How iPod changed everything

Apple just announced that it is finally ending production of the iPod. At 21 years of age, it outlived many of the dramatic changes it witnessed and triggered. In this age dominated by streaming (and a vinyl resurgence) the iPod did not really have a place anymore, other than with its ever diminishing base of super fans. It should probably have ceased production long ago, but the iPod holds a special place in Apple’s heart and sentimentalism likely played a role in allowing it to reach its 21^st birthday before it was finally put out to pasture. And there is no doubt that the iPod earned that special place, because it was the change catalyst that transformed Apple into the mega corporation that it is today. But the iPod did even more than that, it was the trailblazer that created the environment in which today’s digital entertainment world could exist.

Back in my early days as an analyst I went to my first ever Apple analyst briefing, for the launch of the second generation. I felt like a fish out of water, with the room full of dry tech analysts asking Apple about its education strategy, its server products, its enterprise computing strategy. Then little me in the corner, asked about the iPod, and the entire room turned to me with bemused faces, just like the pub scene in American Werewolf in London.

Every successive briefing session I went to, the iPod became an ever bigger deal and the other analysts in the room started asking questions about it too. The iPod shuffled along at a steady pace until the launch of the iTunes Music Store, at which point it suddenly had a purposes it previously lacked, and sales lifted off. Apple has never looked back.

It is no coincidence that it was music that propelled the iPod to tech immortality. Steve Jobs was a massive music fan and it was his passion that helped ensure the iPod continued to receive the support it needed, even when it was not yet showing signs of fulfilling its huge potential. Apple has always been a company that is as obsessed with content as it is hardware and this is why the iPod and subsequent Apple devices have been so central to the growth of digital entertainment.

As the iPod evolved from scroll wheel to touch screen it became the launchpad for something even bigger for Apple: the iPhone (the first gen iPhone was a direct evolution of the iPod touch, at a time when smart phones were all keys). With the iPhone came apps. Just in the same way that the iPod was not the first digital music player, so Apple was not the first to make mobile apps nor of course the first to make a smartphone. But in all three cases, Apple took a promising but struggling format and made it ready for primetime. This early follower strategy underpinned Apple’s success in the 2000s and the early 2010s.

Pandora was an early beneficiary of Apple’s app strategy, being natively installed on US iPhones. The result was another lift off, with Pandora soon becoming he most widely used streaming app on the planet, even though it was only available in the US. Just as with the iTiunes / iPod combination, Apple understood the cruciality of an integrated content / device experience and its App Store became the launch pad for today’s digital entertainment economy. It did so by allowing app developers across the world to find a global audience which did not need to worry about clumsy installations and fragmented billing. Everything happened in one place, seamlessly and effortlessly. Google soon followed with its own take on the app store. Now you will struggle to find a games, music, video, news, podcast or book provider that does not use the Apple App Store, nor indeed a consumer that does not use apps to consumer content. 

Apple’s subsequent launch of the iPad and Apple TV further accelerated the adoption of digital content, giving audiences and content companies more choice about where they could benefit from the app economy. Apple Music, Apple TV, Apple Books, Podcasts, News, Arcade and more followed, helping cement Apple not just as a catalyst for the digital entertainment economy, but also as a major content player in its own right.

None of this would have happened without the iPod. So even though many readers will be too young to have even owned an iPod, spare a thought for this now departed member of the digital ecosystem, because without it, the devices you use and the entertainment you consume would look very, very different.

Farewell iPod!

The Real Problem With Streaming

Much of the debate around the sustainability of streaming has understandably focused on artist and songwriter income and transparency.  It is a debate that I have contributed to frequently.  But the more fundamental structural issues are whether the business models are commercially sustainable and if they are, what the implications are.  Music consumption is inarguably moving towards access based models so the question is not whether streaming should happen or not, but how to make it work as well as it possibly can for all parties.  As unfair as it might seem, the baseline issues regarding creator income could go unchanged without streaming business models falling apart.  But, as I will explain, if broader commercial sustainability issues are not fixed then many streaming businesses will collapse leaving just a couple of companies standing.  And that scenario would almost certainly be worse for creators than the current one.

