Sour notes in digital music sales

Kai Ryssdal Dec 15, 2006

KAI RYSSDAL: Wii’s and Sony’s new PlayStation 3 are both flying off the shelves, boosting the bottom lines at both companies. That’s a problem Apple knows well. It’s sold 1.2 billion iPods so far, but a research report out this week hinted sales over at iTunes aren’t so hot and that digital music overall might be in for some problems. Josh Bernoff’s the analyst at Forrester Research who wrote the paper. Josh, good to talk to you.

JOSH BERNOFF: It’s good to talk to you, too.

KAI RYSSDAL: It’s not that Apple sales might be slowing. We don’t really know that yet. The data’s not conclusive. But they’re making a lot of their money on really small transactions.

JOSH BERNOFF: That’s right. Most of the transactions that are happening on the iTunes music store are for, you know, 99 cents, $1.99 and about one-third of the buyers, the heavy buyers, account for 80 percent of the revenue. So you really have a situation where a relatively small number of people are supporting the store and the rest are just buying a few songs here and there.

KAI RYSSDAL: In a dollars and cents standpoint, though, why does it matter that these transactions are so small?

JOSH BERNOFF: The profit on a small transaction is very low for a company like Apple. They need to pay out about two-thirds of every transaction to the music label, to the people who originally created the music and then they’re also going to have to be paying out transaction costs to people like Visa or MasterCard. So you look at that, there’s just not a whole lot of room left on a tiny transaction like that to make a profit from selling music.

KAI RYSSDAL: You know, it sounds a lot like traditional music stores where profit margins are really small after the artists and the CD manufacturers and all the rest of them in the production chain get their cut.

JOSH BERNOFF: Well, I think, you know, if you go through retail, there are all sorts of costs of actually pressing the albums and getting them out there. But at least at the end of the day, people are likely to end up spending $14 when they end up buying the album. Here, you’ve removed a lot of the friction. Somebody can make an impulse purchase for a relatively small amount, but it seems to be part of the problem is that that’s exactly what they’re doing: they’re making these very small purchases instead of actually buying album-sized chunks. So while the CD sales have dropped by over $2 billion, less than half of that is getting made up by iTunes sales and unless we see some pretty serious growth happening here, you’re going to see a smaller music industry than we used to have.

KAI RYSSDAL: What’s your take on how they might fix that, though?

JOSH BERNOFF: Well, there’s the possibility that by removing the protections, you could have a whole lot of stores all competing to sell songs that went on iPods. Whereas right now, with the digital rights protecting music, only Apple is able to sell music that can go onto iPods. So I think there’s very little risk in selling unprotected music whereas the rewards to the music industry would be to get themselves out from under Apple’s thumb, have more stores selling this and potentially attract more consumers not as willing to buy music when they have to live within the restrictions that the digital rights protections include.

KAI RYSSDAL: No offense here, Josh, but you can’t possibly be the only guy who’s thought of this.

JOSH BERNOFF: That’s certainly true, but you know, it took the music industry about three or four years after the debut of Napster to finally come to the point where they would allow any kind of electronic transactions. Now I think it’s going to continue to take them another, you know, year or two to go the next step and realize that selling unprotected music may be the only way out of this dilemma for them.

KAI RYSSDAL: All right. Josh Bernoff at Forrester Research. Thanks a lot, Josh.

JOSH BERNOFF: Thanks. It was good to talk to you.

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