Beats Music has a simple question for mobile carriers: Why not subsidize music rather than hardware? That is, can you sell more phones by offering 20 million songs for free? Beats Electronics co-founder/CEO Jimmy Iovine has told mobile carriers that music, rather than smartphone rebates, can help set them apart from their competitors.
“Why don’t you take a chance on giving us $100 rather than giving Samsung $100?” Iovine has asked, according to a person familiar with the conversations.
Along with Beats Music, other subscription services, and record labels, are making their pitches to U.S. mobile carriers in an effort to add subscribers and work toward the scale necessary in the digital music business. Digital music is notoriously difficult. The largest subscription services have between 4 million and 6 million subscribers globally. Others have between 1 million and 2 million, or less.
“The real holy grail for the music industry is how you get these to 100 million subscribers,” says an executive at a music subscription service.
Partnerships with mobile carriers aren’t the only tool in the tool box. Improved products, different pricing strategies and the ongoing evolution of the marketplace will also play roles. But, at the very least, successful mobile partnerships will make digital music much more accessible.
Music industry executives firmly believe two things: Access models like subscriptions are the future of recorded music, and partnerships with mobile carriers are crucial for the growth of the subscription market and digital music in general.
“They’re extremely important. They’ve been a critical factor in the scale that we’ve seen in some of the European markets,” says Stephen Bryan, executive VP of digital strategy and business development at Warner Music Group (WMG). “The lack of a major carrier partner in the U.S. is one of the reasons why we may not have reached the scale we think is possible.”
Few other tactics can match the mobile partnership’s ability to quickly add subscribers. In a country with 314 million citizens — not all of them old enough to use a mobile phone — there are 238.8 million mobile phone subscribers and 143.3 million smartphone owners, according to comScore. In comparison, there were 20 million subscribers to digital services worldwide at the end of 2012, according to IFPI. In a best-case scenario, that number might approach 30 million by the end of this year. But in the grand scheme of things, 30 million is a pittance.
Any one U.S. carrier’s subscription base far exceeds the number of customers in the global music-subscription market. Market leader Verizon Wireless finished the second quarter with 118 million subscribers, which includes pre- and postpaid mobile subscriptions and additional connected devices like tablets. Second-place AT&T Mobility has 108 million. The size of these companies shows the value of their marketing campaigns to the resource-poor subscription services with which they partner.
If mobile partnerships have so much potential for the music business, why has the United States seen so few of them? It’s not for lack of trying, executives tell Billboard. “We’re in constant conversations with the carriers and working on models that will work for them from a business perspective,” a music subscription executive says. “They definitely like the idea. It’s a matter of coming up with the right messaging that fits with what they’re doing and their other marketing strategies.”
A successful pitch to a mobile carrier includes at least one of three levers: the subscription service’s ability to drive new subscribers, help increase average revenue per user and help retain subscribers.
The pitches have worked elsewhere. During the last few years, Spotify, Rhapsody, Deezer, WiMP and others have established partnerships with mobile carriers or broadband providers throughout Europe. Rdio has partnered with mobile carrier Oi in Brazil to provide carrier billing for subscribers.
But a number of factors, namely the nature of the market, have prevented pitches from succeeding stateside.
The shape of mobile markets is a function of competition, which itself is influenced by attitudes of various countries’ regulators toward market concentration. The United States is dominated by two carriers, Verizon and AT&T. The third and fourth carriers are substantially smaller. Sprint, the third-largest, and T-Mobile, the fourth, have 53 million and 43 million subscribers, respectively, or less than half of second-place AT&T. Other carriers are even smaller. TracFone, the leader in prepaid services, has more than 12 million. Not all subscribers use smartphones that can run subscription services, but smartphone adoption continues to rise, to 143 million in July from 114 million a year earlier, according to comScore.
Two other prepaid carriers, MetroPCS and Cricket Wireless, have 9 million and 4.8 million subscribers, respectively. But MetroPCS, now owned by T-Mobile, and Cricket Wireless, which AT&T plans to purchase, stand out in the U.S. market for their use of music to help lure and retain customers.
MetroPCS’ partnership with Rhapsody allows its customers to add the service for just $5 a month (half the regular price for Rhapsody’s mobile offering). Cricket developed its own subscription service, Muve Music, that’s bundled — free of additional charge — with some of its unlimited voice, text and data plans. Since launching in January 2011, Muve has grown to nearly 1.7 million subscribers, the most of any subscription service in the States.
A large U.S. carrier like Verizon or AT&T has less impetus to partner with music services. Both companies have dominant market positions and satisfied customers who don’t often leave. Music executives acknowledge the difficulty in pitching to companies that are surviving just fine without music partnerships.
In the last four quarters, Verizon Wireless, the company’s mobile division, had earnings before interest, taxes, depreciation and amortization (EBITDA) of $31.8 billion on revenue of $65.1 billion. Since second-quarter 2012, revenue and accounts grew in the mid-single digits while EBITDA rose 10%. Churn, the percentage of customers who left in the second quarter, was less than 1%.
European markets are characterized by greater competition between similarly sized companies. As a result, any one mobile carrier is more willing to offer value-added products like music or video streaming services (sports offerings are quite common) than a U.S. carrier.