The Steve Jobs Revenue Share Legacy

As I revealed in my book ‘Awakening’, when Steve Jobs struck the original iTunes Music Store deal he walked away a happy man despite having given the major labels the big revenue percentages they wanted.  Why?  Because it meant that it was really hard for anyone without ulterior business aims like Apple had, to make money from selling tracks as a standalone business.  The revenue shares negotiated back then set the reference point for all digital deals since.  The fact that streaming services pay out more than 70% of revenues to rights holders can be traced back to that deal.

The Great Role Reversal And The De Facto Label Monopoly

In the digital era the record labels undisputedly hold the whip hand, and some.  In the analogue era the roles were reversed.  Retailers were the dominant partners and they knew it.  Record labels actually paid retailers for placement to promote new releases.  Compare and contrast that with labels contractually compelling services to provide placement.  Both models are wrong and both engender corrosive behaviour.  Because the major labels account for the majority of music sales it is nigh on impossible for a non-niche music service to operate without all three on board.  This gives each label the effective power of veto.  So even though no major label is a monopoly in its own right each has an effective monopoly power in licensing.  These factors give labels them the strength and confidence to demand terms that would not take place in an openly competitive market.  This, for example, is very different to how digital deals are done in the much more fragmented TV rights landscape.

Loading The Risk Onto Music Services

Why all this matters for the sustainability of streaming services is because of how it manifests in commercial terms.  Recent contract leaks have revealed to everyone the details of what insiders long knew, that labels and publishers front-load deals.  Services both have to pay large amounts up front and agree to guaranteed payments to rights owners regardless of how well the service performs.  (Some labels proudly state they don’t charge advances but instead charge a ‘set up fee’ for every track in their catalogue. Call it what you like, making a music service pay money up front is an advance payment.)  Even without considering the entirely intentional complexity of details such as minimas, floors and ceilings, the underlying principle is simple: a record label secures a fixed level of revenue regardless, while a music service assumes a fixed level of cost regardless.

Labels call this covering their risk and argue that it ensures that the services that get licensed are committed to being a success.  Which is a sound and reasonable position in principle, except that in practice it often results in the exact opposite by transferring all of the risk to the music service.  Saddling the service with so much up front debt increases the chance it will fail by ensuring large portions (sometimes the majority) of available working capital is spent on rights, not on building great product or marketing to consumers.

Skewing The Market To Big Tech Companies

None of this matters too much if you are a successful service or a big tech company (both of which have lots of working capital).  Both Google and Apple are rumoured to have paid advances in the region of $1 billion.  While the payments are much smaller for most music services, Apple, with its $183 billion in revenues and $194 billion in cash reserves can afford $1 billion a lot more easily than a pre-revenue start up with $1 million in investment can afford $250,000.  Similarly a pre-revenue, pre-product start up is more likely to launch late and miss its targets but will still be on the hook for the minimum revenue guarantees (MRG).

It is abundantly clear that this model skews the market towards big players and to tech companies that simply want to use music as a tool for helping sell their core products.   Record labels complain that they don’t get enough value out of big companies like Google and Samsung, but unless they make the market more accessible to companies that are only in the business of selling music they can have no room for complaint.  The situation is a direct consequence of major label and major publisher licensing strategy.

Short Termism And From Evil To Exceptional

Matters are compounded by an increasingly short term outlook from label licensing divisions, with the focus on internal quarterly revenue targets, or if you are lucky, annual targets.  The fact that much of label and publisher digital revenue comprises guarantees and advance payments means that their view of the digital market is different from how the market is performing.  If our small start up that pays $250,000 in rights payments doesn’t even get its product to market, the rights holders still see that digital revenue even though the marketplace does not.  (One failed music service that didn’t even launch went into bankruptcy owing two major labels $30 million).

