The streaming music business is dead, long live the streaming music business

apple_lala Apple’s acquisition of Lala yesterday is the coda to an interesting chapter in the evolution of the music industry. It comes on the heels of MySpace’s acquisitions of iLike and iMeem (both at similarly distressed prices to the reported ~50% discount in the Lala deal) as well as the launch of (nearly) inline streaming music in Google’s search results. Talk about mixed messages: the business of on-demand streaming music (vs. streaming radio like Pandora) is broadly being conceded as a failure just as the user experience is finally hitting the mainstream.

In the last 24hrs, I’ve read a lot of analysis across the spectrum and heard the thoughts of friends in various segments of the music industry. Here are some of the big issues that are front of my mind.

Whither the MP3 of streaming music?

Most of the people I respect in online music have been opining for on-demand streaming music for years. So, their first reaction has echoed that of my friend Lucas: music in the cloud will now be a reality. But *how* it will become a reality matters too, and I think that’s been lost a bit in the discussion so far.

In the download world, an open format (MP3) pre-dated Apple’s entry. So, they had no choice but to support it in order to make their software and devices backwards compatible. In fact, it’s easy to forget today that the market for iTunes and the iPod was largely built around satisfying the needs of consumers of illegally acquired music (the iTunes Music Store was actually launched over 2 years after iTunes debuted). If not for that pre-existing market condition, I don’t think it’s hard to believe the iPod would only play AAC music files (Apple’s proprietary format). Remember that no one could compete with the iTunes Music Store as a legitimate storefront for online music until less than two years ago, when the labels agreed to let Amazon and others sell in MP3 format so that customers could play the songs sold by retailers other than Apple on iPods. (This in itself was an interesting saga with Jobs publicly justifying why Apple would never support someone else’s proprietary format on their software/devices and why they would never license Apple’s DRM to others. In the end, the labels’ fear of Apple’s growing control of the online music value chain was greater than their fear of piracy and they called Jobs’s bluff by actually licensing MP3 sales.)

The relevance here is that there is no MP3 equivalent for streaming music — no pre-existing open standard that consumers will require Apple to support before they buy a wifi-enabled iPod (aka iPod Touch). Just like there is no (legitimate) way to play films or tv shows not downloaded from the iTunes Store on your Apple TV, there will be no way to consume on-demand streaming music from other sources in the native player on your iPod. You will of course continue to be able to install separate third-party applications, like Pandora or Spotify, to manage and play streaming music you acquire through those services. But, that silo will continue to be incompatible with iTunes and the rest of your music library while the native player will offer you an integrated consumption experience across downloaded and streaming music. Maybe this will still be good enough for the small number of power-users who care enough to want an alternative to the Apple offering (like those of us today who install the eMusic or Amazon download manager to have a somewhat equivalent purchase alternative to the iTunes Music Store).

However the segment for whom I think the lack of an open streaming music standard is potentially most harmful is the actual artists and the growing industry of direct-to-fan enablers, including my good friends at Topspin. Direct-to-fan sales are better for the artist because they get to own the customer relationship with the people who are *their* fans to begin with (see my boy Ian explaining to Wired how important this is) and they can have more control of the offering and better margins by cutting out middle-men like Apple. Today, I can buy an album directly from Topspin artists like Get Busy Committee or Fitz & The Tantrums (two of my current faves) in MP3 format and play it in iTunes and on my iPod. How exactly are they going to sell me streaming music outside of iTunes (or a 3rd-party service)? There are products like MobileRoadie, which artists can use to create their own branded iPhone/iPod app. But, I don’t foresee consumers being willing to switch apps every time they want to hear a new artist (and forget about a streaming playlist with multiple artists).

Licenses, schmicenses!

Several commentators on the Lala deal have noted that their licenses with the labels expire in the case of an acquisition. And I hear from insiders that Apple has already had requests for streaming licenses denied by at least some labels. Here’s why neither of those things matter.

Apple is going to build a kick-ass streaming experience natively integrated into their service/software/device stack of the iTunes Music Store, iTunes, and the iPod. They are going to get the thousands of independent labels, aggregators like TuneCore who represent individual artists, and at least one or two major labels (my bet is EMI will be first) to give them streaming licenses on a critical mass of music. Then, they are going to use the iTunes Music Store to promote the shit out of both downloads and streaming (most likely bundled) from the artists for whom they have streaming licenses while at the same time freezing out promotions for any hold-outs.

This is a non-issue IMHO and every song you can buy as a download from the iTunes Music Store today will be available for streaming within a year of launch (just ask NBC how well playing chicken with Apple works).

Sustaining innovation doesn’t work.

This post is already way longer than I intended, so I’ll leave this point as more of a footnote. On-demand streaming music is the future. Everyone I respect believes it, Apple believes it, it is the logical conclusion of the path the music consumer experience has been on since Napster. And yet it is a business widely viewed as “toxic” by investors, several of whom in recent months have demonstrated they think so little of its future potential that they are willing to take steep losses on their investments to get out. What gives?

Not only were these businesses endorsed by the major labels, both iMeem and Lala actually had labels as investors (as does Spotify). The reason that on-demand streaming music is a great product but shitty business is because the license fees demanded by the labels make it impossible to make money with any kind of offering that consumers will think is reasonable. It’s somewhat counter-intuitive that a vendor who is an investor wouldn’t be willing to adjust their pricing in order to preserve the value of their investment. But Warner Records, in particular, made it clear that are happy to spend tens of millions of dollars co-opting companies they see as potential threats and running them out of business in order to prevent hundreds of millions of dollars in (perceived) cannibalization.

This is Clayton Christensen 101:

By only pursuing ‘sustaining innovations’ that perpetuate what has historically helped them succeed, companies unwittingly open the door to ‘disruptive innovations’.

In other words, by trying to take an innovation and use it only to perpetuate and/or protect legacy business models, incumbents give new entrants the opportunity to do things the way the market actually wants them to be done regardless of how they have been done in the past. By trying to force LaLa from being a potentially disruptive innovation into a sustaining innovation, Warner Music and the other major labels unintentionally drove them into the arms of Apple, still the biggest threat to the legacy model the labels are trying to preserve. (Studios and networks trying to “de-fang” Hulu, take note.)

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