Last week’s post on YouTube and Viacom got some great comments. If you get a moment go read them. Ram Medury brings up the case of VAS content providers in India, who get a small fraction of the revenues. The rest is kept by the Indian mobile service provider. Senthil says that it’s about the quality of the content. If the content is compelling it will pull in the dollars. Also, Robert Young at Gigaom has a very thought provoking post on the subject of Google and old media companies.
Onward ho! As promised, this week I take up another interesting space where the “Content vs. Distribution” battle is being played out – digital music.
The chart above indexes the growth in the value of Apple and EMI plc since March 2002. EMI is one of the big four music “labels”, the others being Universal, Warner and Sony. The difference in the market cap growth for Apple and EMI, two companies who essentially eat out of the same plate (the music industry) is astounding. AAPL has grown by 600%, while EMI has lost market cap. EMI is now in merger talks with Warner Music.
Apple isn’t all about music, but their growth in revenue, earnings and market cap, in the last 4 years has been all about the iPod. The chart below shows you how closely correlated they are. Incidentally, it took me 10 seconds to pull this chart together on the Gridstone platform. Try doing that with anything else out there. Short commercial break now ends.
What makes the iPod so successful? There is no question that the iPod is a design marvel. I own two iPods myself and I love its looks and usability. But the iPod also owes its commercial success in large part to the near absence of competition.
Apple’s iPod and iTunes together are a closed system. iTunes doesn’t work with other portable music players and the iPod doesn’t work with other digital jukeboxes. The songs you download from Apples music store cannot be played on portable music players other than the iPod. You can however, convert your CDs into mp3 and play them on your iPod.
The reason this is a closed system is something called DRM (Digital Rights Management). The music you download from Apple store comes wrapped in software which implements the rights you have to that music – to play it on upto 5 computers and any iPod. The DRM is there because the music companies insist upon it. Pirated music is the number one reason why music sales have been dropping year after year.
DRM essentially is the glue that binds the “closed system” together. Apple’s DRM called “Fairplay” is proprietary to Apple. There are many industry commentators that have been calling for DRM free music. Steve Jobs also supports it, oddly. But there is no doubt in my mind that DRM free music is bad for the iPod.
Let’s look at the competitive dynamics of the digital music industry with DRM. In order for the DRM to work, the system needs to be a closed one. An industry standard DRM is unlikely to emerge simply because it is not in the interest of its leading players. So what does it take to be a player in this closed-system-DRM-based industry?
For one, you have to be an electronics manufacturer, since you have to make your own portable music players. That cuts the field down quite significantly. Second, you need to have the software development capability to come up with a DRM and an online music store. Third, you have to have the industry credibility to get the four major music labels to sign up with you. If you lose one of them, your customers are going to have a sub-optimal experience.
As you can see, the bar is quite high. Not surprisingly, today there are very few players of any significance. Microsoft and Sony have closed systems. Yahoo Music tries to get by without a player. Undoubtedly, with a 70% + market share, the 800 pound gorilla in this industry is Apple. They not only have a gigantic market share, they have pricing power.
Without DRM, or with a DRM standard, the market would be a whole lot more competitive. The music distribution business would be sundered from the music player manufacturing business. Many more players would jump into the fray leading to accelerated innovation and lower prices. The consumer would have more choices. One choice that they don’t get to exercise today would be to a really cheap portable music player that would play legally downloaded music. More competition would certainly impact the iPod – first its margins, then its market share. Although, it might expand the market size and Apple might still come out ahead.
And what of the music labels? Certainly, piracy and casual file sharing is hurting their prospects. But their insistence on DRM is puzzling. Their music is out there on CDs without any DRM protection. There is no sense in closing the stable door after the horse has bolted. Maybe they see something that we don’t. But any which way, it must hurt a lot, that a distributor of their music has created more market value than the top four music labels combined.