Apple needs to find a way to swim upstream

This week’s iPhone 5 launch event was greeted with less enthusiasm than usual, at least among the self-appointed Apple cognoscenti. “Underwhelming,” was a widely shared verdict, “boring,” or simply, “meh.” But there was one group of Apple watchers who couldn’t have been happier with the announcements: Pandora investors.

Contrary to speculation that erupted after the Wall Street Journal reported that Apple was in talks with the record companies about launching a rival music streaming service, there was no announcement of such a service at the Apple event. Shares of Pandora closed at $10.58 the day after the Apple news conference, up more than 9 percent from the bottom of the 20 percent beat-down they suffered after the Journal story broke. Not a full recovery, perhaps, but the panic-selling seems to have subsided, at least for now.

I wouldn’t get too complacent if I were Pandora, however. Apple is almost certainly considering a music streaming product. Streaming is now the fastest-growing mode of online music consumption and web radio services like Pandora and Spotify are becoming critical cogs in the music discovery process both for listeners and for the record labels. For Apple not to play in the space eventually would risk its position atop the digital music food chain.

The only questions are, when? And, how?

The good news for Pandora is that when Apple does launch a streaming product it’s unlikely to be a direct competitor. Pandora is modeled on ad-supported terrestrial radio. Though it has a million or so paying subscribers among its 150 million registered users worldwide, 90 percent of its revenue comes from ad sales. Apart from the fact that the murderous royalty rates that apply to web radio have prevented Pandora from ever turning a profit, it’s hard to imagine Apple really wants to get into the business of selling radio ad time.

Exactly how Apple would monetize a streaming music service, however, is not immediately obviously. It has billing relationships with 425 million iTunes users worldwide, making that the logical foundation from which to launch any new music service. Any new music streaming product, therefore, would most likely be based predominantly on paid subscriptions.

The hard question for Apple is whether it can build a meaningful paid-subscription business without grossly cannibalizing its current per-track paid download business. There are very few examples of those two models being successfully combined within a single content service or a single billing relationship. Cable TV operators have built successful subscription services, but they have never been able to gain much traction in the pay-per-view business except for content that is not available on their subscription platforms, like boxing or wrestling events. Amazon is trying do both with its Prime Instant Video subscription service along side its video-on-demand service but it has yet to prove that model can work at any kind of scale. Amazon is also able to leverage Prime to boost sales of physical goods, an option not available to Apple.

What Apple is most likely discussing with the labels, as Wedbush Securities analyst Michael Pachter recently speculated, are licenses for some sort of hybrid service in which songs heard via the streaming service could be purchased instantly for download through iTunes. While that potentially has tremendous upside for the labels, it’s also a potential nightmare from a rights perspective.

Music rights and royalties are largely fashioned around use-cases. With different use-cases, come different sets of rights, different rights owners, and different royalty schemes. Combing different use-cases, involving promotional uses, performances and reproductions under a single license will not be easy.

The labels also face the question of whether they even want to combine streaming and purchases under a single deal, with a single operator (especially one they still feel burned them in the past). Right now, the division of labor between streaming services and download services is paying off. After years of unfulfilled promises, royalties from music streaming services are finally developing into a meaningful revenue stream for the labels, thanks to the growing number of streaming services in the market and their growing success. At the same time, iTunes and other download services still provide the bulk of their digital revenue. Combining those functions in a single deal could reduce inter-modal competition and lead to lower net revenue.

Still, as consumers’ media preferences shift generally from paying for ownership to paying for access, a move by Apple into streaming is probably inevitable. But it won’t be easy to manage and it probably won’t happen quickly.



Question of the week

What’s the best way for Apple to monetize a music streaming service?