This revenue comfort blanket insulates labels and publishers from much of the marketplace pain.  So if/when things go wrong, they feel it later, delaying their response.  There is also a cynicism in much deal making, with rigid templates applied to deals and a willingness to compromise principles if the price is right. The latter point was illustrated by the leaked negotiations between UMG and industry bête noir Kim Dotcom in which former digital head Rob Wells referred to being able to ‘downgrade’ Dotcom from ‘evil to bad’ and then from ‘bad to good and from good to exceptional partner’.  The message is clear, if there is enough money on the table, anyone can be a business partner whatever the implications might be for the rest of the market.

Wafer Thin Margins, Deep Pockets And The Innovation Drain

Current licensing strategy biases the market towards those with deep pockets and fatally compromises profitability.  Once all costs are factored in, a music subscription can theoretically have an operating margin of between 3% and 5%. Though only if it doesn’t invest sufficiently on marketing, customer retention and product innovation. But of course the streaming market is in early growth stage so every service has to spend heavily which means that profitability becomes a hostage to fortune. No wonder Daniel Ek is clear that Spotify is a growth business rather than on a profit crusade.

The market dynamics also create an innovation talent drain.  If you were a would-be start up founder the huge up front costs, non-existent margins, and complex time consuming licensing do not exactly make building a music app a welcome experience.  Building a games app however is an entirely different proposition: you own 100% of the rights, you don’t pay a penny to 3rd party rights holders and consumers actually pay for your product.  Music is already a problematic enough sector as it is without burdening it with a punitive licensing framework.

These are the structural challenges that could yet bring down the entire edifice of the streaming music economy.  The irony is that if Spotify has a successful IPO (sans profit of course) it will trigger a wave of copycat services and investment that will perpetuate the status quo a little further.  But it will only be a temporary delay.  Sometime or another the hard questions must be answered.

iTunes Radio: Another Chapter in Apple’s Cautious Cloud Music Strategy

As expected Apple today announced the launch of the music industry’s worst kept secret iTunes Radio, a Pandora-like personalized radio service.  iTunes Radio is integrated into the new iOS7, is free with ads to all, free without ads to Tunes Match subscribers. There’s enough different and new in iTunes Radio to make it stand out from the pack and to ensure it has a typically high quality Apple touch.  But the prevailing narrative will be that Apple has taken the conservative me-too strategic option rather than bringing new transformative innovation to the marketplace.  In many respects that analysis rings true but the complete picture is far more nuanced.

Apple is not in the business of creating markets or being a first mover.  Apple is the archetypal early-follower.  That applies even more to digital music than to hardware for Apple.  The iTunes Music Store was far from the first download store, but it was, and arguably still is, the best.  Apple is in the business of selling hardware and its music strategy is dictated by its ability to help it sell hardware.  Rather than balance itself precariously on the bleeding edge of digital music innovation Apple waits for music technology to become ready for prime time.

Two Reasons Why Apple Has to Go Slow With the Cloud

All of that has rung true for a decade+ at Apple.  But now there are new factors in the mix which play determining roles in Apple’s music strategy:

• Apple has become a mainstream company: Apple’s nineties and noughties heritage was that of the early adopter tech aficionado.  Now Apple is a mainstream consumer product company.  Since the start of 2011 Apple has sold 468 million iPods and iPads. In doing so it has brought swathes of mass market consumers into the iTunes ecosystem, resulting in 575 million credit card linked iTunes accounts.  But all this means that Apple now has to move more carefully, innovating at a pace that is appropriate for a majority of its customer base not just the highly engaged top end.  Spotify’s 6 million paying subscribers is a fantastic achievement but pales compared to Apple’s iTunes user count. The simple fact is that Apple does not think that $9.99 subscriptions are yet ready for primetime for mainstream consumers.
• The shift to the cloud will impact device pricing strategy: currently Apple’s device pricing strategy is dictated by storage capacity.  The bigger the hard drive the higher the price. But once/if everything shifts to the cloud bigger memory capacities matter much less.  This is why Apple has to go slow with the cloud.  If it goes too quickly it could accelerate the transition at a rate it cannot manage and end up wreaking havoc in its core device business all for the sake of keeping digital music fans happy.  A personalized radio service is a neat complement to downloads.  It won’t win any awards for innovation but it will give mainstream Apple customers enough extra value without disrupting device sales, or indeed music sales.  iTunes Radio buys Apple crucial time as it plans its cloud-era device and pricing strategy.

