The music industry is being inexorably drawn to a new business model centered on streaming subscription services, 15 years after music swapping pioneer Napster galvanized the industry and was then shut down by the courts. Now, a convergence of sorts is occurring around the subscription model.
Dozens of start-ups and well-known brands have launched or are launching new music streaming subscription services this year, including makers of headphones and stereos. For example, Seattle-based MediaNet Digital, which sells music streaming technology, is helping 50 firms launch streaming services this year. And SoundCloud, a site for uploading and sharing music, recently raised $60 million in venture capital with a $700 million valuation, according to a Wall Street Journal report.
The numbers driving the trend are the music industry’s revenues from streaming and subscription services, which grew nearly 60% — to $571 million in 2012 — over the previous year, according to the latest data from the Recording Industry Association of America (RIAA). Including Internet radio services like Pandora, revenues from the so-called digital “access models” crossed $1 billion in 2012. (Access models are services that allow users to choose large libraries of music rather than purchasing individual songs or albums, according to the RIAA.) Digital access models accounted for 15% of the music industry’s total revenues of $7.1 billion in 2012, up from 3% in 2007, according to the RIAA.
But streaming services still don’t provide revenues anywhere near those in the heyday of record and CD sales, which have shrunk to a fraction of what they once were. Physical sales of music in 2012 declined by 16.5% to $2.8 billion from $3.4 billion in 2011, according to the RIAA. Overall revenue has suffered as music moves to cloud platforms, and “micropayments from streaming services have yet to amount to anything meaningful,” New York Times columnist David Carr wrote this week.
But the growing impact of streaming services is becoming apparent on music sales charts. For example, driven by shares on user-created playlists from services like Spotify and Rdio, the song “Thrift Shop” by Macklemore and Ryan Lewis topped the Billboard Top 100 last year. That was the first time in nearly 20 years that a song without a major label attached to it topped the Billboard Hot 100, according to Time. Indeed, indie groups grew their share of the music business to 34.5% as of June 2013, pushing Universal Music Group to second position with 28.3%, according to research firm Nielsen SoundScan. That is a reversal from 2007, when indie groups had 25.8% of the market and Universal had a 28.8% share.
The Gathering Subscription Party
The big record labels are so far playing along with the subscription model, licensing music to digital service providers. Among the companies to recently launch a streaming service is Beats Electronics, the headphone maker founded by music entrepreneur Jimmy Iovine and hip-hop mogul Dr. Dre. On January 21, the firm launched Beats Music, a streaming subscription service with a free trial and a $9.99 monthly fee thereafter. Beats has licensed more than 20 million songs from the “big three” music companies — Universal Music Group, Sony Music Entertainment and Warner Music Group — and other independent labels.
“The music industry is partnering with [streaming providers] grudgingly, basically because it has no option, as opposed to truly embracing it.” –Peter Fader
Last October, the Pure division of London-based speaker manufacturer Imagination Electronics launched its Pure Connect streaming service in the U.S. Pure Connect, which had previously been introduced in the U.K. and Germany, also has licenses mainly from the three major labels, and offers 15 million tracks in a basic package priced at $4.99 a month and a premium service at $9.99. Pure licenses the music through 7Digital, a U.K.-based company in which Imagination Technologies has invested.
Lined up for similar launches this year are Google’s YouTube-based streaming service and the U.S. launch of France-based Deezer, which already has five million paying subscribers across 80 countries. Google first entered the subscription space last year with its Google Play All Access streaming service.
‘I Told You So’
“For me, it’s terrible to say this: ‘I told you so,'” says Wharton marketing professor Peter Fader. He has advocated the subscription model for the music industry since Napster arrived on the scene 15 years ago. (See: Knowledge at Wharton, July 2, 2003, “Online Music Wings its Way to the Celestial Jukebox”) In May 2000, he testified as an expert witness on Napster’s behalf in the lawsuit filed by the record companies. “It created engagement and conversation, and music sales peaked as the usage of Napster peaked,” Fader notes. Napster had more than 60 million registered users at its high point before shuttering in July 2001 following a court ruling that the site engaged in copyright infringement. (The Napster name and other assets were subsequently sold and used by legally-licensed music services.)
