Just how much is a good music service worth to a large ISP? Hundreds of millions of dollars over just a few years, based on a Billboard estimate of the cost of churn (the rate at which subscribers leave) to a large broadband provider.
Churn carries a high cost and even the slightest reduction has huge benefits. In its Digital Music Report 2010, the IFPI noted that Danish IPS TDC was able to reduce its customer churn by 50% by bundling the Play music service to its broadband service. And as a result of the reduction, TDC generated more revenue and fewer expenses. (Of course, other factors, such as improved bundling and better service quality may have been involved in a 50% churn reduction.) Experts disagree on the actual impact of bundled services, but there is some agreement they help reduce churn.
A look at the costs of customer churn shows the value a music service can offer. Take Comcast, for example. It ended 2008 with 14.9 million Internet subscribers. A typical broadband provider experiences about 1.4% monthly churn. Adjusted to account for people moving to different residences (17% of the population every year), that’s about 14.5% annual churn, or over 2.1 million customers each year. At $43 per subscriber per month (Comcast’s ARPU in 2008) that’s $1.1 billion lost from churn every year. Figuring in $250 in acquisition costs and a 65% gross margin rate (source: JP Morgan, Bear Stearns, Diamond), that comes out to over $500 million in profit contribution lost to churn every year.
A music service alone may not be able to cut every broadband supplier’s churn in half, but even a small improvement would carry big results. What if a music service could reduce churn by 10%? The positive impact over five years, net of taxes, has a present value of $162 million. A 20% churn reduction means a $325 million improvement. And so on. (Assumptions: A discount rate of 5.78% based on Comcast’s financial structure and cost of debt; Comcast’s 2008 organic growth and churn rates would continue for the next five years; and in this case looking at a five-year window is more appropriate than a decades-long time frame.)
Of course, a company like Comcast would not actually pay these amounts to license a music service over a five-year period, but these numbers show that broadband providers have reason to place a large value on a music service that is properly integrated into its product offering.
For this reason, record labels have ample reason to pursue deals with broadband providers. Music services should be put to their highest-valued uses. The industry needs to look beyond advertising and direct customers payments in order unlock far greater value than is currently being achieved.