This article first appeared in the May 4, 2013 issue of Billboard magazine, which also features our cover story on Rod Stewart's return to rock, an in-depth look at the 10th anniversary of the iTunes Music Store, our incomparable charts and columns, and much more. Head here to purchase the issue, and here to subscribe.
In the 10 years since it opened, the iTunes Music Store has come to sell not just music but TV shows, movies, ebooks and apps.
It began as something Apple billed as “running at break-even” and was treated as something that supports Apple’s device sales.
But if it does succeed in supporting a highly profitable hardware business, why haven’t other hardware vendors tried to replicate it? Part of the reason is that it’s a long process, but another part is that operating the iTunes store consumes nearly $3.5 billion per year. Some of that is transactional costs but some is curation and server and communications infrastructure. Apple spends $10 billion per year in capital expenditures, of which servers and associated equipment account for an estimated 20%.
iTunes has had consistent growth: From 2008 to 2012, it has respectively reaped 27%, 34%, 30%, 46% and 30% yearly gross revenue growth. The compounding of this growth has meant a quadrupling in five years. If this persists, iTunes could become a $50 billion business in a few years. That’s bigger than all of Apple was in 2009.
The success depends on the mutually supporting device business: More content makes devices more desirable and more devices create more demand for content. Apple’s famous obsession with integration is essential to ensuring this virtuous cycle. It started with the iPod and continued with the iPhone and iPad. This attention to detail is sometimes seen as overbearing or controlling. The most obvious instance is the treatment of pricing.
In the case of music, pricing has been a matter of contention with content owners and it is evolving with the pricing of video items. Pricing control has become a matter of litigation with respect to books. The control over pricing affects how the company treats curation and promotional efforts and even accounting practices.
Consider that for apps, Apple doesn’t determine the selling price of the products and therefore doesn’t consider itself to be “the primary obligor to the customer.” Therefore, Apple accounts for such sales on a net basis, recognizing in its sales only the commission it retains. In other words, the portion that is remitted to app developers ($8 billion to date) isn’t accounted for as revenue. This crucial distinction is the reason that the exponential growth in iPhone sales and apps isn’t reflected in Apple’s iTunes reporting.
These payments to content owners are what fuel the ecosystem around Apple. Accessories makers also benefit from the device business but they typically are required to pay to license the “Made for iPod/iPad/iPhone” trademark. Content owners are only asked to pay the 30% commission for each sale. Apple spends most of that to enable the transaction (hence the “break-even”) operating model. Indeed, selling physical media -- whether CDs, DVDs or videogames -- typically incurs additional distribution costs beyond the 30% cut when returns, retail markup and transportation costs are added. Prior to Apple’s entry, app developers frequently had to give up 45% or more to the “channel.”
When considering the future evolution of the iTunes store the primary observation is how the various media types are “converging” in terms of business models. After the model for music sales was established, music videos were slotted in without any major changes. TV shows and movies followed. Apps then appeared, and except for the variable pricing (which settled quickly into a few price points of 0 cents, 99 cents and multiples thereof) became indistinguishable from other media content. They were categorized, featured, discovered and sold the same way.
Apps, however, brought a few additional “features.” They were upgradeable; they could be ad-supported with several ad networks available; they could be metered and their use monitored by the developer; they had the game center; they allowed for in-app purchases. In this sense, apps became “smart content” that benefited the user and the developer after the initial purchase was made.
This evolution from songs to apps leads one to wonder what could happen with further convergence between media formats. Perhaps the idea of a “video-based app” or the transition of the TV into a smart device that runs apps is a technological fantasy, but it’s conceivable that something along those lines is possible. If it does happen, it is Apple that is best-positioned to first make it happen. Not because it has better engineers or marketers, but because it has the iTunes store: the one-stop shop for new media experiments. If and when a new device appears, one can be sure that it will have an iTunes store-based ecosystem built in.