According to Fader, the streaming subscription model wins on several levels. “[One,] it is much more consumer friendly when you encourage people to consume as much as possible,” he says. “You want them to discover, talk about it, mash things up, [create] playlists and have a good time with it.” The labels “should be fighting and falling all over” to woo distributors and consumers, he states. Two, consumers are no longer interested in collecting physical music albums; it is more important they have access to the music. “The streaming subscription model encourages that kind of broad sharing.”
Three, the streaming services allow companies to compile data on who is listening to which song, when they are listening to it and who they are sharing it with, says Fader. Record labels could use those insights to identify their most valuable customers and market other products and services to them. Fader calls these the “costless benefits” of the streaming subscription service.
According to Kartik Hosanagar, a Wharton professor of operations and information management, the subscription model is the way ahead for the music industry, and is preferable to building a business model around downloads. “With downloads, the low end of the market won’t pay for it because the music can be obtained for free [via piracy],” he says, noting that this segment will likely also take advantage of the no-frills free versions that many streaming services offer. “The high end of the market will find streaming more convenient because they have ‘anytime-anywhere’ access to the music, versus buying the song on one device and not having access on another.”
The music labels clearly see big gains from subscription-based services. “[They] can have a very important role, and have already begun contributing meaningfully to industry sales,” Joshua P. Friedlander, vice president of strategic data analysis at the RIAA, says in an e-mailed response to Knowledge at Wharton. “We think the contribution from those services will continue to grow.” Streaming services include paid subscriptions, ad-supported on-demand services and Internet radio. The Washington, D.C.-based RIAA represents more than 1,600 record labels and distributors who collectively distribute about 85% of the recorded music sold in the U.S.
Meanwhile, songwriters and music publishers are hoping that they will get better compensation for their work than they have from the download model as streaming services continue to grow. For now, interactive streaming music services comprise a relatively small but growing percentage of income that songwriters collect, notes David Israelite, president and CEO of the National Music Publishers Association in Washington, D.C. All the same, music publishers and songwriters “are embracing new business models that provide new methods of revenue for songwriters,” he adds. “Business models must be built in such a way that those providing content are compensated fairly.”
According to Friedlander, music labels in the U.S. have been “extremely active in partnering with digital services” to provide music offerings. The digital service partners of music labels include large companies like Google, Microsoft and Apple and small start-ups. More than 500 authorized digital services exist worldwide, he says, citing data from the London-based International Federation of the Phonographic Industry, a trade group for the recording industry.
But Fader says the shift is a case of too little, too late. “I don’t think it reflects a change in the tragic trajectory the industry is on,” he notes. “The music industry is partnering with [streaming providers] grudgingly, basically because it has no option, as opposed to truly embracing it and encouraging the kinds of behavior that would be associated with a streaming subscription model.”
To reinforce his point, Fader says the music industry continues to fight against distributors like Google and others “who are actually doing good things for the industry.” He adds that the industry continues to want to control the messaging and the distribution. “They continue to push back on all the new services, continue to set onerous rates and very restrictive conditions and continue to make life difficult for the [music streaming services] — the Spotifys and Pandoras and a lot of the upstarts.”
Noam Meppen, U.S. sales director for Pure, says streaming is “a challenging business technology that has made some headaches for many people in the music industry.” He is convinced the music labels will continue to license to other streaming services. “If the music companies are faced with a choice of licensing music to subscription music services or having people steal the music through file-sharing sites, then they would at least rather get a few pennies per listen [rather] than nothing.”
“It’s not easy money for [streaming] companies like Pure. The music labels would like some up-front guarantees of revenue streams with each additional user.” –Noam Meppen
In the long term, content ownership is also likely to shift from music companies to distributors, Hosanagar predicts. Many companies that offer video streaming, such as Netflix, Amazon and Comcast, are starting to distribute content that they also own. He expects that music-focused firms like Spotify will eventually do the same. For example, Netflix last year entered the business of original programming with “House of Cards,” an American political drama series that is now in its second season and set for a third.
Flip-Flops and ‘Tragic Mistakes’
To its credit, on the heels of Napster the music industry did attempt to start streaming subscription services, but they were short-lived, says Fader. “They are lost in the dustbin of history — services like PressPlay [owned by Sony Music Entertainment and Universal Music Group], for instance. But because [record labels] are just fundamentally unable to run that kind of business, they couldn’t keep them afloat.”
