The growth rate in digital music revenue has declined the last six years as adoption matures (and overall industry revenues continue to shrink). However, the latest IFPI Digital Music Report shows that 2011 saw the first actual increase in the growth rate, from 5% in 2009 to 8% in 2010, since the IFPI began keeping records in 2004. What’s driving that growth? Well, potentially lots of things, but the report highlights the adoption of paid subscription services as one of the key drivers.

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I’ve argued for years that the best opportunity for digital music revenue growth is through subscription services.  Despite heavy investment, until recently offerings have not been compelling enough to gain any real traction. Last year, however, paid subscribers grew by 65%. So what has changed to advance adoption of subscription services?

  • The penetration of smartphones and connected devices mean a user is no longer tied to a desktop in order to consume subscription music
  • Transition to cloud-based access, browser-based UIs and multi-device apps, make the experience portable
  • Ability to use competing services like Rhapsody on dominant devices like an iPhone make those services more relevant
  • Integration of social networking and services, such as the Facebook and Spotify tie-up, drives awareness and engagement
  • New and interesting services like Spotify, Rdio, Mog, Deezer, Galaxie and others
  • Consumer adoption of video services like Netflix and Hulu are building a general acceptance of the subscription model

Subscription is a fantastic business model that converts unpredictable one-off purchases into steady revenue.  All-you-can-eat subscription offerings can also grow the overall industry by increasing the annual average revenue per user as well as combat piracy (why steal when you have access to everything legitimately?).

So why hasn’t the dominate US digital music service, iTunes, launched a subscription offering? Some have argued that Apple doesn’t care about making money from music sales and uses iTunes only to drive hardware sales. Well, that argument perfectly fits a subscription model that would tether the user to the service (and device). Others argue that a subscription service would decrease overall revenue as only those that currently spend more than the monthly subscription cost would find it economically attractive. This argument ignores the added value that comes from unlimited access and the dramatic decrease in actual cost-per-song.

To play things out, let’s do a little back of the envelope calculation:

Total US revenue from digital downloads in 2010 was $2.8B, of which iTunes accounted for roughly 70% (or $1.54B). The 80/20 rule suggests that 20% of Apple’s hard-core “heavy users” generate 80% of that revenue, while the remaining 80% “light users” are your casual purchasers who maybe download a few songs a year. An unlimited subscription service would most likely appeal to the “heavy users”. iTunes has 200M user accounts, although a lot of those are people who have registered to access the App store, not iTunes. If we assume that half of those 200M are US-based users who purchase music , that gives us 20M “heavy users” (200M accounts x 50% US music purchasers x 20% heavy users = 20M). That means that 20M users generate $1.23B in sales (80% of $1.54B total) or an average of $61.60 annually per user. That leaves the 80M “light users” who average $3.85 per year (($1.54B – $1.23B)/80M), which at least passes the sniff test. A $10/month subscription service would generate $120 annually per user, or a nearly 100% increase in total revenue from the “heavy users” and an additional $116 annually for any “light user”. If all “heavy users” switched to a subscription service, that is an additional $1.16B in total revenue for both Apple and the Music Industry. Assuming Apple takes 30%, that means an extra $350M annually. Realistically, 100% of “heavy users” probably wouldn’t switch over, but lets assume half do (which is only 5% of Apple’s total user base) and 1% of “light users” see enough value that they switch as well. That equates to over a billion dollars in additional revenue through a subscription service in the US alone ($584M in addition to the $61.60/per “heavy user” and $464M in addition to the $3.85/per “light user”). That feels like a win-win for Apple, the Music Industry and consumers.

Now, to bring things back to reality, these back of the envelope calculations are in no-way a precise estimate of market size or cannibalization. This little scenario also equates to a subscriber base of over 10M ((20M “heavy users” x50% = 10M) + (80M “light users” x 1% = 800K)) while the largest US subscription service (Rhapsody) currently has only 1M subscribers. However, iTunes is easily 10x the size of Rhapsody and Spotify currently has 2.5M global paid subscribers, so the thought of 10M iTunes subscribers is not out of the question.

Anyway, all this is meant to do is showcase that paid subscription music services are growing widely and that the business model makes sense for the largest players and the industry as a whole.

Sources: Nielsen, IFPI, NPD

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