Apple, Spotify, and the futile economics of music streaming

So, Apple is planning to launch its new music streaming service at its Worldwide Developers Conference next week, according to the Wall Street Journal.

Several weeks ago, I suggested that it didn’t make much sense for Apple to pursue such a thing. While I certainly didn’t expect the company to take my advice and forget about streaming, everything I’ve heard since then has only convinced me that the efforts to launch this service represent a distraction, at best, for a company that’s selling a gazillion iPhones every quarter.

To illustrate why, let’s start with two nuggets from the latest Journal story:

In Spotify, Apple faces an entrenched competitor that has used a seven-year head start to build a daunting lead. Spotify reported more than $1 billion in revenue last year and said it ended the year with 15 million paying subscribers, plus around 45 million free users.

And:

Spotify accounts for 86 percent of the on-demand music-streaming market in the U.S., according to data shared with music publishers. Its share of the international market is believed to be similar.

Now, I love Spotify. I switched to the paid Spotify service several years ago, and have all but stopped using iTunes.

But while that $1 billion figure sounds “daunting,” remember that in the two most recent quarters, Apple reported $58 billion and $75 billion in revenue. One billion? Far short of material when measured against Apple’s yardstick.

Indeed, Apple, the undisputed king of the dying digital download market, probably makes more than Spotify each year from music. Though it’s hard to say how much more.

Apple’s sales of music downloads are part of the broader iTunes category that also includes App Store sales. Overall, iTunes sales were $5.4 billion for the past six months, up from $5 billion from the same period a year ago.

But, as Apple reported in its most-recent earnings filing, that growth was driven by App Store sales: “This growth was partially offset by year-over-year decreases in combined net sales of digital media, consisting of music, movies, TV shows and books, of 4 percent and 5 percent in the second quarter and first six months of 2015, respectively.”

So, if we assumed annual iTunes sales this year of $10 billion, music is some subset of that. More than Spotify, probably, but headed in the wrong direction.

Still, it’s not like Spotify has established itself as a sustainable, long-term juggernaut. It’s not clear that Spotify has really figured out how to leverage its user base into a profitable operation.

Instead, Spotify recently announced a major overhaul of its service to include video, podcasts, and new ad-targeting services. And to support this, Spotify was reportedly raising another $350 million in funding. After seven years in business, Spotify is still trying to make sense of its own business.

Spotify can still boast of a fast-growing user base. If Apple has some radical new vision for the music streaming experience that will slow that momentum, I haven’t heard it.

Mostly, according to the Journal, Apple seems convinced it can leverage the huge iTunes customer base who have already handed over their credit card information. Similar arguments about leveraging the user base were made about the launch of iTunes Radio, the so-called Pandora killer that we haven’t heard much about since.

Still, let’s assume people really do rush to embrace the new music service, that it chokes off Spotify. Here’s how the Journal explains the risk/reward balance for Apple:

Of the 110 million people who bought music on the iTunes Store last year, the average customer spent a little more than $30 over a 12-month period, according to music-industry estimates. Persuading a significant share of those buyers to switch to a product that costs $120 a year will be a challenge, but would be lucrative for Apple and the record companies. But the move could backfire, if many subscribers are drawn from the elite ranks of iTunes purchasers who spend more than $120 a year.

Could backfire. What’s important to know regarding that average of $30 is how much is driven by those power users. If you spent $150 last year on iTunes music downloads, you can switch to the new streaming service and get more music while spending less money.

To increase revenue, Apple will have to convince those spending less than $120 annually to increase their spending by signing up for a subscription. And the number of people who do that will have to offset the lost revenue from power buyers.

In other words, Apple will be doing well to break even in terms of overall net revenue. More likely, it will take a hit in the short term, and has to hope over the long run it finds a way to entice those iTunes customers over to the new service.

This all brings me back to my original feeling about Apple and music streaming: Why bother? If this isn’t helping you sell iPhones, then it seems like a lot of effort for little gain.

Of course, sometimes the heart wants what the heart wants. Apple is deeply wedded to the music business for historic and emotional reasons.

But it still seems like the company is putting forth an extraordinary amount of effort to salvage a relationship it doesn’t really need anymore.