iTunes Case Study | Audio Transcript

This is Professor Michael Rappa from North Carolina State University in Raleigh, North Carolina. And I’m here to speak with you about my course, Managing the Digital Enterprise.

The iTunes Music Store, Apple Computer’s website for legal music downloads has been largely responsible for the digital transformation of the music industry. Today iTunes counts for some 70% of the legal music downloads, and really came on to the scene at a time when the music industry was at its wit’s end in dealing with illegal music downloads through peer-to-peer systems like the earlier version of Napster, and some of its descendants.

There’s really so much to say about what Apple is doing, both with respect to iTunes itself and of course the iPod, the digital music listening device, which is tightly integrated in with its music downloading service. Let me start by saying a few things. First off, that iTunes is now one of several various music downloading services that are competing in the marketplace, and are pursuing variations in business models.

So whether it’s a pay-per-song model like iTunes, or a monthly subscription service like Rhapsody, or several others, or some combination of downloads and subscription-based music streaming, we’re really seeing a lot of creativity, in terms of the experimentation, with regard to what approach is going to be the most sustainable. And so certainly iTunes is the organization to watch nowadays.

But we are seeing a variety of experiments going on in trying to provide a sustainable, legal music digital service. And I suppose we’ll continue to see a great deal more creativity in the future, especially from Apple itself. And if you look at the iTunes Music Store today, you can easily download the application, install it on a Windows or Macintosh based computer, and begin to explore it yourself. And I highly recommend that.

But if you look around, one of the most notable conclusions you walk away with is this is really a work in progress, in terms of the blistering pace at which they are evolving iTunes to adjust to customer preferences, to try out new things, and just to push and propel the music industry into the future. And it is an industry which was badly in need of some impetus. It really was somewhat befuddled, in terms of what to do when it came to the emergence of the commercial internet, and also just the comprehensive digitalization of the music business. So Apple’s iTunes is really the site to watch.

And I’d like to kind of highlight a few of the interesting trends that are emerging that we see today on iTunes, in this discussion.

So one point, right from the start, to recognize is obviously Apple Computer really came to the music industry through the hardware side of things. They were very inventive, in terms of taking an enormous amount of experience and user interface design to come up with just a tremendously appealing digital music listening device, the iPod.

And then, I think, in a stroke of brilliance, they recognized an opportunity to greatly expand the popularity of the iPod with a kind of comprehensive strategy of providing music downloads through a very user friendly interface called the iTunes Music Store, which is more or less coupled, in terms of music format, with the iPod itself. And so the demand for iPod had taken off. And one way to insure its continued success would be by feeding it with content, and primarily music.

But as you go around the iTunes Music Store, what you quickly discover is that Apple is moving ahead speedily, trying to drive other kinds of content, whether it’s audio books, music videos, movie trailers, and other kinds of things. We’re going to see more and more of this strategy of pushing sales of the iPod, which is really the profit center for Apple as a hardware/software company, with content obviously pulled from other providers, whether it’s music distributors, Sony and so forth, as well as other kinds of digital content publishers. So there’s a comprehensive strategy there, which again is a beautiful illustration of a carefully constructed business model that ultimately was the key to a kind of profitable success for business.

Obviously there are many components. There’s the brilliant software and beautiful hardware, all tied up together with the content. But it was the business model which, I think, provides the glue that holds all this together, and makes it profitable for Apple to maintain sustainable business. So as we look deep into iTunes, one of the things that we see right away is just a kind of creative ferment, in terms of the ever expanding amount of content, not just along the trajectory of more and more songs. Yes that’s true. But through a kind of variety of other kinds of content, and through some of the kinds of tools that we’ve seen before, in terms of things that help customers both find what they’re looking for, find things they’re not looking for, and to kind of pull together a wider opportunity, in terms of helping the music consumer find and purchase music.

Another key element in this overall strategy was to strike an agreement with music distributors, the major music distributors, as well as hundreds of independent music publishers, to more or less tag song purchases to a kind of anchor 99¢ per download, getting it under that psychological $1.00 point that just, I think, is locked in people’s minds as a kind of fee anchor point, in terms of people’s spur decisions to purchase and enjoy music. It’s just really two facets: one, bringing it down to such a low price by being able to download individual songs, in a sense now unbundling the notion of an album or CD as an entire work that one would have to pay $12.00, or $14.00, or $15.00 or more, and two, having a motivation maybe to buy a single song, or one or two songs by an artist.

But in a sense, the price threshold was thrown up much higher, because the music was bundled together with 10 or 12 other songs. So it’s this 99¢ price point for individual songs that really opens the door to a different kind of approach to consuming music, and what we’ve seen for much of the past 25 to 30 years – you know, when we went from single vinyl 45s to the kind of large long-playing or LP format album in the 1960s.

So that unbundling of songs, in a sense, from being tied together on an album. Sure, you can purchase the album if you want. And sure, you can produce an album if you’re an artist. But now you’ve been freed up on both sides, both for the consumer to purchase individual songs, and perhaps even more importantly, for artists to sell singles again, to sell individual songs that might have some appeal.