What Apple Could (and Should) Do

The shift to the cloud is of course inevitable and for all that iTunes Radio may buy Apple some time, the challenges must be faced. The answer to Apple’s problems may lie in the problem itself.  If consumers increasingly shy away from higher memory devices – and therefore more expensive devices – content may prove to be the way in which Apple maintains premium price points across its device portfolio.

Content is the core reason people use iPads and iPods and one of the core reasons people use iPhones.  A smart move would be to take that importance and bake it into the value proposition.  Instead of charging a premium based on memory size alone, Apple could additional sell content-device bundles (and longer term phase out memory size pricing entirely).  For example pricing tiers for iPads could look something like this:

• Price point 1: 16GB, no content
• Price point 2: 32GB $/€/£10 a month of iTunes content
• Price point 3: 32GB $/€/£10 a month of iTunes content and on demand music streaming

The reputation of content-device bundles got somewhat tarnished by the Comes With Music experience, but the model remains fundamentally sound.  Apple could just be the company to make it work. If it does, iTunes Radio will have proved to be a crucial first step on that journey.

In the meantime iTunes Radio is another important, incremental step in Apple’s cautious cloud music strategy.  Cautious because Apple is intent on innovating at a pace that matches the appetite of its mainstream customers.  Cautious because a hasty move could turn iTunes Music sales upside down with direct cannibalisation. And most importantly of all, cautious because Apple knows that if it gets it wrong it could disrupt device pricing strategy, with major repercussions right across Apple’s business.

In short there are many reasons for Apple to go slow with its cloud music strategy.  That might not make for the most exciting of music product roadmaps, but it does mean that Apple is building for long term sustainability and viability.  That in itself is of crucial importance for the music industry and should help ensure Apple remains a music industry partner of true scale for years to come.

iTunes @ 10

On Sunday 28^th April Apple’s iTunes Store will celebrate its 10^th birthday.  It is arguably the single most important milestone in the digital music market to date.  In these days of cloud and streaming dominated industry discourse it easy to forget just how important Apple has been in the history of digital music and how equally important it remains today.  In 2012, iTunes generated approximately $3 billion in trade revenues for the recorded music industry, equivalent to around  55% of all digital trade income and close to a fifth of all global recorded music trade revenue.  By comparison Spotify was closer to 10% of digital trade revenues and 4% of all global trade revenue.  Spotify is clearly at a much earlier stage of growth and represents the future, but iTunes is far, far from being a historical footnote.

The Four Ages of iTunes

The history of iTunes falls into four key chapters:

