Digital Audio Insider -- the economics of music and other digital content

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Digital Audio Insider is David Harrell's blog about the economics of music and other digital content. I write from the perspective of a musican who has self-released four albums with the indie rock band the Layaways.

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January 09, 2006

Why Music Subscriptions Are Like Health Clubs
by David Harrell
You've probably heard of the "health club business model." The idea is to sign up as many people as possible for a service that most are unlikely to fully use. A health club would be overrun if all of its members exercised regularly, but since most of us have better intentions than discipline for exercise, gym attendance drops dramatically as New Year's resolutions are broken. And if you never get around to canceling that membership, the result is a "free" income stream for the health club. Gym rats get their money's worth from their memberships, the rest of us are paying for something that we don't use.

Of course, if you think about it, this principle applies to pretty much any business that offers an unlimited commodity or service for a fixed price: Lose money on a few customers and make it back (and more) with the rest. An all-you-can-eat restaurant can tolerate a few gluttons because of most of the dining crowd isn't so ravenous. Similarly, a healthy majority subsidizes the seriously ill within a health insurance plan.

With online music subscriptions, there's no worry that subscribers will overrun a physical location (for the sake of argument let's assume that server capacity is unlimited) and "running out" of downloads obviously isn't an issue. But there is an unavoidable limiting factor -- the fees the service must pay record companies and distributors for each song downloaded or streamed. Here are the details for Rhapsody Unlimited and eMusic, based on the actual per-song payouts that I've seen:

Rhapsody Unlimited allows subscribers unlimited listening to all of the tracks in its catalog for $9.99 a month. From that subscription fee, record companies and distributors are paid one cent for every song streamed. While $9.99 would cover 999 songs a month (ignoring all other business expenses for Rhapsody), a subscriber can easily exceed that number. Assuming an average song length of 4 minutes, you can listen to 15 songs in an hour. It'd take a whopping 67 hours of listening time each month to hear 999 tracks, but that averages out to just over two hours and 15 minutes a day. Factoring in other costs (servers, salaries, marketing, etc.), any customer who regularly listens for an hour or two daily is probably a net loss for Rhapsody.

With eMusic, it's all downloads, not streams. There are three subscription plans, starting at $9.99 a month. Technically, eMusic has a revenue sharing model where a percentage of its subscription revenue paid back to the record companies and distributors. But the revenue share dollars are translated into a per-track royalty each month when paying the record companies. (I'm assuming the revenue sharing amount is simply divided by the total number of downloads for the month.) Due to reporting lag, I only have data for one month of our sales via eMusic. For May 2005, it was 24 cents a track.

Because "royalties" are a fixed percentage of revenue for eMusic, it doesn't really matter how many tracks subscribers download each month. But it is interesting to see that how the royalty-per-track paid for a specific month compares to the subscription prices:

eMusic royalty costs per subscriber, May 2005
Subscription Plan Downloads per Month Maximum payout to record companies
$9.99 40 $9.60
$14.99 65 $15.60
$19.99 90 $21.60

In this interview, CEO David Pakman says that eMusic subscribers are currently averaging 31 downloads a month. Using the 24-cent-per-track royalty rate from May, that would translate into a revenue sharing amount in excess of 70% of the base subscription price. Given other expenses -- including what appear to be massive customer acquisition costs as eMusic pays its web affiliates a $6 bounty for every new trial user they deliver -- it seems likely that eMusic's current profit margin is razor thin, at best.

I'm wondering if such numbers are the reason behind Apple/Steve Jobs's reluctance to offer a music subscription service. From what I've read, Apple doesn't make much (if any) money on the downloads sold at iTunes, though the service does help Apple sell gazillions of very profitable iPods. But given the devotion of iPod/iTunes customers, maybe Jobs figures they're all a bunch of gym rats that would stream tracks all day with an iTunes subscription service, putting a major dent in Apple's bottom line.

(Note: some changes were made to the eMusic section on 1/17/2006, after I confirmed that eMusic did in fact have a revenue sharing model. Which means that the health club comparison really doesn't hold for eMusic, though I'm still amazed about the percentage of its subscription revenues that eMusic pays to the record companies.)

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    Out Now -- "Maybe Next Year" -- The New Holiday Album:

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