Global Economics

Digital Music: In Search of Biz Model


As the Big Four record labels embrace digital downloads they must become more user-friendly and market to the Asia mobile crowd

Once the scourge of the music industry, digital downloads are now officially "the way forward" for the "Big Four" record labels - EMI, SonyBMG, Universal and Warner Music, which together control over 70% of the world's recorded music - now that they have numbers to justify it, anyway.

Two years ago, music labels were making virtually nothing from digital music. By the end of 2005, digital music generated $1.1 billion in revenues in 2005 - almost triple from 2004 - which accounted for 6% of revenues earned that year, according to the International Federation of Phonogram and Videogram Producers' (IFPI) 2006 Digital Music Report.

What's more interesting is that the music industry is well aware that digital music is increasingly becoming a mobile phone play, not least because ringtones - which count as digital music - accounted for 40% of digital music dollars last year. And it's only going to get bigger.

Certainly this isn't news to the mobile industry. The iPod has shown the value of porting digital music to media players, and handset makers have long since set their sights on making phones the default media player of choice for users (see "One of these is the future of digital music", p. 16).

Meanwhile, 2006 has seen a rash of new music services launched by cellcos worldwide. In Asia alone, all cellcos in China, Korea and Japan have music download services, as do most cellcos in Hong Kong, and in markets from Indonesia to Australia. SK Telecom went as far as launching a groundbreaking joint venture with Warner Music last month for a South Korean mobile download service. Others have partnered with third-party music services like Soundbuzz, which has cellco partners in Australia, Singapore, India and Hong Kong.

That's the good news.

The catch is that while demand for digital music is skyrocketing, the business case is still rickety for mobile operators, as well as other service providers that want to offer music download services. Few doubt that there's money to be made from mobile music services. What's less certain is how big everyone's slice of the pie will be, and how the music labels can balance consumer demand with copyright controls that may not always work in the consumers' interests.

BLOOD ON THE FULL-TRACKS

The monetization issue is tricky not least because at the end of the day music is just one content purchase option among many, says Marcel Fenez, Asia-Pacific leader of Entertainment & Media Practices at PriceWaterhouseCoopers.

"Music is competing for consumer entertainment dollars from other sectors, and they are all growing much faster," he says.

For example, video games will grow 13% CAGR in the next few years, driven by online and wireless sales, while pay TV content revenues will grow 10%. Sports revenues will grow 8%, and film 6%.

"In terms of content growth, you're in a competitive world, and it's all being delivered the same way - via broadband and mobile," Fenez says, though he does point out that mobile music will be a $1 billion business in Asia by 2010.

However, one chief issue for mobile music services is that mobile music is driven largely by ringtones, not full track downloads. This isn't necessarily a bad thing in the sense that ringtones, ringback tones, music video clips and even music karaoke have been successful to varying degrees.

On the other hand, the full-track model is the one most players across the value chain are chasing.

This has been the case in Korea, Asia's hottest digital music market, according to Philip Kim, managing director of investment and advisory firm IRG Ltd.

"Korean users aren't paying for full song tracks. People spend money on devices, games, avatars, but not music," Kim says, although he does add that music clips do bring in revenues.

Koreans aren't the only ones not paying for full tracks. A March survey from research company Synovate covering key North Asian markets found that while two-thirds of users under 25 had downloaded music, only 27% paid for it. Across all demographics, that figure was 17%. In China, only 15% said they'd paid for digital music.

On the bright side, the same Synovate survey reports that 42% of respondents intend to buy digital music in the next year.

LICENSING: IT AIN'T EASY

However, for cellcos hoping to offer full-track music services the biggest challenge may not be getting to users to pay so much as acquiring the rights to the content in the first place.

The music licensing regime is almost horrifically complex. Start with the basic premise that every song has at least two copyrights (one for the music and lyrics, and one for the actual sound recording), and the fact that these rights can be held by multiple licensing societies, as well the producers and musicians. Operators that want to license music from, say, Warner/Chappell (the music publishing arm of Warner Music Group) have to obtain separate licenses from at least 25 different collection societies just for the European market.