• Baby Steps: On January 9^th 2001 Apple launched its iTunes music management software, and later that year in November came the first ever iPod.  Back then there was no iTunes Store and Apple made it very clear how they expected their customers to acquire digital music with their ad campaign slogan: ‘Rip Mix Burn’.  Revolutionary as it was though, the iPod got off to a modest start: despite multiple product updates, by the end of 2002 Apple had still only shifted 600,000 iPods. iTunes wasn’t changing the world, not yet.
• Changing the Tune: In April 2003 Apple launched the iTunes Music Store in the US, and then in 2004 in the UK, Germany, France and Canada, as well as an EU Store.  There were plenty of download stores already of course – Apple is always an early follower not a first mover – but they were crippled by restrictive DRM, cumbersome technology and lack of interoperability.  Most stores didn’t even allow buyers to transfer to MP3 players or burn to CD. And if you were lucky enough to be allowed to transfer to an MP3 player, your device probably didn’t even support the store’s DRM it probably also relied on incompatible 3^rd party music management software.  Apple changed all of that in an instant, delivering an end-to-end integrated experience.  Steve Jobs, through a combination of sheer force of personality and a commitment to spend big on marketing (really big) managed to persuade the big labels to support unlimited iPods, CD burning and multiple PCs.  Digital music hadn’t so much been stuck in the starting blocks as having its feet nailed to them.  Jobs set digital music free.  By July 2004 the iTunes Music Store had hit 100 million downloads, but more significantly by the end of 2005 Apple had sold 42.2 million iPods. iTunes was now selling iPods, and fast.
• Beyond Music: When Apple was in the business of selling monochrome screen iPods, music was the killer app and iTunes was the marketing tool. But that changed on June 29 2007 with the launch of the iPhone.  Apple soon needed more than music to market its multimedia, touch screen, accelerometer enabled devices. Movies were proving difficult to license and TV shows faced free competition from Hulu, iPlayer, ABC.com et al. The solution of course was the App Store.  The App Store took just 3 months to hit 100 million downloads – it had taken the iTunes Music Store 15 months to hit the same milestone.  Apple remained, and remains, firmly committed to music but its attention is inherently diluted by all of the other content types that iPhones and iPads cater for.  When Apple launches a new device it is EA Games you see demonstrating a new game to showcase the device’s capabilities, not a new music track.  (And of course the word ‘music’ got dropped from the iTunes Store name long ago.)
• The Platform Challenge: The App Store turned the iTunes Store into a platform, albeit it a highly controlled one.  This created an unprecedented window of opportunity for competing digital music services, suddenly they could break into the previously impenetrable iTunes ecosystem.  Pandora was an early mover and within a year of launching its iPhone app had acquired 6 million iPhone users, 60% of its then 10 million active users.  Shazam was another beneficiary, with the iPhone app finally giving Shazam relevancy and context it had long lacked.  And now of course we have Spotify, Deezer, Rhapsody, Rdio et al all hugely dependent on the iPhone, using it as the central reason subscribers pay 9.99.

Responding to Streaming

Many commentators suggest Apple is being left behind in the streaming era.  It echoes comments that Apple was getting left behind by the social age, and its responses then (Ping! and Genius) are not the most compelling of evidence for Apple jumping on the latest digital music bandwagon.  Apple will of course have to eventually move towards a more consumption and access based model but it will wait, as it always does, until streaming and is ready for primetime.  (A radio service is a logical interim step). Spotify’s 6 million paying subscribers are impressive but pale compared to Apple’s 450 million credit card linked iTunes account.  And besides, iTunes is enjoying its most successful period ever (see figure).  For all the need of interactive multimedia products to market iPhones and iPads, music remains one of the key use cases and the iTunes Store has seen an unprecedented surge in music downloads as millions of new music fans enter the iTunes ecosystem as iPad and iPhone buyers.

Interestingly Apple’s music download growth appears to be strongly outpacing the overall digital music market (see figure).  According to the IFPI total global digital trade revenue grew by 8% in 2012 but Apple’s iTunes downloads grew by about 50% during the same period, culminating in 25 billion cumulative downloads in Q4 2012.  Multiple factors are at play: iTunes has rolled out to new territories and a portion of the downloads will also be free.  Nonetheless, iTunes remains the beating heart of digital music.

The Next Chapter

Apple’s next big digital music move will have major strategic ramifications that will go far beyond the iTunes Store.  Currently Apple’s device pricing model is driven by storage capacity.  And of course in a streaming age consumers will store less and less content on their devices, so the ability to charge a premium for extra storage capacity will diminish.  This is a key reason why Apple has to go slow with the cloud.  Music however also presents an opportunity to safeguard price premiums.  Apple has shied away from subscriptions (Steve Jobs famously baited then-Rhapsody owner Rob Glaser that subscriptions were mere rentals) but device-bundled-subscriptions are now an opportunity that Apple simply has to take seriously.  Instead of charging a monthly fee for subscriptions Apple could create ‘iTunes-Unlimited’ editions’ of iPads and iPhones that would include ‘device lifetime’ access to either unlimited music streams or a monthly allowance of iTunes credits (for use on all forms of iTunes content).  The latter probably sits most comfortably with Apple as it presents the opportunity for tiers of access (e.g. $5 of monthly iTunes credit, $10 of monthly credit etc.) and so would enable Apple to support multiple product price tiers.

