Music subscription store economics
After all the talk, and there has been much of it lately, I really don’t get the music subscription store economics. Arguably subscription model better fulfills demand of music listeners. Hey, who would not like to have every tune ever recorded at his or her fingertips? However, to make a model sustainable you have to think about more than just demand requirements.
My understanding is that subscription stores incur some variable cost, which can be made up of one or more of the following:
1. Per-user license fees
2. Broadband cost
3. Misc (referrals, customer database tracking, CPU costs, etc)
Whatever these costs are, and whatever they are made up of, it seems that they have to be non zero.
From there, subscription model leads to following dynamics:
1. Initial curse of the commons:
Whenever there is a resource that is free to use it gets overused, i.e. listeners download huge amounts of songs by which causing resource provider to incur costs beyond recuperation. This fits with the idea that this store “better” satisfies needs of users which would all like infinite access to music
2. Steady state:
Once users download all music, store collects the fees and incurs only costs of new downloads. But, user does not get incremental satisfaction of getting access to huge amounts of music as s/he did before, and has to be satisfied with new music only. That means that they would be willing to pay to continue using service only the amount that they would ordinarily spend on music per month. Willingness to pay and price vary per user dramatically (just think of pop-crazy teenager and mid-age user that knows he likes Rolling Stones). So, per-month pricing has to be set so that it reflects an average per-song willingness to pay which may be very hard for a very diverse user group. Moreover, there is only limited ability to price-differentiate between offerings, so user is either able to access music (videos, collections, etc) or s/he is not.
3. Piracy risk:
Once DRM for a subscription service is cracked all available content can be pirated and distributed around. So, pricing has to include a risk premium that would take into account probability of such thing happening. Given that it is not question whether, but when will the DRM be broken, I am not sure how or even if such risk premium can be assessed.
4. Consumer churn:
Every time a subscription service looses a customer (and why wouldn’t it since their customers can transition to a better service w/out incurring music repurchase cost), they loose a revenue stream. Whenever they acquire a customer they incur startup costs (customer acquisition + initial downloads from part 1). This is reminiscent of cable-DSL wars in which consumers win, but it takes 10 years for broadband to be adopted in the most prosperous country in the world.
On the other hand, per-song store economics allows user to pay only for songs they use. In Apple model this is very close to the 2-part tariff, which is an optimal pricing model (remember MGEC?):
- ITMS charges users marginal cost of song distribution (license fee + distribution costs + transaction costs)
- Apple captures consumer surplus (entry or membership fee) through iPod margins
Kind of reminds you of Costco, doesn’t it?
In this model there is no initial curse of the commons, since marginal costs of music distribution are covered, there is no steady state problem since it allows flexibility to exactly satisfy variable demand of users (pop-crazy teenager and mid-age user). There is only a limited piracy risk since users don’t have access to the whole library of music. Finally they don’t care if customer leaves, since profit was made when customer entered (bought an iPod), so if they want to leave - so be it.
It seems to me that the only way Yahoo and alike stores can survive is to extract extra revenue per download through other channels (such as advertisements). But, actions like these further reduce customers’ willingness to pay and thus reduce resulting revenues. And the vicious cycle continues.
Right now, my money is on ITMS.