The music industry is undergoing a complete revolution. Digital technology has matured and the MP3 format means that music archives require between one-twentieth and one-tenth as much storage space [because of compression technology]. These factors, along with the Internet, are transforming the music industry. Apple, the U.S. giant, was the first company to move into this market, with its iTunes downloads service. However, the competition threatens to become ferocious, as competitors Yahoo and Microsoft reveal their intentions. Francesco D. Sandulli and Samuel Martín Barbero, both from the Complutense University of Madrid, analyze the best strategies for winning the next round in the battle.
Both professors work for the department of business management and UCM-DMR Consulting. In their joint study, “Music on the Internet: Strategies to Follow,” they stress that the current competitive environment has been transformed by the appearance of two revolutionary inventions: Digital technology during the 1980s and the MP3 (Motion Picture Experts Group Layer 3) format in the early 1990s. The German firm Fraunhofer Gesellschaft was the first company to market MP3 technology.
Already, the revolution “has had a major impact on the production of digital products. For example, it improved the quality of production, as in the consumer markets where new devices for music reproduction appeared,” the study notes. For its part, MP3 technology has had its greatest impact on distribution, gradually replacing traditional, physical distribution with digital technology. “As a result of these technological developments, some traditional players see that their positions are threatened by networks of Peer-to-Peer (P2P) users, which act as streamlined, alternative channels of distribution,” add the professors.
A Fierce Competition
Apple, the company created by Steve Jobs, was the first company to give a name to this new market. In October 2001, Apple launched its iPod device. Later, in October 2003, Apple launched its iTunes shop, which has a catalog of 700,000 songs in digital format. With the help of the world’s five largest recorded music companies, iTunes has been able to sell more than 60 million songs and acquire a 70% share of that market.
However, other giants such as Microsoft and Yahoo are bringing out their big guns in an effort to fight Apple for this attractive new market. According to Jupiter Research, subscription-based sales of online music will grow eightfold by 2009, from $113 million in 2004, to $890 million. Moreover, revenues from online downloads of music will reach $809 million by 2009, five times the $158 million in sales expected for this year.
Aware of the bright prospects, Microsoft recently launched MSN Music, its Internet music shop. In early September Microsoft also launched the tenth version of its Media Player, which enables users to reproduce audio and video. Barely 12 days later, Yahoo announced its acquisition of Musicmatch, an Internet download service, for $160 million. Musicmatch offers a music radio service with more than 900,000 songs and a catalog of more than 700,000 songs, according to Expansión, the Spanish newspaper. Under Yahoo’s wing, the new service will be called ‘Launch,’ and it will serve 23 million users.
Who will wind up winning this battle? What will the traditional players be able to do? According to Sandulli and Martín, the future belongs to companies that learn how to construct a wide-ranging catalog of songs; set competitive prices; and add value to their sales. This could involve, for example, developing virtual communities or packaging products in new ways. Combining all of these three elements will allow companies to generate economies of scale, the experts say.
Four other factors are involved, according to Sandulli and Martín. To compete against similar rivals and P2P networks, it is important to achieve economies of scale and take advantage of market niches. “Some large chains of supermarkets [or hypermarkets] are interested in using the Internet music market to strengthen their positions in the market for digital music despite the low margins, if this approach helps them obtain unusually high profits in their markets for musical devices.” They warn that “those players who act exclusively in the Internet music market will suffer greater damage, because they will feel compelled to enter a competitive market that has low margins, without being able to recover their lost revenues by acquiring new business in other markets.”
Two other valuable approaches involve personalization and technology. “The key factor that will determine competitive advantage is if the technology can be imitated and if the personalization strategy can also be imitated” by competitors, Sandulli and Martin write. Apple provides an example.
A Unique Style
“Apple uses AAC technology, which is superior to technology used by such competitors as Sony Music and Vitaminic. Nevertheless, AAC technology is manufactured by MPEG Group, and there is nothing to prevent MPEG Group from selling its technology to Apple’s competitors.” The danger for Apple is that AAC can hardly be considered a competitive advantage because its rivals could agree to adopt the technology that currently sets Apple apart.
The same danger exists in the arena of personalization. “The personalization of products via the Internet allows companies to gain a competitive advantage, provided that their competitors don’t also personalize their products,” note Sandulli and Martín. “In this market, it is hard to view either the personalization of the product or the personalization of the purchasing process as a powerful competitive advantage because they are both so easy to imitate.”
As Sandulli and Martin explain, neither Apple nor Sony has opted to differentiate itself in terms of pricing. “The two companies offer the same price of 99 cents.” Moreover, “the ability to differentiate by pricing depends on how specific your product is. The more specific your product, the more likely you can differentiate it by price. Apple and Sony do not do that. On the contrary, Vitaminic differentiates itself in terms of time; the more recent the song [for sale], the higher its price.”
Imitating the online shopping process is another approach. In this respect, Apple, the current leader, runs the risk that a competitor “reaches the same agreement that Apple has made with Amazon for using Amazon’s One-click system. When it comes to online navigational style, the [Spanish] real estate portal, Idealista.com, suffered when its style was replicated by Vivendi, its competitor.”
Nevertheless, personalization can provide a competitive advantage in the battle against P2P networks and, above all, against those competitors who do not operate on the Net. “For that reason, it can be tempting to invest in personalization so you can grab market share away from traditional channels. For example, one hypermarket chain uses its Internet portal to enable customers to create personalized CDs of their favorite songs. The customer then picks up and pays for the CD at any brick-and-mortar store in the chain.”
The Danger of Give-aways
Every digital-music marketing strategy must take account of the fact that consumers are not used to paying for online music downloads because of the impact of Napster and other sites. A 2001 Jupiter Research study stressed that only three out of every ten Web users would pay to acquire content online. To overcome this barrier, the study recommended that companies enrich the online buying experience with virtual networks and special sorts of packaging. The professors say this approach could involve selling digital music along with other products such as videos. They could also provide biographical information about the artists, relevant photographs, and so forth.
The authors warn that it would be “extremely arduous and expensive” for music companies to take legal action against P2P networks. “Unlike Napster, P2P networks have a distributed character, and you would need to take action against every member of the network.” Regarding P2P networks, they warn companies not to lose sight of a key fact: “[Online] behavior that reflects the self-interest of each member is enough to generate a sustainable degree of cooperation, over time. As a result, the existence of the network is not threatened even when users have the complete freedom to behave as they wish.”
When the collective group of individuals benefits from the cooperative efforts of other users, free behavior winds up working. “In the case of P2P networks, this happens when some users use the network only to download archives, but they don’t also contribute to the network of archives.” The cost-free solidarity of P2P networks is a clear threat to companies that distribute music via the Internet. To get people to pay for downloading their music from the Net, those companies will have to find ways to turn them into loyal customers.