Whatever Apple decides to do with iTunes in the next 10 years, it will remain a key player and do not bet against it still being the preeminent force a decade from now.

Apple Hits 25 Billion Downloads: What it Means for the Music Industry

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.

Another Nail in the CD Coffin: HMV Call in the Administrators

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

Why the Music Industry Needs Another iPod Moment

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.

How the App Economy Has Transformed Product Strategy

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.

Q1 UK Music Sales and the Role of the Post-Holiday Surge

Today UK music industry trade body the BPI announced the milestone of digital music revenues exceeding physical music revenues for the first time. At first glance the numbers are impressive but there is important context.  Although it might appear that the UK is closing the gap on US digital music ‘channel shift’ there still remains clear blue water.

Digital revenues surpassed 50% of total recorded music sales in the US last year, but almost reached that point in 2010, level pegging physical sales on 49% at year end (performing rights made up the rest according the IFPI).  By comparison full year digital revenues in the UK in 2011 made up 35.4% of total trade revenues according to the BPI’s (invaluable) 2012 Yearbook.

The BPI’s announcement today refers to 1^st quarter data alone.  In Q1 2012 digital accounted for 55% of income at £86.5 million, up from £70 million in Q1 2011 when it accounted for 46.1% of income.  The eagle eyed of you will have noticed that even in 2011 digital’s Q1 share was markedly above the annual total of 35.4%.  Underlying this disparity is the emergence of a new wave of seasonal purchase behaviour, what I call the Post-Holiday Surge.

Christmas / holiday period sales have always been by far the most important for record labels (highlighting why it is so important that someone somewhere gets digital gifting fixed – and iTunes vouchers are not the answer).  The advent of digital has created a second wave of festive spending: after the Christmas / holiday period we now see a surge in digital sales as people fill up their brand new MP3 players, tablets and smartphones with new music.  Although because Apple accounts for c.75% of digital download sales it is probably more accurate to restate that as ‘we now see a surge in digital sales as Apple customers fill up their brand new iPods, iPads and iPhones with new music from the iTunes Music Store’. (Other digital channels such as Spotify of course play a major role in digital revenue, but less so in the post-holiday boom).

This is why Q1 increasingly over reports for digital sales.  That is not to take anything away from the numbers reported by the BPI (it is a key milestone worthy of celebration) but it shouldn’t distract us from the fact that the UK remains somewhere between 1.5 and 2 years behind the US in terms of the shift to digital.  If trends continue at their current rate the end of year digital revenue share in the UK should hit somewhere in the region of 46% to 48% i.e. pretty much where the US was in 2010.

Digital sales are growing, but still not quickly enough across the entire year.  Full year 2011 UK trade data shows that physical income declined by £84.2 million while digital grew by £55.8 million (a net loss of £28.4 million).  In Q1 2012 a very different picture appears: year-on-year digital increased by £16.5 million while physical declined by £12.3 million, a net gain of £4.2 million.

The Post-Holiday Surge phenomenon illustrates where digital needs to be performing at now and for the whole year, namely growing more quickly than CD sales contract across 12 months of sales. In the UK, Q1 is digital’s quarter, now it needs to take ownership of the entire year just like it did in the US.

The Music Format Bill of Rights

Today I have published the latest Music Industry Blog report:  ‘The Music Format Bill Of Rights: A Manifesto for the Next Generation of Music Products’.  The report is currently available free of charge to Music Industry Blog subscribers.  To subscribe to this blog and to receive a copy of the report simply add your email address to the ‘EMAIL SUBSCRIPTION’ box to left.

