Pando

After years of false starts, Apple is finally poised to kill Spotify and take over streaming music. There's just one catch...

By David Holmes , written on May 14, 2015

From The News Desk

Apple's road to building a streaming music service hasn't been easy.

From the failure of its music-based social network Ping to the drastic retooling and rebranding of its $3 billion Beats acquisition, this journey has been fraught with false starts and failed features.

But today, on the heels of new details about its upcoming possibly-Spotify-killing streaming service -- courtesy, as usual, of 9to5Mac -- and with Apple only weeks away from unveiling this new subscription offering at next month's Worldwide Developers Conference, the company's in a fantastic position. The only entity standing in Apple's way isn't Spotify or Pandora or YouTube or some other competitor, however. It's record labels.

Thanks to its size, influence, and cachet in the music industry, Apple possesses many advantages in this increasingly crowded space. Despite huge head starts from Pandora and Spotify, which today have 80 and 60 million users, respectively, Apple has 800 million credit cards on file. If it convinces only 10 percent of these cardholders to sign up for a subscription streaming service, it will already have caught up with Pandora and surpassed Spotify. Furthermore, many in the industry believe that the audience for streaming music is still in its infancy. As more and more people around the world gain access to the Internet, particularly on mobile devices, and as online streaming options continue to come pre-installed in vehicles, supplanting the surprisingly resilient and still extremely popular terrestrial radio, there are going to be a billion customers for the taking.

Even yesterday's news, though it may not sound too impressive on first glance, improves Apple's position, if only slightly. The company's bringing back the social elements of Ping, which will give artists the chance to build profiles, cross-promote other artists, and post previews and track samples. And while artists rejected these features few years earlier, the rise of SoundCloud as an indispensable marketing tool for big-name artists has set a precedent for this type of behavior that didn't exist when Ping originally debuted.

Apple has the cash to outmarket and outlast its competitors, the ability to integrate with every iOS device on the planet, and the connections with music industry incumbents that go farther back in time and are arguably stronger than those of any other tech platform. There's just one caveat: Pricing.

Spotify and Pandora offer free options that, despite subjecting users to advertisements and -- in Spotify's case -- providing only limited mobile functionality, are incredibly popular among users for the obvious reason that, well, they're free. Apple will not offer such an option. That's not greed on Apple's part, in fact it's quite the opposite. Because unless some marketing company invents an audio ad unit that magically hypnotizes users into buying any product, ad-supported streaming is not a sustainable business model. It was fun to think it was sustainable for a while. But even as Pandora and Spotify experiment with new ad offerings and continue to scale their audience, neither company has achieved sustained profitability. And the reason is simple: Not enough paying customers.

The numbers tell the whole story: The amount of revenue created in 2013 from ads served up to users of Spotify's free tier, music consumers on YouTube, and other freeloaders was $220 million. Meanwhile, The revenue created by people who pay for a subscription to Spotify or other on-demand streaming services was nearly three times that, amounting to $628 million. What makes this disparity even more extreme is that, assuming the average subscription is around $120 a year, there are only around 50 million people who pay for streaming services. As for the amount of freeloaders? If Accustream's estimates are correct that 38.4% of all YouTube views are music videos, it means there could be almost 400 million monthly active users who pay for music not with money, but with the time it takes to tolerate and tune-out advertisements between songs. Think about that: 50 million paying users create $628 million in annual revenue -- or $120 a year per user -- while 400 million freeloaders create only $220 million a year -- or around $0.50 a year pre user. No wonder streaming platforms can barely make a profit -- if at all -- while most artists have been forced to view streaming not as a legitimate revenue source but merely a form of exposure.

That's why Apple's refusal to offer a free option makes perfect sense. But will users agree to pay, especially with free options on the table? Possibly not. And if they don't it will be because of the greed of record labels, not Apple.

Apple had reportedly lobbied with labels to charge around $5 a month, or half of what competitors like Spotify and Rdio charge for its paid versions. As I've argued in the past, $5 a month -- or $60 a year -- is close to the sweet spot for music consumers who, even at the music industry's height in 1999 when CDs cost upwards of $17 each, spent $64 a year on music. So despite the fact that the $120 a year Spotify charges is an enormously good bargain for access to virtually every song in the world, it's fundamentally overpriced. That's why Spotify has failed to convince more than 25 percent of its user base to pony up cash and why the system is rigged for everyone but labels which own the rights to the music and therefore hold all the bargaining power.

But labels rejected Apple's $5 price-point. So the company offered a compromise: $7.99 a month. But the labels still claimed that's still too low. And so now Apple is back to offering $9.99 a month -- the same amount Spotify charges and the same amount 75 percent of its users refuse to pay and will continue to refuse to pay as long as the company stays in business. So now Apple is rightly worried that listeners won't choose its service over a free one, even if it can offer a deeper catalog with more exclusive content. Apple has now resorted to asking labels to force Spotify to get rid of its free option by threatening to pull their catalogs. With no other option on the table, I welcome such a development because it would far more fairness and viability to streaming music business models, even if the tactics are pretty dirty. The problem is, the tactics aren't just dirty -- they may be illegal, having already drawn scrutiny from the Federal Trade Commission, the Department of Justice, and the European Union as possible antitrust violations. If regulators drop the hammer on Apple, the chances of it dominating streaming music are greatly diminished. So again, the streaming music space is as dysfunctional as ever and it's basically all because of the major labels' inexhaustible greed and their refusal to make the same compromises that streaming companies have made for years -- and that artists have made for decades.

Of course, the record industry -- which plays the PR game as well as anybody -- is placing all the blame on Apple. "All the way up to Tim Cook, these guys are cutthroat," an anonymous source told the Verge. But that's entirely disingenuous. This is what the labels want, otherwise they would never have rejected Apple's lower prices.

I understand that my sympathy for Apple, along with the fact that I wouldn't mind seeing Tim Cook's company win this space, probably make me sound like as big a fanboy as those sexless twerps who waited in line for hours to get a gold Apple Watch. But no, the contrary is true: as somebody whose head isn't permanently lodged in the sand, I get that Apple is a giant, terrifying beast of a company that subjects many workers to appalling working conditions and is the very worst offender at evading corporate US taxes through offshore havens. Unfortunately, it's also the only tech company with the influence, connections, and cachet to bring some semblance of sanity back to the music industry, even if leads to Apple having a monopoly over on-demand streaming music.

Of course, even if Apple's able to successfully pioneer a business model for streaming that is finally sustainable for platforms, consumers, and rights holders, there's no guarantee that these spoils will be passed onto creators, which is the whole point of this discussion. And that would be the biggest tragedy of all: Handing sole distribution power to just company while artists are still getting screwed.

[illustration by Brad Jonas]