Ian Chapman-Banks, VP of Motorola Asia Pacific, as well as its North Asia GM of marketing and business development for mobile devices, can testify to the difficulty of acquiring song licenses. Motorola had to get clearances for all of the 10,000 tracks it offers on its MotoMusic.com music download Web site, which launched in China last year.

"It took us a year to get those 10,000 songs licensed," he says.

Chapman-Banks admits that one reason for this was Motorola's inexperience with the music licensing game. "This was a new business for us, so the learning curve was quite steep.

Adding further to the complexity is that the various elements in the music value chain - from labels and publishing groups to operators and even the artists themselves - are still fiercely debating the terms and percentages involved in the digital music business model.

Lachie Rutherford, president of Warner Music Asia-Pacific (and chairman of IFPI Asia Pacific), admits that the current licensing regime is "very complicated and not user-friendly. I don't know how to deal with it, but clearly we'd better think of something."

Luckily, there are initiatives underway to try and simplify the licensing process. Warner/Chappell Music has launched its Pan-European Digital Licensing (PEDL) initiative, under which it hopes to create a one-stop shop licensing service by authorizing a handful of designated collection societies to grant pan-European digital licenses.

Meanwhile, the newly formed Digital Data Exchange (DDEX) - a US-based organization founded by 11 charter members, including the Big Four, Apple, Microsoft, RealNetworks and ASCAP - plans to create voluntary standards that tackle the problem of back-office incompatibility between cellcos, collecting societies, music publishers and record labels, which is "creating a log jam and increasing costs for the transition to digital distribution."

DREAM A LITTLE DRM

Even so, licensing isn't the only element that's user-unfriendly. The use of DRM and copy-control software remains a controversial point that pits a legitimate need to protect copyright against a smooth user experience. Many users have become increasingly frustrated with the revelation that music they download from iTunes and other music services is not easily transferable to other devices and are often incompatible with other players.

The mobile music scene is likely to be no different. For example, customers of MotoMusic.com can only play their tracks on the first Motorola handset they transfer them to. Also, the songs are encrypted and unlocked using downloaded keys that the users pay for via SMS. The trouble is that if the user changes handsets (or loses the handset), they must pay for another key to listen to the track again.

Nokia's music phones have similar properties, although Jawahar Kanjilal, director of multimedia experiences at Nokia Asia Pacific, says the user doesn't have to be penalized when they change handsets. "Features can be enabled so that if you lose or change your handset, customer service can identify which songs you have already paid for and reactivate them," he says.

However, the bottom line, says Tom Jacobs, director of research for the "Voodoo Sciences" section of Sun Microsystems, is that mobile consumers aren't happy with DRM in practice. And neither, ironically, are the music labels.

"Consumers have been resistant to licensing terms and technologies, and many will be happy with digital music until they buy a new music player and discover that they can't transfer any of the music they downloaded from iTunes onto it," Jacobs says.

Ironically, he says, the problem isn't label greed or paranoia over piracy but the lack of interoperability between proprietary DRM solutions. "The music labels are looking for something better than a proprietary system that locks music onto a particular device."

The even greater irony is that DRM for mobile has been standardized for some time under the Open Mobile Alliance, whose DRM 2.0 standard was finalized last year. However, adoption of OMA DRM 2.0 has been seriously hampered by - of all things - arguments over patent royalties. The MPEG Licensing Authority - one of the two chief patent pools in the standard - has been charging royalties of $1.00 per handset, which many cellcos have rejected as too high.

"That went over like a lead balloon for the GSM operators, which started evaluating proprietary solutions from other vendors that were able to offer lower prices, but then you're back to the problem of interoperability," Jacobs says.

Sun, characteristically, is proposing a federated, network-based approach to DRM as a solution, where DRM rights are tied to a network ID rather than a device. Since digital music players connect to the network either directly or by proxy via a PC, rights can be validated and renewed every so often just by logging on. Sun has also launched Open Media Commons, an open-source, royalty-free model that works independently of any particular piece of software or OS, and is submitting the technology to various standards bodies.

