Why Does Apple Want to Halve the Price of On-Demand Music?

Apple is asking record labels to agree to a $5/month subscription price for its Beats Music on-demand service, instead of the going rate of $10/month that it and others (Spotify, Rhapsody, etc.) charge in the US market.  This development started as rumor a few weeks ago, then rose to specific evidence of record label conversations confirmed by musician and artists’ rights champion David Lowery at the recent Common Ground intellectual property conference at George Mason University near Washington DC.  As of this past Friday, the evidence became strong enough for the Wall Street Journal to treat it as fact.

Re/code also reports that despite the major labels’ apparently cool reception to the new pricing, Spotify is already responding by offering a family plan in which additional family members can add their own subscriptions to a $10/month plan for $5/month.  (Beats Music has been offering discounted family plans through AT&T wireless accounts for a while.)  As Re/code reports, one reason that Apple has given for the change to $5/month is that it has found that its best iTunes customers spend about $60/year on the service.  Given that music download revenue has begun to drop rapidly, Apple apparently believes that it can entice iTunes users to an all-you-can-eat subscription service at the same spending level, instead of losing those users to free music services (or illegal downloads).  In other words, $5/month subscriptions are being offered to labels as a way to shore up revenues at $60 ARPU (annual revenue per user) from people who actually still pay for music .

This reasoning is clearly designed to appeal to record labels, which are known to be unhappy about the accelerating decline in purchases.  But is it Apple’s real motivation for halving the price of on-demand subscriptions?  I don’t think so.

The first thing to understand about on-demand music services is that despite all the talk about monthly subscription fees, the vast majority of users do not pay for them.  Research from Edison Research and Triton Digital has determined that the use of YouTube as a de facto on-demand music streaming service draws a US audience of four times all other on-demand services combined — including Spotify (paid and free).  Put another way, only about 8% of US users of on-demand music services actually pay for them.  Spotify’s percentage of paying US users has stabilized at 25% — which I am proud to say that readers of this blog predicted three years ago — while Google Play, Rhapsody, Rdio, and Beats Music do not offer free tiers for on-demand music.

On-demand music use is growing rapidly, but Apple only has a tiny piece of the market.  Beats Music has merely a few hundred thousand users, compared to the estimated 60 million who use YouTube as an on-demand music service and Spotify’s 12 million total US users.  Even when one counts only paying users, Beats Music still accounts for well below 10% of the market.

Apple clearly must do something dramatic to become a serious contender.  Integrating Beats Music into iTunes (and thereby marketing it heavily to the enormous iTunes audience) by itself isn’t going to expand the market enough to be meaningful to Apple.  And even if Apple thinks it can increase the paying user base disproportionately by halving the price, that’s not much of an increase in audience size — especially since the vast majority of the on-demand audience already gets it for free.

No, my view is that Apple’s primary purpose in halving the price is to throw the on-demand market into disarray.  Services like Spotify and Rhapsody have been operating their businesses based on the expectation of $10/month revenue for years.  Obviously, if Apple comes out with a rebranded Beats Music (iTunes On Demand, iTunes Beats, iTunes Unlimited, iTunes Jukebox, or whatever they end up calling it) at $5/month, all of the other on-demand services will have to offer the same price.  Spotify, Rhapsody, and Rdio would find themselves with unsustainable financial structures and/or the necessity of renegotiating their record label deals.  The best that any of these “pure play” services could hope for is to become acquisition bait for companies that are big and diverse enough to be able to cross-subsidize them (Yahoo and AOL come to mind).  A move to $5/month could even cause Google to rethink its plan to launch a paid subscription music service associated with YouTube.

In short, I predict that if Apple gets record companies to agree to $5/month for on-demand music, we will see a repeat of the shakeout that occurred around 2007-2008, which left only a handful of on-demand services in the market.  When the smoke clears, Apple could well find itself with a much larger chunk of the on-demand music market than if it were to try to grow its share organically.

The remaining mystery is whether Apple intends to add a free tier to Beats Music, such as a limited on-demand capability under the iTunes Radio banner.  The advent of free, legal on-demand music from Spotify and (effectively) YouTube in 2011 did cause the on-demand model to grow from a niche product for music geeks to a mainstream offering.  On-demand is still not quite as popular as Internet radio — I estimate the on-demand audience to be about 60% of the size of the audience for Pandora, iHeartRadio, etc. — but it has surpassed the user base for paid digital downloads.

On-demand is clearly a big part of the music industry’s digital future.  Apple is behind in the transition from downloads to access-based models and needs to catch up.  Only dramatic, disruptive gestures can make this happen, and halving the price is certainly one of them.

Now, since you were so good at predicting Spotify’s percentage of paying US users, let’s see how you do with this one.  Here’s a poll: 

UPDATE 29 March, 2015: It looks like we were wrong.  Although the majority of respondents to the poll predicted that Apple would succeed in lowering the price of subscription music to $5/month, the major labels are holding the line at $10/month.  That’s the pricing that Apple expects to maintain when it launches its rebranded on-demand streaming service later this year.

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