heavy metal band, my level of interest in this announcement is perhaps a little biased. But there are a couple of important factors here:
- The digital hold outs are being won over by downloads. When Apple first launched the iTunes Music Store there were plenty of high profile holdouts, the most significant of which being the Beatles. Over the subsequent years most of those holdouts have come on board. iTunes is no longer the scary unknown quantity it once was. iTunes is now the establishment. Its FUD Factor (Fear Uncertainty and Doubt) has largely diminished.
- But streaming is still a step too far. By contrast streaming services such as Spotify are at a much earlier stage of their evolution and their FUD Factor is high. Thus Spotify has a sizeable body of holdouts, including AC/DC. The same fear of the unknown that once afflicted iTunes now tars Spotify, Deezer, Rdio et al. The paid download might feel like the embodiment of security and safeness now, but back in the early noughties it struck terror into the hearts of many music industry executives who, rightly as it transpired, feared that it would result in consumers hacking away at albums to skip to the singles. Streaming will ultimately hone its model and win over the doubters but it will be a slow and steady process. After all it took a decade for AC/DC to be won over by iTunes.
The Importance of Not Getting too Hung Up on Yesterday’s Stars
Back when the Beatles were finally licensed to the iTunes Store I went on record as saying it wasn’t actually a big deal for the digital music market. I found myself the subject of torrents of abuse from Beatles fans (for entertainment’s sake you can see the comments here). The point I was making was that the Beatles, as important as they are both creatively and commercially, are part of the past. They are not what matters to the generation of young music fans that the music industry really needs to win over with (paid) digital services. The Digital Natives who currently just aren’t spending money on music. The Beatles were a big coup but they mattered much more to Steve Job’s generation than to tweens and teenagers. For sake of impartiality I have to apply the same rule to AC/DC, who matter much more to my generation than to the Digital Natives. AC/DC finally being won over to the iTunes Store is important progress, but much more important will be more digital services which get young music fans on the music spending ladder. BBM Music is a rare and under-appreciated foray into this market.
Defusing the Demographic Timebomb
A Demographic Timebomb is ticking: unless the Digital Natives start spending meaningful amounts of money on music soon (either directly or indirectly) the gaping hole they will leave in music spending as they get older (and thus have more music to spend) will make the current decline in music revenues look like a mere blip. In fact this is a warning I first made 7 years ago, and we are already feeling the first effects, but there is still time to address the issue.
A lot is made of the importance of iTunes in tapping the young, pre-credit card market, by dint of teenagers using their parents’ iTunes accounts to buy music. It is certainly an important factor but the scale is far below where it needs to be to have a meaningful impact on the pre-credit card youth and it is unfair to expect Apple to bear all of that burden. Although it is worth considering that as the iPod transitions towards being a youth product that Apple may yet be the key link in the youth chain.
So welcome to the digital age AC/DC, and congratulations to Apple for getting them on board the digital bandwagon, but I hope your arrival does not distract from the even more important task of winning over the Digital Natives.
The importance of Apple to the digital music market cannot be overstated. Without Apple the digital market would be vastly smaller than it is now. With all of the talk of streaming services and the shift to the consumption era it is easy to think of Apple’s iTunes Store as yesterday’s game. Such an assumption is as dangerous as looking upon the CD as an irrelevance in the present era. The CD and iTunes combined account for approximately 78% of total recorded music revenue in the world’s 10 largest music markets. And yet neither look like they are going to provide the momentum the music industry needs over the next few years. Despite its vast importance to music revenue today, the CD is obviously on a fixed downward path. And the download is not so dramatically different in profile in that it is the dominate revenue source yet is not delivering the dynamic growth the digital market needs. Key to this is of course the role of Apple.