BEING BORING

Whatever the solution to DRM, it has to be something that consumers will accept. Thanks to the SonyBMG rootkit incident, some consumers may find any level of DRM unacceptable. However, Jacobs says that many consumers are already coming to terms with some (if not all) of the restrictions that come with digital music.

"If you look at the Apple model, you can only burn a song so many times and people got over it," he says. "I think that as long as it's done right and is as easy and unobtrusive as possible, end-users will accept it more."

User-friendliness applies to more than just DRM - it's also necessary to keep consumers from turning to the file sharing networks and sites offering unlicensed content that make DRM necessary in the first place, says Doug Kaplan, VP of Asia-Pacific at Real Networks.

Indeed, one key finding of the Synovate survey was that 86% of respondents said the music industry could do more to help them get more digital music, such as better searchability,

Consequently, value-add is another strategy being developed by various players in the mobile music value chain to attract users.

"One of the big questions now is, how does the handset become the album experience of 30 years ago?" says Chris White, senior director of global product marketing, music, mobile devices business at Motorola. "Things like rich content, artwork, info on the songs, lyric sheets - we can bring that to the mobile device. We'd like to work with the music labels to learn how to bundle that kind of content, because the download is going to be a complete experience, not just a 99 cent song."

PCCW, which launched its full-track music download service "Moov" last month, is going for a community-based approach to value-add, says Janice Lee, executive VP for TV marketing and content management at PCCW.

"One strategy we're pursuing is to add value to the content that pirates can't, such as personalized playlists and creating communities that allow customers to share songs and playlists with each other," she says.

PCCW is also looking at a converged strategy where its music content is synced with its mobile and fixed-line offerings. Cellcos like SK Telecom, KTF and KDDI have similar strategies in play.

Warner Music's Rutherford agrees that value-add is the way to go, and says that the music labels are now recognizing that the pure digital music format is changing their product line and creating new opportunities in the process.

"The Apple model is boring," he says. "With handsets here, you can get the album if you want it, but you can also get the videos, interviews with the artists and producers, or whatever. Calling this another distribution channel is to miss the opportunities here."

However, he maintains that it's everyone's responsibility to make digital music a success, not just the labels that control it.

TRASH

-- Tough competition from games, video and other media

-- Licensing music is a labyrinthine process

-- Costly DRM standards = proprietary device lock-ins

-- Most users paying for clips, not full tracks

ONE OF THESE IS THE FUTURE OF DIGITAL MUSIC

And it may not be the iPod - at least not until it gets wireless connectivity.

A report released last month by Yankee Group forecasts that the fate of MP3 players will depend on replacement cycles as markets saturate. By 2008, only 10% of MP3 player purchases in the US will be first-time purchases.

Moreover, the other 90% of sales will be driven by devices that feature voice telephony and Internet connectivity, the report says.

ABI Research has reached a similar conclusion, as mobile phones designed for playing music start hitting the market with greater memory capabilities than ever. Many new handsets support removable flash memory cards with capacities that match or exceed the lower-end MP3 players on the street today. The Nokia N91 comes with 4 GB of memory. Samsung's SGH-i310 has twice as much disk space.

"As the cellular handset becomes the one device that the world carries, the standalone MP3 player may well be left behind," says Alan Varghese, ABI Research's principal analyst of wireless semiconductor research.

Varghese adds that while high-end digital music players are packing as much as 60 GB of memory, there's "a point of diminishing returns beyond which a user doesn't care whether the device can store 2,000 songs or 7,500."

Such data echoes the message put forth by handset makers that have been enabling a range of music features in new cellphones, from Sony Ericsson's Walkman phones to Motorola's new ROKR E2, due for launch later this year. Nokia is also promoting music apps not only via handsets such as the N series of multimedia phones, but also service applications like AirAlbum and Visual Radio, which have been commercially launched in seven markets each.

Handset makers say the numbers are in their favor. Apple is expected to sell 80 million iPods this year, while the handset industry will sell well over 900 million mobile phones - over two-thirds of which will have music player functions.

"The iPod started the wave, but we will be shipping 80 million handsets with music players in them this year, and 150 million with FM radios," says Jawahar Kanjilal, director of multimedia experiences at Nokia Asia Pacific.


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