The predominant type of subscription plan in both regions is also a factor. “The vast majority of wireless customers in the United States are postpaid, meaning they get a subsidy for their phone, get a two-year contract and they pay an agreed-upon amount every month,” BTIG Research wireless analyst Walter Piecyk says. “The rest of the world, whether it’s Brazil or Europe, particularly in emerging markets, is prepaid.” Those prepaid services help differentiate themselves using such offerings as music services.
Data is another issue. The U.S. postpaid-based market is characterized by expensive, all-you-can-eat plans that allow subscribers to maximize the use of their data-hungry smartphones. “Operators just care about getting paid for data usage,” Piecyk says.
U.S. carriers make money on plans for such smartphones. Carriers initially offered all-you-can-eat mobile Web access for a fixed monthly fee. Once network congestion became a problem, carriers switched to tiered data plans with penalties for overages. Data-addicted Americans pay an average of $93 a month for smartphone plans, according to Nielsen. U.K. consumers pay just 25 Euros ($40).
The nature of Europe’s digital music markets has been a factor. “You don’t have Pandora overseas,” a digital executive says. The lack of compelling free alternatives in Europe makes it easier for a subscription service to convince a mobile carrier that it can help drive value. Pandora, which operates mainly in the United States but also in Australia and New Zealand, has more than 72 million monthly users. A U.S. carrier can simply let its customers use Pandora and profit from their mobile data usage.
There has also been a timing difference. Subscription services became established quickly in some European markets. But such services weren’t successful during the era of Rhapsody and Napster in the 2000s and still don’t have great name recognition. Europe was earlier to the new subscription era. For example, Spotify launched in late 2008 in some European countries and quickly experienced strong consumer adoption.
That early European success helped pitches, WMG’s Bryan says. “So when the service went into negotiations with the carriers, they were able to present a strong proposition that a bundle was going to resonate with carrier subscribers because they had significant traction in the country.”
Establishing these partnerships isn’t easy. There’s a push-and-pull between mobile carriers and labels, and deals tend to fall apart over unit economics, a subscription executive says. Mobile carriers want to pay less, labels want them to pay more, and subscription services are in the middle, trying to get all parties to sign off on unique deals that are customized to the particular market and parties involved.
Plus, music has to compete with sports and other entertainment for carriers’ attention. Verizon has partnered with the NFL to allow its customers to stream select games through the NFL’s mobile app for $5 a month. ESPN has reportedly discussed with one major U.S. carrier subsidies that would allow mobile subscribers to consume the sports network’s content without the related data usage counting toward their monthly limits.
But it helps that today’s subscription services have vastly improved on their predecessors. Gartner analyst Mike McGuire notes that U.S. mobile carriers have had digital music services in the past. Verizon offered a Rhapsody-powered service called V Cast, Sprint offered a download store, and AT&T partnered with Napster. “The problem was they were expensive and inferior services,” McGuire says.
Getting the first music-mobile partnership is key. Executives believe a domino theory will come into play: Once the first carrier establishes a partnership, its competitors will follow suit. The first domino is expected to fall soon. Bryan says carriers now recognize that subscriptions are gaining a foothold in the marketplace. “There will be at least one partnership in the next 12 months,” he predicts.
While partnerships may be near, they may not be a total panacea. “It’s one path, certainly not the only path, to create something scalable,” a digital music executive says.
Consumers have already shown their ability to adopt a paid streaming service without the involvement of telecommunications companies. One need look no further than Netflix, whose North American on-demand streaming business had 28.6 million paying customers at the end of June.
The takeaway from Netflix is simple: A great product with a great price will attract customers. Subscription services can address both variables. The products have improved through the years but, judging from market demand, they don’t yet hit the mainstream consumer’s sweet spot. Although there have been exceptions, pricing has been almost completely unchanged through the years. A basic rule of economics will work for subscriptions just as it works for bread, milk and beer: A lower price will lead to more customers.
Free is an effective price. Executives point to the “freemium” model exemplified by Spotify, currently replicated in the United States by Rdio, as one method of driving growth. A service attracts a large number of listeners to its free, ad-supported service and then works to convert them to the paid service — although conversation has proved challenging. Although selling advertisements adds a new layer of complexity — Spotify has an in-house team, and Rdio will outsource to Cumulus Media — it appears to be worth the effort.
Spotify executives point to a conversion rate of nearly 25% based on publicly announced numbers for paid subscribers (6 million) and registered users (24 million). The wrinkle with that ratio: Spotify has many more millions of inactive registered users that, if included, would lower the ratio markedly.
The challenge for Spotify and others is using freemium to convert users to premium so users’ music and playlists can follow them wherever they go.
Even improved payment processing can help drive subscriptions. Muve, bundled for no additional charge with mobile plans, is the best example of reducing payment friction. Sony Music Unlimited is another example. Michael Aragon, Sony Network Entertainment VP/GM of global digital video and music services, says the service is heavily used on Sony’s PlayStation 4 and PlayStation Vita, two platforms where payment friction is a factor. “That’s why we wanted to make sure we had a cohesive payment strategy.”