Apple CEO Tim Cook told us at the launch of the iPhone 5 that ‘Apple still loves music’ and so it does. But music is inherently less central to Apple’s content and device strategy than it was 5 years ago. When the iPod launched it had a monochrome screen and did little else than play audio. Music was the killer app with which to market iPods. Now games, apps, video and books show off the capabilities of colour touch screen iPads and iPhones much better than a static audio file (even if music remains one of the key activities on both those devices). In the early days of the iPod Apple needed the record labels more than they did Apple. Indeed, to begin with the iPod was far from a runaway success. By the end of 2002, one year after launch, the iPod had only sold 625,000 units. The iTunes Music Store changed the story, delivering not only unprecedented digital music milestones, but also record iPod sales. After the first full year of the iTunes Music Store, sales of the iPod had quintupled from 2 million to 10 million, and one year later they surpassed 40 million. The iPod and the iTunes Music Store had a clear symbiotic relationship. Now though, Apple’s devices benefit from a much broader array of content and services from the iTunes Store, which pointedly is no longer called the iTunes MUSIC Store.
Apple’s diversification of device and content strategy heralded a brave new chapter in Apple’s history but it has also left the digital music market without the fiercely energized catalyst that kicked it into motion. By the time Apple launched the iPhone in 2007, the installed base of iPods was already slowing. Though sales were still increasing, the majority of those were either replacement or additional purchases. So although iPod sales were booming still, the number of new iTunes Music Store customers was not. Throughout 2008 I presented the data to a number of senior record label executives at the time and I argued that they needed to start planning for a post-iPod slow down. Some of them didn’t take me too seriously, and who could blame them, after all iPod sales were growing strongly and iTunes downloads were growing at a stellar rate. But now, with a few years of market data behind us, the true scale of the post-iPod slowdown is clear (see figure). As soon as iPod sales slowed, so did the digital music market. Prior to 2008 the digital music market had grown by an average annual rate of 85.2%, after 2008 that rate dropped to 7.5%. In many markets the 2009 slowdown was of falling-off-a-cliff proportions: in the US digital growth slipped from 30% in 2008 to a near flat-lining 1% in 2009.
Streaming services have started to bring some welcome momentum to digital music. But much more is needed from them if growth is to be reinvigorated. That growth may also be helped by new music formats like the forthcoming Lady Gaga album app. Whatever the source of it, it is clear that the music needs another iPod momentum to kick the digital market back into life.
Mobile apps can stake a pretty solid claim to being the single most important shift in consumer product behaviour in the last 5 years. Sure the devices themselves are pivotally important, but were it not for the apps consumers install on them, they would just be better versions of the feature phones and early smartphones from half a decade earlier. Apps have transformed consumers’ expectations of what digital experiences should be, and not just on connected devices. But Apps have also transformed product strategy, in two key ways:
- Apps have replaced product strategy with feature strategy
- Apps have created a renaissance in the consumer software market
Apps have replaced product strategy with feature strategy
Though there are a good number of apps which can be genuinely held up as fully fledged products (Google Maps, Angry Birds, WhatsApp etc.) many are in fact product features rather than products. Shazam for example is a fantastic feature, so fantastic that it should be as ubiquitous in music products as a volume button, but it is nonetheless a feature not a product. Don’t mistake this for a derogatory critique: indeed feature strategy is virtually the core DNA of the app model. After all apps rely upon the core product of the smartphone or tablet itself to do much of the hard work.
Apps co-exist with the core functionality of the device in order to layer extra features on top. Instagram uses a phone’s camera and web functionality, Layar uses the camera and GPS and so forth. In short, apps add features and functionality to hardware products. That does not make them inherently any less valuable for doing so, but it does make them dramatically different from pre-App products. Even the majority of utility apps, such as those that track rail and flight schedules, or the weather are at heart browser bookmarks on steroids. Games are perhaps the only app category which in the main can be considered as self-contained products.
This shift from product strategy to feature strategy has slashed the time it takes for products to get to market and has dramatically reduced development overhead, but it is a model riven with risk. Consumers and the device ecosystem companies are winners, but many app developers are exposed. On the one hand they have the insecurity associated with platform dependency, on the other they know that if their features are that good that they will likely be integrated into the device’s core OS or into the featureset of another app with broader functionality. Sometimes those scenarios will be achieved via favourable commercial avenues (such as an acquisition or licensing) but sometimes it will just be flat out plagiarism.
The lesson for app developers is clear: if your app is a feature and it is good, then you need to plan for how to turn it into a product, else plan for what to do when your app has become someone else’s feature.
