Why Amazon's Approach to Licensing Could Be the Future of Digital Music

Even though the just-launched Amazon Music Price is receiving some criticism, it hints at a future with different types of subscription services and different prices. One day the $10-per-month subscription service will reach its limit, and another model will be needed to keep subscription revenues growing.

Amazon's streaming service, free to subscribers of Amazon Prime, debuted with a limited catalog of about one million tracks from tens of thousands of artists -- a subscription service can easily exceed 20 million tracks -- and catalog titles rather than new releases and current hits. (It also debuted without recordings from Universal Music Group.) The service is accessed via the Web or mobile app.

Prime Music's size and type of catalog has attracted some derision. "It's not a compelling offer since it's a limited offer," one executive told Billboard. An article at TechCrunch also bemoaned the lack of hits. "It’s hard to tell who is the target audience for Amazon’s service."

Amazon Launched Prime Music Streaming Service Minus UMG

Amazon Prime Music's target audience is the people who are unlikely to pay for the current slate of on-demand subscription offerings.

How does a company reach these unlikely subscribers? One approach is to offer a standard, full-catalog service and slash the price (and eat the loss). But that's impractical. A better approach would be to offer a service with just enough of a catalog and a low enough price.

Here's where Amazon's controversial licensing terms come into play. Amazon's initial offer to labels was a pro-rated share of a fixed revenue pool. And the company wanted to license only a fraction of the available catalog. If the goal is to offer a simple, inexpensive digital music service, this "just enough" approach makes sense.

The music business needs to follow Amazon's lead and create different tiers of subscription services. It needs to experiment with licensing selections of catalogs rather than full catalogs.

The first option is a one-size-fits-all service. This is what we've seen for the last ten years. The goal has been to push the current business model until consumers learn to appreciate it. Over the years, a common refrain from executives has been that consumers hadn't yet appreciated the value of having unlimited access to tens of millions of songs.

Of course, people in the music business easily understand the value of the streaming business model. They are high-value customers who spend an inordinate amount of time and money on recorded music and hardware for enjoying it. What's $10 a month when you're already shelling out hundreds each month on downloads, vinyl, concert tickets, merchandise and concessions?

But if the goal is to broaden the market, different products and different prices might be necessary.

The second option is to embrace limited catalogs, or what could be microlicensing. Rather than offer every track in the licensable universe, offer just a portion of the available catalog -- and price it accordingly. 

Microlicensing has a few advantages. Licensing just a slice of the licensable universe can lead to lower licensing costs. The result will be lower prices for consumers. A typical on-demand streaming service costs $10 per month. A genre-specific service can be priced to reflect the limited selection. A country-only service priced at $3 or $4 per month is arguably a better way to reach mainstream consumers than a full-fare, $10-per-month service.

This approach should attract questions. Why should labels take less for a single genre service whose users can generate just as much streaming activity as full-fare users? Why would labels want to devalue the full-fare services?

The reality is labels won't get full fare from all streaming users. The earliest customers might pay $10 per month, or slightly less through an annual contract or family plan. But the later adopters probably won't pay $10. But if you drop the price to $5 to attract more customers, you're taking less from the people most willing to pay.

Microlicensing can allow for differentiated services that don't directly compete with full-fare services. The less expensive service would give lower-value consumers an option at an attractive price, and it wouldn't devalue the more expensive service with the larger catalog. 

Consider a hypothetical scenario with two tiers of subscription services. In the first scenario, the full-fare subscription services attract 15 million customers at $10 per month and annual revenue of $1.8 billion. This is the size of the subscription market if only of full-fare subscription services. But if a second tier of subscription service is also offered, it will attract a different and plentiful customer with a lower target price. The second tier of services -- the microlicensed tier -- attracts 30 million customers at $3 per month and annual revenue of about $1.1 billion. Assuming none of the full-fare subscribers downgrade to the less expensive option, total revenue is about $2.9 billion.

In the second scenario, only a full-fare subscription service is offered but the price is $3 per month to attract more customers. At $3 per month, 45 million customers generate $1.6 billion in annual revenue -- $1.3 billion less than the two-tier approach. In effect, $1.6 billion has been lost to customers who would have paid more given the chance.

These numbers are only used for illustrative purposes, but they show the inherent problem in offering one tier of full-fare, full-catalog subscription services. Growing the market requires finding tens of millions of additional subscribers, but those subscribers need an attractive price. The best way to offer an attractive price -- without cannibalizing revenues from the subscribers most willing to pay -- is to offer a pared down service that has just enough catalog and features. 

A basic tenet of pricing says to choose a price based on demand rather than costs. Netflix is a good example of licensing with pricing in mind. It starts with a price -- $7.99 per month -- and licenses accordingly. It doesn't have the newest titles and it lacks popular catalog, and its customers don't seem to mind. The Nextflix catalog is "just enough" to attract tens of millions of satisfied subscribers.