The major music companies are now forming partnerships with indie labels, but Fader wonders if such acts are whole-hearted. He points to Warner’s seesaw relationship with YouTube, for example. Warner in 2006 made an agreement with YouTube to distribute and license its songs and other material. Two years later, however, Warner sued YouTube over royalty disputes, only to come back in 2009 to renew the partnership. “There are no angels here. It pains them to get involved in some of these relationships,” says Fader. “They’re doing it out of desperation, not out of opportunity.”
In addition to flip-flops with digital distributors, the music industry made a “tragic mistake” in partnering with Apple’s iTunes in 2003, according to Fader. “Instead of enabling and encouraging broad consumption of music, it was a la carte — one song at a time downloads — and there was no engagement with users,” he says. “It was actually inhibiting people’s [ability] to consume a lot of music.” Eventually, the music companies’ alliance with iTunes led to an explosion of unauthorized file sharing, he adds, noting that while it may be true that measurable amounts of piracy went down, consumers found all sorts of “below the radar” ways to obtain music illegally.
“That was a major consequence of the labels’ battle against the unauthorized sites,” Fader notes. “They made it much more difficult for themselves to monitor such activities, while it was still pretty easy for consumers to engage in it.”
Friedlander has a different view. “There’s no magic bullet to fight piracy,” he says. “But the combination of anti-piracy measures and development of good legal alternatives — including streaming services — has meaningfully reduced the amount of unauthorized music acquisition.”
According to Hosanagar, online subscription models could be useful in combating unauthorized downloads, particularly in Asia where piracy rates are high. Users may not want to pay for downloads, but a streaming service has two advantages, he says. “One, you can’t pirate the content, and two, it may be hard to get people to pay for a song. But they might be willing to pay for a service with its breadth of collection, customer support and personalization.” Meppen of Pure also believes the subscription model is “the best response” to piracy. If you provide a variety of easy-to-access options to consumers, that is what is going to get you a decrease in piracy or illegal downloading.”
“[The music industry] will never ever regain the luster they had in the summer of 2000 when the entire world was using the same portal — Napster — to access music in a way that they never were able to do before.” –Peter Fader
But Hosanagar does not expect the subscription model to take off in a hurry. “We are talking about a change in user behavior, so it will take time,” he says. “Users may be reluctant to rebuild [their music] collections, but I think they will increasingly ask themselves this question — ‘Buy versus subscribe?’ — every time they [want] new music.” In addition, he notes that the greatest challenge of the subscription model is that “content owners have a lot of power and won’t agree to just about any terms that are set.” In other words, the model has to evolve in ways that all parties find acceptable.
Indeed, not all streaming services have taken off. According to a Wall Street Journal story, “While Spotify and Pandora have built sizable followings, many of the other existing competitors in subscription-based music-streaming services have failed to gain significant traction, and few disclose subscriber numbers.” Adds Meppen: “It’s not easy money for companies like Pure. The music labels would like some up-front guarantees of revenue streams with each additional user.”
Fader says the streaming subscription model is “a great way to go, but it is not nearly enough to bring the industry back to even a fraction of where it was 10 years ago.” He acknowledges that some of the new subscription-service providers are doing well. Yet, he feels the overall outlook for the sector is “gloomy.”
Finding the ‘Golden Model’
Despite his dour view of the music business, Fader says he actually has “deep respect” for it — and that underlies his advice on how the industry should reinvent itself. “The labels are very good at identifying the next sound — helping to point out and refine the right kinds of artists — and shaping our tastes,” he notes. “That is their main job. But the problem is they are overstepping their capabilities by focusing so much on the distribution side as well.”
Fader’s says the “golden model” for the music industry is to encourage streaming through a subscription model “and then come up with these nifty ways that get people deeply involved with the songs and artists that they like.” Indeed, in a 2002 Knowledge at Wharton story, Fader suggested that music companies should view their songs not as intellectual property, but as commercials for other value-added services like albums, concerts, movies and other related merchandise that could bring in new revenues.
According to Meppen, music companies have in recent years helped create new incubators for content. He points to the way that firms are recruiting and promoting artists through reality music shows like The X Factor, The Voice and American Idol. “When those new talents release their first albums, there is already some awareness, and the music companies don’t have to start from ground zero to market those artists.”
But Fader fears the music labels’ reluctance to embrace new distribution models may have permanently hobbled the industry. “By now, there is so much money off the table,” he says. “They will never ever regain the luster they had in the summer of 2000 when the entire world was using the same portal — Napster — to access music in a way that they never were able to do before, and they never will do it again for the rest of history.”