Is Digital Music the Next Eurozone Crisis Waiting To Happen?

Much of the contemporary debate about digital music’s financials centres around perceived inequities in artist pay outs, particularly from streaming services.  These are very valid concerns and I continue to argue for an honest and transparent debate.  However there are two equally worrying issues: the sustainability of the stores and services themselves and the class divide that has grown between the US and European digital music markets.

The Trans-Atlantic Digital Divide

It has been clear for a number of years now that the US digital market has been massively outperforming its European peers.  A number of factors contribute to this, including:

  • The stronger footprint of Apple in the US
  • That the US is a more unified and more easily addressable consumer market
  • The fragmented rights landscape in Europe
  • European online consumer behaviour lags that of the US

Those factors alone would be enough to stifle European prospects, but paradoxically Europe has developed a much larger number of digital services than the US, both in relative and absolute terms.  According to the IFPI et al’s Pro-Music website, pre-accession Western Europe has 465 services compared to just 24 for the entire US.  In relative terms that translates to 1 service for every 600 thousand European Internet Users compared to 1 for every 10 million US Internet Users.

Music’s Digital Double Whammy

So in effect we have a ‘digital double whammy’: Europe has too many services chasing too few customers.  When we look at the per-service revenue picture the picture becomes even more concerning (see figure).  In the chart we are looking at the Average Margin Per Service (AMPS).  This assumes an operating margin of approximately 20% per service following deductions for recording rights, publishing rights and payments.  20% may sound like a healthy margin but bear in mind that this pot has to pay for a wide range of costs, including Marketing, Technology, Fulfilment, Customer Care, Staff etc.  (In fact scale is crucial and even Apple can only make downloads an ‘on average break even’ business.)  Of course the exact margins vary according to the precise business model, label terms etc but the 20% assumption gives us a good working measure to gauge regional trends.

The first thing that jumps out is the massive disparity in US AMPS ($26.03m) compared to Europe ($0.61m).  In effect the over-supply of European services acts as an accelerator on the disparity between the regions. At a country level there is further diversity, with the UK and France standing out as the strongest – or rather least weak – margin markets.

Scrapping over Apple’s left-overs

But of course the digital music market is not an equally distributed one.  Apple’s iTunes store accounts for the vast majority of the download market, hence the second metric in the chart: AMPS post-Apple.  This shows the average margin per service based upon what is left of the market after Apple’s share has been removed.  (To do this a 70% share assumption was applied to the paid download segment of each digital market.  In some markets this will underrepresent, in others over-represent, but it nonetheless gives us a good comparative directional guide).  Looking at AMPS post-Apple the situation is starker, with the average margin per service in Italy dropping to less than a quarter of a million dollars.

Too many services are chasing too few customers

Back in 2006 at JupiterResearch I wrote a report that made a case for the lack of sustainability in the digital music value chain in Europe and the risk it posed for services.  5 1/2 years on and the situation is unfortunately beginning to come to fruition.  The reason we haven’t had a market implosion yet is because so many of the owners of these services – such as ISPs and mobile operators – continue to show appetite to run them at a loss because of perceived benefits to their core businesses.  But the simple fact is that there are too many services.  In the pre-digital age most markets had but a small handful of national music retailers.  So why in the digital age should that become dozens, particularly when the recorded music market is half its peak size? (The UK alone has 74 services).

When choice doesn’t = choice at all 

And it is not as if these 465 services are bringing extensive choice to European consumers.  The majority of them offer the same catalogue, at the same price with the same device support.  All that this over supply of me-too services does is muddy the water.  There is so much choice that there is no choice at all.  If digital music is ever going to get out of its current impasse, the music industry must fix the over-supply issue. Until it does so, any progress in discussions on artist pay-outs is going to be constrained by the growing concerns posed by an underperforming digital market.