Now when you’re able to buy songs individually and download them, the first thing that becomes readily apparent is that you can obviously select the songs that are of most interest to you, and then mix songs together, this idea of creating play lists that pull together either your favorite songs, or a genre of songs, or some creative mixture of songs that provide an opportunity for the music listener to really become creative themselves, in terms of how they listen to music.

Now not everyone is musically intoned, and may not have the best skills when it comes to creating play lists. But what you quickly find out as you navigate around iTunes, is that this play list phenomena is one which Apple is really readily feeding to the consumer by providing them with examples of play lists, celebrity play lists, and also allowing consumers themselves – other iTunes customers – to publish their play lists as so-called iMixes, and in a sense share their creativity, in terms of how they mix music together. And so that’s kind of another layer on top of what’s happening, in terms of how people listen to music, that I think we need to pay attention to and understand.

You know it’s not that different, or one could say it’s somewhat akin to the recommender type business processes that we’ve seen before when we looked at Amazon.com, or when we look at Netflix, where we see how customers are able to provide recommendations to other customers, or how we use data about customers, in order to generate recommendations for other customers. This is another kind of facet of that approach, where we’re really tying together now the power of our customer base as a community, and pulling out information, either passively or proactively, that helps other consumers search, and find, and enjoy the product, in this case music, or whatever it may be.

There’s a lot we can talk about, in terms of how iTunes is shaping the way people consume and listen to music. But I think I’ll leave much of that to yourself, in terms of your own explorations as you move around iTunes. I think it’s a great learning by doing exercise simply to explore, and learn, and see firsthand. And then as I’ve said, this is just an enormous creative moment in history, in terms of what’s happening with digital music, that it’s really changing almost week by week by week. So one really has to tap in and look at it for or herself or himself.

But let me turn your attention to another side of iTunes, which is really to kind of ask: what impact is it having on the upstream part of the business, back into music creation, music publishing, and music distribution as we’ve traditionally known it. Some of the things that we see Apple doing now are really quite interesting. If you think about it for a second, Apple now has become positioned in that value chain that we’ve talked about in the past, between the upstream artists and producers, and the downstream consumers. iTunes is positioned now as kind of major distributor of music.

And the music distribution industry as we’ve traditionally known it really has to contend with the fact that iTunes has become a very critical part of the sort of value chain between themselves and their customers. I imagine it’s a bit of a love/hate relationship right now. And the music industry, I think, probably has been really spun around the last ten years, between illegal downloads and peer-to-peer file sharing, and now something like what Apple is doing, where they’re really not sure what role they’re playing in this process, and certainly concerned about how they’re going to capture value into the future.

The interesting question is, really, where is this all heading? And I think one indication of exactly where it’s heading is by taking a close look at what Apple is doing and saying with the people who create and produce music. So if you look at some of Apple’s marketing efforts, what you see is, for example, the layering of an affiliate business model, whereby they’re allowing people to link directly to iTunes songs, so that people who purchase and download the songs will receive a kind of affiliate fee in return. We’re also seeing a kind of tying in with some Google ad words.

So iTunes is doing some very interesting things, by allowing music producers to advertise their works via Google, and tie it back into the iTunes store. We’re seeing the use of RSS feeds, which of course have become extremely popular in the last year or two. And we also see – and I think this is the most let’s just say interesting and maybe also eye opening facet of what Apple’s doing – and that really has to do with its ability now to go further upstream in this value chain, by really trying to move around the major music distributors, and going right to the artists and producers. And so if you look closely at iTunes, you’ll see that now they’ve come up with a kind of opportunity to become an iTunes producer, and they’ll provide you with the software application that you need to prepare music for submission to iTunes.

Step back and think about that now. Presently, for the most part, Apple has to license music from the current copyright holders of that music, which are the large music labels, or music distributors. And for every song that gets downloaded, about two thirds of the download price – about 60¢ of that or more – actually goes back to the distributor that is the copyright owner of that music. And Apple takes a fairly small share, especially after considering the cost of running the iTunes Store, and the digital downloads, and the marketing effort, and so forth. Yes, part of the strategy is to profit from the iPod. But to the extent that Apple can move upstream, around the entrenched music distributors, and go direct to artists and producers, it can strike a much better deal that is not only more beneficial to Apple, but also more beneficial, perhaps, to those music producers, and the artists themselves.

And so I think all sorts of alarm bells have to be going off among the major music labels. They must see that in the not too distant future, as the ability to produce master music continues to get less and less of a costly proposition, that artists and their producers are going to be able to, in a sense, produce iTunes ready music. And that music is going to go direct, in a sense, from the artist and producer, right into the iTunes distribution channel, and just go right around the traditional distribution channel, not caring about being distributed on CDs in stores, in typical retail storefronts. But instead, just going right from the mastering process right into the distribution channel, whether it’s one song, or several songs, or whether the music is tied with video, or what have you.

This is just a kind of groundbreaking situation, where we see the potential for an industry to just be turned upside down. And it’s not too farfetched to envision in not more than five to ten years, Apple becoming one of the single largest music distributors on the planet, simply because of what it’s been able to do.