Apps have created a renaissance in the consumer software market
It is sometimes easy to lose sight of just what apps are: software. In the PC age software was for most people one of three things:
- Microsoft Windows and Office
- An anti-virus tool
- A bunch of free-trial bloatware shortcuts preinstalled on their desk top pre point of sale
Mainstream PC behaviour was defined by Microsoft functionality and browser based activity. Sure, software from the likes of Real Networks and Adobe supported much of those browser based experiences, but they were to the consumer effectively extensions of the core OS rather than software products themselves. A premium consumer software market did exist but never broke through to mainstream. Consumers didn’t know where to look for software, whether it would install properly, whether it would work on their PC, and then on top of all this they were faced with having to provide credit card details to small companies they knew nothing about.
Mobile apps changed all of that. App stores simultaneously fixed the discovery, billing, installation and compatibility issues in one fair swoop. Apps have enabled the consumer software market to finally reach its true opportunity. Just in the same way that the iPod allowed digital music to fulfil its potential.
Apps continue to transform consumer behaviour and expectations
So where will feature strategy and the reinvigorated consumer software business take us? What is clear is that consumers are getting exposed to a wider array of digital experiences and are evolving more sophisticated digital behaviours due to apps. Apps are also enabling consumers to do things more effectively and efficiently, and are empowering them with more information to make better decisions, whether that be getting the best flight price or choosing the best local plumber. They are also making consumers expect a lot more from a device’s ecosystem than just the devices. How often do you see a phone company advertise its handsets with the screen turned off? It is the apps that count. For now, however good Nokia might be able to make its smartphones it knows that its app catalogue and ecosystem struggles to hold a candle to Apple’s App store and ecosystem (the same of course applies to all other handset manufacturers).
Apps have become velvet handcuffs for connected device owners
But what happens if/when consumers start to shift at scale between ecosystems? For example, say Apple finds swathes of its iPhone and iPad customers switching to competitors in the future, what sort of backlash will occur when consumers find they have to expensively reassemble their app collections to reconstruct the features they grew used to on their Apple devices? Perhaps a smart handset manufacturer would consider investing in an app amnesty, giving new customers the equivalents of their iOS apps for free on their new handsets.
For now though, Apple’s market leading app catalogue behaves like velvet handcuffs on its customers and gives it a product strategy grace period, in which it could get away with having a sub-par product generation, with customers staying loyal because of not wanting to lose their App collections. But not even the strength of Apple’s app catalogue would not enable them to keep hold of disaffected customers much longer than that. After all, apps are features, not the product itself.
Apple’s $1 billion patent infringement victory against Samsung raises a number of increasingly pressing issues about innovation in the consumer technology space. There is no doubt that Apple has done more than any other single company to shape the smartphone marketplace. It is also clear that the average smartphone form-factor and feature set look dramatically different post-iPhone than they did pre-iPhone. And there is an argument to be had that those same form factors and feature sets bear more than passing resemblance to the iPhone. But this raises the issue of where the ‘a high tide raises all boats’ market evolution argument stops and the patent infringement one starts.
Samsung is the Buffer State in Apple’s Proxy War with Google
Apple’s case against Samsung was in effect a proxy war against Android. Samsung became the target because it was doing a better job of making Android compete against Apple than anyone else. While competitors like Nokia and HTC have laundry lists of product names and numbers, Apple’s elegantly simple iPhone brand cuts through the smartphone name clutter like the proverbial knife through warm butter. Among numerous other factors Samsung recognized the supreme value of establishing such clear brands (such as the Galaxy) and pivoting their portfolio around them. Samsung became competitor #1, the Android success story, racking up a 50% share of the smartphone market in Q2012 according to IDC, which compares to just 17% for Apple.
The final impact of the ruling is yet to be seen, with countless potential challenges and subsequent actions likely to come. There are also interesting geopolitical issues at stake, not least of which is the degree to which a Californian jury and judge will be perceived on the international stage as having the requisite impartiality to rule upon competition between a South Korean and a Californian based company. But leaving aside the legal permutations for a moment, let’s instead take a look at the known unknowns and their likely impact on the marketplace:
- Competitive patent strategy. Over the last couple of years we have seen an acceleration of the use of patents in the consumer technology and Internet arenas. Patents have quickly become established as an extra part of competition strategy among big technology firms. Now, instead of just relying on product development, marketing, pricing and positioning technology, companies can use patent claims to help strengthen their position at the direct expense of the competition.
