The Cruel Math Behind Why Streaming Will Never Save The Music Industry

Mark Rogowsky 3/20/14
The recorded music business has had a pretty lousy 15 years, shrinking by half from its peak of $40 billion in 1999. And the past year hasn’t exactly been much better, according to the International Federation for the Phonographic Industry (IFPI). Revenues slipped another 4% overall and even digital downloads, dominated by Apple’s iTunes, fell by 2%. That’s the first time they’ve ever seen a decline. There is some good news, though, in that paid streaming services crossed the $1 billion threshold, with an estimated 28 million customers worldwide. The IFPI says that’s up from just 20 million a year before and a lot of industry people believe that revenue from streaming could eventually lead the music business to new heights. But when you look deeper, you’ll see that there’s a fundamental disconnect between what the experts believe it will take to get there. And unless that gap is bridged, streaming services might be the golden goose that turns into a lead balloon.

David Pakman, a venture capitalist with Venrock and the former CEO of eMusic, has a very thoughtful blog post titled “The Price of Music” in which he runs through the history of how much people spent on music back at the peak of the CD era. It turns out that the $40 billion was spent by around 600 million people who each shelled out about $64 a year. Today, the total dollars spent on music is about half, but interestingly enough per-customer outlays haven’t changed dramatically. Apple’s figures for iTunes are around $48 a year, for example.

For the music industry, an uphill battle.

Most of the streaming services, though, cost about $10 a month here in the U.S., including Spotify and the recently launched Beats Music. At the music industry’s annual Midem conference, Marc Geiger, the global head of music for William Morris Endeavor, gave a bullish presentation on the potential of streaming services. He suggested that the record labels should embrace them fully, make all their music available, and not fear the low price the services would charge because, well, “they start cheap, and they go up.”

Geiger envisioned a future in which 1 billion people pay $15 per month for streaming subscription, yielding a whopping $180 billion in revenues for the music industry. (About 25-30% would go to distributors like Spotify, but even at the $135 billion figure Geiger used, streaming alone would be more than 4x larger than the entire industry was for the labels back in 1999.) On top of that, he thinks that ad-based services like YouTube will generate another $50 billion, of which the labels will get 50%.

There’s just one problem. Pakman believes that $10 is way too much money, let alone $15, for a monthly subscription price:

“Consumers are willing to spend somewhere around $45 – $65 per year on music … [T]hese numbers have remained consistent regardless of music format, from CD to download. Curiously, the on-demand subscription music services like Spotify, Deezer, Rdio and Beats Music are all priced the same … This is because the three major record labels … have mandated a minimum price … The services are not able to charge a price they believe will result in maximum adoption by consumers. The data shows that $120 per year is far beyond what the overwhelming majority of consumers will pay for music and instead shows that a price closer to $48 per year is likely much closer to a sweet spot to attract a large number of subscribers.”

Pretend for a moment that instead of requiring Spotify to charge $120, the labels allow it to offer the same service for $48. And let’s say it’s allowed to keep 30% of that. The labels would receive a bit over $33. Now, let’s say the number of music buyers merely returns to the 600 million level of 1999 — not at all unrealistic given that nearly everyone will have a smartphone in the coming years. That’s $20 billion from streaming, about 1/3 more than the labels earned last year, according to the IFPI numbers. If Geiger is right that (1) subscription prices can rise over time (2) the market for these services is closer to 1 billion people, then there seems to be little harm in starting with a lower price and very gradually testing consumer resistance to seeing that price rise.

The current plan, by contrast, seems doomed to produce unsatisfactory results. Looking at the 8 million new customers for streaming services in 2013 might make it seem like the $10 price is working, but realistically growth has barely accelerated in the past 3 years (12 million new customers came online in the prior 24 months). At current trends, it could take a decade to bring 100 million people into the streaming fold at $120. It’s also possible that they might never come.

On a related note, the other day Pandora raised prices for its Pandora One service, which offers commercial-free listening. Pandora, unlike Spotify and Beats, doesn’t allow you to select individual songs from a catalog of millions, but is nevertheless quite popular, with 250 million registered users. Just 3.3 million of them, though, pay for Pandora One, the company says. That service had cost as little as $36 annually and will now be $48 for existing customers and $60 for new ones. By Pakman’s logic, that’s too much to gain mass appeal. And given that Pandora was already struggling to sell it, making it cost more is unlikely to change that equation. The fact iTunes Radio costs just $25 a year can’t help either. Pandora says it had no choice as royalty rates have increased substantially.

It’s a different version of the same problem Spotify and its ilk have: Lack of control over price. And here, even the bigger players would be in a similar situation. Music is controlled by the record labels and music publishers and regulators are very unlikely to let those entities fall into the hands of distributors, no matter how deep their pockets or how strong their desire to just integrate the industry. (I’ve argued in the past Apple should buy Pandora. A similar case could be made for purchasing Spotify at this point.) So even though Geiger was talking about how in the “age of giants” it’s possible that Spotify and Pandora might become roadkill for Google GOOG -1.98%, Apple AAPL +1.19%, Facebook or whomever, realistically, it’s up to the labels to make change happen.

Don’t bet on it happening soon.



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