It’s true that the current music distributors own a tremendous amount of content. Much of the recorded music that’s been produced in the last century is owned by those relatively few labels. And that content is still going to have a market. And it’s still going to be sought after by customers, and they’re still going to make money. The point I’m trying to make here is that artists today, the people who are creating music today, have a chance not only to capture more of that value for themselves by avoiding and not even bothering with physical distribution, and working directly with iTunes as music distributor. I think that the relationship between iTunes and those music producers is just going to be much more attractive to both parties, and eliminating the proverbial middleman in this process by going directly digital, both from a content point of view and a distributional point of view as well.

We also see Apple recognizing, I think, in part of this vision they have moving into the future, moving into providing assistance to music producers who publicize the availability of their music via iTunes. And so Apple, I think, has a very clear lock on this. They really do understand that there is a great opportunity for them to engage directly with music, with the artists themselves, and with their producers, to draw them directly into the iTunes distribution channel, to work with them to publicize their music. And I think we see all of the elements falling into place for Apple to become the world’s largest music distributor, barring any serious competition to emerge in the next few years.

So what we see emerging is an industry that is enduring enormous change in a relatively short period of time, an entrenched distribution channel, which is trying to cope with the readily available illegal downloading issue, and dealing with that in a very aggressive and what some people might call hostile way, in terms of its legal prosecution of peer-to-peer networks. And on the other hand, now recognizing that people such as Apple are moving at a furious pace, and creating a digital distribution channel that doesn’t really involve them in a very deep way. And in what may be, relatively speaking, a short time, traditional music distribution may find itself in a very difficult strait.

One part of the looming competition in this is one can’t count out the established distributors. They have enormous financial clout. They control the copyrights on so much music. And they have, still, leverage in this competitive game. But I think what’s going to be interesting is how the iTunes model plays out, relative to subscription based services, and especially relative to kind of competing formats when it comes to how music is digitally mastered, and the relative ease in which those music files can play on different digital music players.

As I mentioned, Apple is doing things that couple the music format with the iPod in ways that add switching costs to the consumer, in terms of moving music between different kinds of digital players. So it’s going to be interesting to see, as we get further down the road on this, to what extent new digital music players emerge that become a legitimate challenger to the iPod’s dominance, whether or not consumers start to rethink this issue of music file formats, and whether that has an influence, in terms of where they purchase music, what file formats they’re using, what digital players they’re using. But for now, I think iPod’s got this situation sewn up pretty well, and I think has some momentum to bring it forward still a couple more years into the future without any serious erosion of their position.

Some of the other aspects of iTunes that are notable and important to its evolving success have been now the advent of podcasting. Currently Apple is doing all it can to facilitate the distribution of homegrown podcasts over the internet, by providing opportunities for people to share podcasts via the iTunes Music Store. I think there are also some very important things that iTunes has done, in terms of how it has approached the overall terms of use, in terms of what the consumer can do with music. And I think it made a major breakthrough, in terms of saying – “Look. We can sell you songs for 99¢ apiece. You can mix those songs together in any kind of variation that you wish. And then you can burn those play lists to CDs in a fairly unrestricted manner.” You have to look very closely at the terms of use, and kind of understand how that’s working. But up until the point that iTunes came along, I think Apple really kind of broke through, and negotiated some relatively less restrictive terms for people to do legal things with the music they purchase.

I think there’s also some interesting things going around, in terms of pushing the envelope in people’s ability to share music, in localize wireless or localized area networks, to be able to share their music listening with each other. And just doing whatever they can to provide an attractive legal alternative to especially the younger demographic, to listen to music in a way that is not in violation of the copyright owner’s rights.

And so where we see Apple heading with iTunes, I think it will continue to be a defender of what consumers want to do with music, and using now their growing leverage to push established music distributors forward in loosening up some of the more restrictive elements that they might otherwise want or think are necessary to remain profitable.

Now the last point I’d like to make – and I think again, one needs to go into the iTunes Music Store and look very closely at what’s going on there nowadays, because it’s evolving rapidly. But if you look at some of the things that are happening, you’ll see where Apple is trying to generate a higher profit from the revenue off of its downloads. For example, we’re seeing some effort at bundling, whereby album downloads are being encouraged by adding incentives, such as digital booklets, music videos that come along with the entire album purchase. And so it’s things like this that I think we can expect to say, whereby whatever Apple can do to differentiate the product and provide a higher degree of margin on the things that it’s doing – and also just providing interesting opportunities for artists – we’re going to see that happen,

My last point on Apple and iTunes is a very simple one. And that is that what’s really interesting is that Apple really now knows more about the music consumer’s listening and buying habits than just about anyone on the planet. Their ability to capture the data stream of its users, via the iTunes Music Store, has got to be just a very, very helpful component of understanding where the music entertainment industry is going.

This is Professor Michael Rappa wishing you all the best with your studies.

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Unedited transcript of audio podcast produced on October 6, 2005.

Audio source file: http://digitalenterprise.org/podcasts/itunes.mp3

Michael Rappa is the Alan T. Dickson Distinguished University Professor of Technology Management at North Carolina State University.

For more information, please visit: digitalenterprise.org