Here are a few highlights of the report:

Synopsis

The music industry is in dire need of a genuine successor to the CD, and the download is not it. The current debates over access versus ownership and of streaming services hurting download sales ring true because a stream is a decent like-for-like replacement for a download.  The premium product needs to be much more than a mere download.  It needs dramatically reinventing for the digital age, built around four fundamental and inalienable principles of being Dynamic, Interactive, Social and Curated (D.I.S.C.).  This is nothing less than an entire new music format that will enable the next generation of music products.  Products that will be radically different from their predecessors and that will crucially be artist-specific, not store or service specific.  Rights owners will have to overcome some major licensing and commercial issues, but the stakes are high enough to warrant the effort.  At risk is the entire future of premium music products.

D.I.S.C.: The Music Format Bill Of Rights

The opportunity for the next generation of music format is of the highest order but to fulfil that potential , lessons from the current digital music market must be learned and acted upon to ensure mistakes are not repeated.  The next generation of music format needs to be dictated by the objective of meeting consumer needs, not rights owner business affairs teams’ T&Cs.  It must be defined by consumer experiences not by business models.  This next generation of music format will in fact both increase rights owner revenue (at an unprecedented rate in the digital arena) and will fuel profitable businesses.  But to do so effectively, ‘the cart’ of commercial terms, rights complexities and stakeholder concerns must follow the ‘horse’ of user experience, not lead it. This coming wave of music format must also be grounded in a number of fundamental and inalienable principles.  And so, with no further ado, welcome to the Music Format Bill of Rights (see figure):

• Dynamic. In the physical era music formats had to be static, it was an inherent characteristic of the model.  But in the digital age in which consumers are perpetually online across a plethora of connected devices there is no such excuse for music format stasis.  The next generation of music format must leverage connectivity to the full, to ensure that relevant new content is dynamically pushed to the consumer, to make the product a living, breathing entity rather than the music experience dead-end that the download currently represents.
• Interactive. Similarly the uni-directional nature of physical music formats and radio was an unavoidable by-product of the broadcast and physical retail paradigms.  Consumers consumed. In the digital age they participate too.  Not only that, they make content experiences richer because of that participation, whether that be by helping drive recommendations and discovery or by creating cool mash-ups. Music products must place interactivity at their core, empowering the user to fully customize their experience.  We are in the age of Media Mass Customization, the lean-back paradigm of the analogue era has been superseded by the lean-forward mode of the digital age.  If music formats don’t embrace this basic principle they will find that no one embraces them.
• Social. Music has always been social, from the Neolithic campfire to the mixtape.  In the digital context music becomes massively social.  Spotify and Facebook’s partnering builds on the important foundations laid by the likes of Last.FM and MySpace.  Music services are learning to integrate social functionality, music products must have it in their core DNA.
• Curated. One of the costs of the digital age is clutter and confusion: there is so much choice that there is effectively no choice at all.  Consumers need guiding through the bewildering array of content, services and features.  High quality, convenient, curated and context aware experiences will be the secret sauce of the next generation of music formats. These quasi-ethereal elements provide the unique value that will differentiate paid from free, premium from ad supported, legal from illegal.  Digital piracy means that all content is available somewhere for free.  That fight is lost, we are inarguably in the post-content scarcity age.  But a music product that creates a uniquely programmed sequence of content, in a uniquely constructed framework of events and contexts will create a uniquely valuable experience that cannot be replicated simply by putting together the free pieces from illegal sources.  The sum will be much greater than its parts.

Table of Contents for the full 20 page report:

Setting The Scene

• Digital’s Failure To Drive a Format Replacement Cycle

Analysis

• Setting the Scene
• (Apparently) The Revolution Will Not Be Digitized
• The Music Consumption Landscape is Dangerously Out of Balance
• Tapping the Ownership Opportunity
• The Music Format Bill Of Rights
• Applying the Laws of Ecosystems to Music Formats
• Building the Future of Premium Music Products
• D.I.S.C. Products Will Be the Top Tier of Mainstream Music Products
• The Importance of a Multi-Channel Retail Strategy
• Learning Lessons from the Past and Present
• We Are In the Per-Person Age, Not the Per-Device Age

Next Steps

Conclusion