- Patent arms race. With the rise of patent trolls (companies’ whose sole objective is to acquire patents and then try to sue established companies for patent infringement) the big established companies themselves have started to acquire patent arsenals. For example, earlier this year Microsoft paid AOL $1.1bn for 925 patents, 650 of which it promptly sold to Facebook for $550m. Before that, in 2011, Microsoft teamed up with long-time rival Apple as well as with just about anyone whose anyone in the smartphone business who isn’t Android (RIM, Sony, Ericsson et) to spend $4.5 bn on 6,000+ patents from bankrupt Canadian teleco equipment maker Nortel. Google had been on the other side of the bidding war and lost out with what was seen by some as a whimsical bidding strategy. Google promptly went onto to buy fading handset manufacturer Motorola for $12.5bn, a company that just happened to have c.17,000 patents in its archives. There are uncanny echoes of the Cold War with both sides stockpiling nuclear weapons. The difference here is that the arsenals are being thrown straight into battle rather than being held back for fear of Mutually Assured Destruction.
- Patents no longer fit for purpose? Patents raise as many questions as they provide answers for in the software and technology spaces. Not only are they subject to legal challenge, the language used in them is often inadequate. What gives a piece of technology competitive edge is not having rounded corners, but the digital mechanics underneath the hood. It is the code inside a piece of software that gives it edge, not the broad user behaviour it supports. That’s why we have market leaders in software and product categories that are crowded with lesser competitors that support the same basic user behaviour. And yet patents focus on the exact opposite of this equation. Patents are typically vaguely worded affairs that talk about broad behaviours such as “a system for controlled distribution of user profiles over a network” (taken directly from a patent which forms the basis of Yahoo’s case against Facebook). Even the more detailed patents – such as Apple’s recent Haptics filing – have a procedural focus. And of course they have to. Patent applications are exactly that: applications. There is no guarantee they will be granted and so a filing company is going to be as secretive as they possibly can rather than give its competition edge. But even if there was a guarantee there is no way in which a technology company is going to publish its source code on a publically accessible document.
And therein lies the problem, if a company is not ever going to include the secret sauce which gives its product the real edge, then what is a technology patent really going to be able to definitively cover? If it inherently comes down to a discussion about supporting usage behaviours then we end up with an unusual and potentially restrictive lens placed upon innovation and invention. The history of innovation and invention is that when something comes along that is good enough, it permeates through the entire market. Sometimes this involves licensing of patents, more often than not it happens through creating similar but different inventions. Think about any consumer electronics purchase, whether that be a digital camera, a laptop or a TV: the products all have pretty much the same mix of features and form factor in their respective price tiers. This is what has happened to date with smartphones.
However if the Apple ruling survives all challenges and is then extended it could have the effect of a forced and artificial split in innovation evolution. Instead of the touchscreen smartphone becoming another step on the innovation path it could become the sole domain of Apple and force the competition to pursue entirely different evolution paths. Now there are obviously both positive and negative connotations of that. But whatever your view point, it will be dramatically different from how other consumer electronics product categories have evolved.
With its origins in early 18th century England, there is an increasingly strong case for a major review of the global patent system and whether it is the right tool to strike an appropriate balance between protecting intellectual property and fostering innovation in the 21st century consumer technology marketplace.
Who’s Competing with Who?
An interesting post-script to the Apple-Samsung case is looking at who else will potentially benefit other than Apple. Right now there will be a host of handset manufacturers who will be hurriedly looking for a Mobile OS Plan B. An uncertain Android future doesn’t leave them many places to turn to other than Microsoft’s Windows 8. Historically no friend of Apple but these days of course part of Apple’s Patent Pact. How long that alliance will remain intact remains to be seen, though a cynic might argue that Apple would leave it in place just long enough for Microsoft to get enough of a foothold to fragment the OS marketplace before it renews hostilities between Cupertino and Redmond. By which stage Apple could have billions worth of patent settlement dollars to wage war with…