It's Volume, Silly: Thinking Global on Digital Music Revenues
Global digital revenues will explode in the next five years, according to a new market research report from Technavio. But where will new digital consumers come from and how much will they pay?
Technavio, a market research company that covers sectors ranging from healthcare to aerospace, believes global annual digital revenues will nearly double to $16.02 billion in 2019 from $8.10 last year -- a cumulative annual growth rate of 14.61 percent. That alone is a bold prediction considering global digital revenues have been far less spectacular in the previous five years. From 2008 to 2013, global digital revenues grew 48 percent, according to the IFPI.
In any case, TechNavio expects a huge influx of digital music users to drive this revenue gain. The company forecasts the number of digital music consumers -- it employs the broad term "users" -- will increase 126 percent to 2.55 billion, from 1.42 billion. These users could be anything from paying downloaders to subscribers to services such as Spotify and Deezer.
Developing markets are thought to offer potential. Rising incomes, increased access to broadband and availability of affordable data plans are believed to be among the main drivers in these countries. TechNavio singled out China, a country with a relatively small digital marketplace in spite of having the world's largest population, and the Asia-Pacific region, or APAC. In fact, TechNavio believes APAC countries will surpass North America in market share by 2019.
North America certainly isn't primed for dizzying digital growth in the next five years. While subscription and ad-supported revenues are growing fast, disappearing download revenues are eroding their gains. In the first half of year, the net result was a slight, $5-million gain on $2.16 billion of retail spending, according to the RIAA. Future gains could far outstrip future download losses, but double-digit digital revenue growth is unlikely in the next few years.
Developing markets won't have the same problem. Large markets like China and Indonesia could provide the growth TechNavio has forecast. But there's a strange aspect to the Global Digital Music Market report: it assumes the average revenue per (digital) user, or ARPU, will increase over the next 5 years, to $6.28 in 2019 from $5.71 last year. Put another way, Technavio believes early digital music adopters have a lower ARPU than the later adopters. (Billboard could get its hands on only a summary that provides broad brushstrokes rather than the more nuanced details of the report.)
This isn't how new products usually work -- especially in technology. Early adopters tend to have a greater price threshold than later adopters. (In marketing terms, the two earliest categories of consumers are innovators and early adopters, but for the sake of this discussion the term "early adopters" will refer to the first wave of consumers.) Prices are highest when new products are released and manufacturing costs are at their highest. Early adopters are willing to pay these prices. Prices drop as demand increases and manufacturing costs drop. The lower prices, and time allowing for greater awareness and education, attract later adopters (called the early majority and late majority by marketers).
Demand for digital goods is not much different. Although the cost of goods doesn't decline as demand increases -- there are no economies of scale that exist in the physical world -- demand tends to increase when prices decline. Using data from a 2011 survey by NewMediaAge, Professor David Touve showed that demand for music subscription services increases as their prices decrease. Whereas 17 percent of respondents would pay £3.99 a month for a subscription service, only 5 percent would pay £7.99 and just 1 percent would pay £10.99. As an aside, £3.99 was the revenue-maximizing price and the £10.99 price resulted in the least revenue.
Although it's not the most plausible outcome, a rising ARPU is not impossible. In one scenario, consumers actually spend more on digital music as they transition from download stores to subscription services. In another scenario, subscription services are able to derive more revenue from a substantial portion of their customers through upgrades to a more expensive, high-definition audio tier of service.
Yet most likely future scenarios will follow the current trend in subscription pricing: lower prices that attract more customers.
There are numerous examples that show subscription services' ARPU drops over time. Consider the mid-year 2014 subscription revenue figures released by the RIAA. Subscription services' ARPU declined to $7.94 from $9.13 in the first half of 2013. That works out to a 23.2-percent revenue increase, astride a 41.8-percent increase in subscribers. This decline isn't a surprise. As time has passed, subscription services have offered consumers more ways to save money: family pricing, student pricing and, as Spotify employed in November, heavy discounting.
Subscription ARPU also drops outside of Western countries. Take Saavn, a streaming service offered in India, the United States and numerous other countries. Saavn's top tier costs $3.56 per month in India at current exchange rates (it's $3.99 per month in the United States). A less expensive tier that's available only in India costs $1.78 per month. Lower prices can be obtained by buying 1-day (8 cents) or 7-day (49 cents) plans through mobile carriers.
ARPU in developing countries cannot be judged by Western standards. As the Saavn example shows, a streaming service must take into account the realities of the markets in which it operates. A service might have a relatively low ARPU in India, but the size of the market -- currently about 1.25 billion people -- means big potential. The same can be said for developing markets in general: billions of consumers, not previously included in the legal digital marketplace, are potential customers for music streaming services on their smartphones.
Going back to Technavio's report, ARPU will decline if APAC countries lead global digital revenue growth in the next five years. These markets will not be able to sustain the high prices being charged in Western markets. And that's not necessarily a bad thing. Given the high piracy and low ARPU in many of these countries, successful digital services APAC markets will be like found money to the music industry.
Lower ARPU -- which could decrease per-stream royalties, by the way -- has its advantages. According to Touve's calculations, subscription revenue in the United Kingdom would have been £57.2 million at the £3.99 price compared to £29.9 million at the £7.99 price and £6.8 million at the £10.99 price. One could point to Apple's 2009 decision to raise iTunes track prices to $1.29 from $0.99 -- with nary a dent in demand -- but this was an aberration. Prices of digital music are going down.