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April 7, 2007

Basis Of Competition

So the big tech news this week - at least, to me - was Monday's announcement from Apple and music publisher EMI that EMI songs would now be available on the iTunes Music Store without any form of DRM or copy protection.

As Keanu might say: whoa.

This is a very big deal, not least of which because it signals a sea change in how the music industry is dealing with the Internet. Historically, music executives have treated their Internet customers in a pretty shabby fashion - first by refusing to recognize the existence of an Internet marketplace at all (Napster changed that), then by building consumer-hostile music stores with poor selection, and, finally, suing people. Put bluntly, none of this has worked. CD sales are in free-fall, dropping 20% in the first quarter of 2006. The only bright spot in the music business has been music downloads through services like iTunes - which, incidentally, reported its 2-billionth song download in January.

So the market has spoken, and it's said that the future of music is digital. But the problem is: how do you deal with piracy?

It's no great secret that music piracy is rampant. It's trivially easy to share music files with people across the globe, and, as a result, people do so, swapping hundreds of thousands of files with one another each and every day. If you want a popular song for free, just fire up your peer-to-peer client of choice and go to town. It's illegal, but it's fast and convenient. And, as we all know, "fast" and "convenient" tend to be the winning attributes of most products these days.

The "solution" to piracy has been to put music in a format that prevents its being shared - e.g., DRM. And the music industry has embraced DRM with the strength and tenacity of a drowning man gripping a life preserver. When you buy music from virtually every legitimate service on the Internet (iTunes, Real Rhapsody, Yahoo! Music), your music comes in a "wrapper" that dictates how you can enjoy it. Depending on the complexity of the wrapper, you might be prevented from copying the song to a CD or to an iPod; might be prevented from "streaming" the song to another device (like an AppleTV or an Xbox 360), and so on. DRM adds complexity, and this complexity is hard for people to manage. As BusinessWeek's Steven Wildstrom recently wrote ("Now Playing: Digital Disarray"):

Imagine a bookstore that sells only works published by Random House. If you want a HarperCollins title, you have to go to the store down the street. In this world, you're permitted to read Penguin (PSO) books either on the train or lying in bed, but Vintage books can only be read on the couch. It's absurd—but no more so than the world of video downloads as they exist today.

All this complexity stands in stark contrast to the utter, beautiful, sheer simplicity of the Compact Disc: pop it in your computer, rip it to the drive, and enjoy your music, well, everywhere. And so continues the piracy problem, where thieves can easily and quickly get DRM-free music that is more convenient and less encumbered than stuff they'd otherwise pay a dollar for.

Steve Jobs has captured the sentiment and the problem quite eloquently in his February essay, "Thoughts On Music." And, it seems, he was serious about his closing statement:

Convincing [music publishers] to license their music to Apple and others DRM-free will create a truly interoperable music marketplace. Apple will embrace this wholeheartedly.

Steve clearly wasn't kidding, and, apparently, EMI decided that the current strategy (DRM, lawsuits, putting fingers in the ears and saying, 'la la la la la') wasn't working. So EMI have done a bit of corporate judo and changed the way they're going to deal with piracy. Rather than trying to eradicate piracy (an impossible dream), EMI has decided to stop selling its legitimate, paying customers a second-class product ... but to charge a little more for it ($1.29 per non-DRM track, vs. $0.99 for one that's DRM-encumbered). EMI is basically offsetting its piracy-related losses by charging an extra $0.30 per track to its legitimate customers.

This is pretty smart. I expect some marketing genius somewhere in EMI Intergalactic HQ finally did a customer segmentation study, and realized that the Venn diagrams of "paying customers" and "hardened pirates" were pretty much non-overlapping -- there's people who are willing to pay a fair price for music, and people who will never give a red cent to anyone for "Stairway To Heaven." And, if that's true, the trick for EMI is to treat those two groups as distinct segments, and to do a better job catering to those who are actually willing to part with their VISA number for the new Pet Shop Boys album (e.g., me). By charging a little more, EMI both earns greater revenue from its customers and gets some invaluable market data about which customers - and how many - are willing to pay more for DRM-free music.

If this takes off, expect the other labels to follow in very, very short order.

The second, less-discussed piece of Monday's announcement has been more surprising to some - namely, that Apple would be willing to sell DRM-free music in the first place. Bill Thompson of the BBC laid it out shortly after Jobs' announcement ("Why I Don't Believe Steve Jobs"):

I don't believe him. If Apple switched off [DRM] then they would probably sell a lot more songs, on which they make very little money, and a lot fewer iPods, on which they make a lot.

(Thompson has since admitted he was wrong - something I give major props for.)

Thompson's initial point, however, is a good one: Apple has been seen as benefitting from DRM even as it decried it. By selling DRM'd songs on iTunes that - mysteriously - only worked with iTunes, AppleTV and the iPod, Apple has built a nice little ecosystem for itself. Music is software, right? So just as a good selection Windows-only software reinforces the desire for people to buy a Windows PC (and reduces the ease of switching to a rival product) so too does iTunes/iPod-only music reinforce your desire to buy an iPod (and reduces the ease of switching to a rival product). It's called "lock-in".

So why give it up?

Well, near as I can tell, Apple has determined that it doesn't need DRM lock-in to win in the music market. And, apparently, they're so convinced of it that they're willing to roll the dice.

Apple is effectively saying that their value proposition without DRM is good enough, and that they're willing to compete on any other axis you like. They're going to compete on brand, on price, on SKU, on form-factor, on design, on hipness, and, of course, on experience.

This actually seems like a good bet to me.

Look, there have been MP3 players in the market for a long, long time - well before the iPod. The thing is, they all sucked. And, until the iTunes Music Store came around, the iPod was competing quite handily with these other players, thank you very much. The product was better, slicker - an integrated experience. And it's worth pointing out that here we are, six years after the iPod launch, and there's still not a product in the market that can touch it.

The experience piece is interesting, too. By ditching DRM, Apple is extending an olive branch to an entire class of musician and label - small indies, mostly - who have not been willing to deal with DRM on iTunes. This market has been ably led to-date by eMusic, and their catalog is a respectable collection of artists you might not have heard of, but who are willing to have their songs shared as a way of gaining exposure. Apple has said that they will be working with these small guys to get them into iTunes - which just makes the iTunes store more of a complete destination, a better experience.

This is phenomenally bad news for the business strategies of non-iTunes music stores, and for other music file formats (read: Windows Media) in general. Other storefronts are basically reduced to competing on selection (hard to do), or experience (even harder to do), while the value of exotic, DRM-laden file formats has just declined sharply.

If I were Samsung or Sony, I'd be making damn sure my player works with iTunes.

The next six months ought to be really, really interesting.

PS - it's worth pointing out that there's software lock-in, and there's partner lock-in, where your business partners add value to your offering that makes it more compelling. In this case, iPod partners include accessory makers who do add-on speakers or iPod cases, as well as people like airlines or car companies who make it easy to add an iPod option to your transportation. Apple hasn't given up their partner lock-in, and I don't expect them to any time soon. Since these partners all offer iPod connectivity through Apple's proprietary Dock Connector - which doesn't work with your Creative Zen Whatever - people will still have substantial incentive to buy an iPod, if only because they can play it through the stereo in their BMW or whatever. Don't cry for Apple just yet.

Posted by Gavin Shearer at April 7, 2007 6:42 PM. Posted to Apple.

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Posted by: ravi at April 10, 2007 9:15 PM

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