For Digital Music, Size Matters -- Music As The Trojan Horse (Or Not)

What a whirlwind it has been the past few months in the world of on demand music streaming -- and, importantly, the rise (and mainstreaming) of the music subscription model.  All of the “usual suspect” behemoths have thrown their over-sized hats into the ring.  First, Apple buys Beats (and Beats Music) for a cool $3 billion.  Next, Amazon launches Prime Music under a stealth subscription model (no separate fee for the service itself, so long as the user already subscribes to Amazon Prime).  And now, YouTube is expected to soon launch its own subscription service.

And, that ain’t great news for the much smaller, privately-held “pure play” on-demand music streaming services like Spotify, Rdio and Rhapsody (not to mention online radio services Pandora -- more on them later).  Yes, Spotify reports that it now has over 10 million subscribers world-wide (in other words, its reach is impressive), but that is a fraction of the reach of the behemoths mentioned above (and their eventual music subscription traction through their built-in captive audiences, sheer marketing mass and brute force of will and virtual unlimited resources).

One more critical thing -- the behemoths business model is fundamentally different than the business models of the stand-alone privately-held services.  For Apple/Beats, Amazon/Prime Music and YouTube, subscription music streaming is just a means to an end -- it serves to serve the company’s underlying core business model (which is fundamentally different for each of these three behemoths).  In other words, the music service itself is just the Trojan Horse -- the entry or retention point.  That means that music service itself need not be stand-alone profitable, so long as its overall impact is positive.  But, for the pure play services (Spotify, Rdio, Rhapsody), the music service IS the thing.  There is nothing else to monetize.

Let’s take Apple/Beats.  Apple is a hardware company pure and simple.  Apple needed an on demand music service (it saw its core music download business declining), so it looked in the marketplace and found a kindred spirit in Beats, which too is fundamentally a hardware company.  For Apple, Beats Music serves as yet another entry and retention point to drive greater hardware sales (iPhones, headphones).

Amazon’s business model is different.  Yes, Amazon too sells hardware (including the new Amazon Fire phone), but Amazon is not and will never fundamentally be a hardware company like Apple.  Amazon is all about ecommerce -- selling stuff -- pure and simple.  So, Amazon Prime Music -- and the hardware that supports it -- are new important entry and retention points into the world of shopping (and critically, mobile shopping).

And now YouTube Music.  You know what that is.  It certainly isn’t about maximizing the monetization of the new service itself (or apparently pleasing the indie labels with its deal terms).  It is ALL about YouTube and Google’s fundamental business model -- to sell ads.  Google already prints money.  Now its voracious appetite turns to music and yet another reason for all of us not to leave its printing press.

We all know that on demand music subscription service economics are tough -- on all players in the overall eco-system.  But, while Apple, Amazon and now YouTube can flick those issues off of their collective shoulders, Spotify, Rdio, and ever-silent Rhapsody cannot.  They MUST be stand-alone profitable -- or they are gone.

What does all of this ultimately mean for those pure-play services?

Yes, Spotify is on its way to an IPO to fill its coffers with new resources to compete.  Nonetheless, its fundamental business model will never change.  That means that ultimately it will be acquired.  White hot gorilla Samsung is a likely candidate (in fact, I have little doubt there is much kicking of the tires now).  Yes, Samsung just recently launched its own music service -- Milk Music -- in partnership with San Diego-based Slacker, but that is just online radio like Pandora.  And, let’s not forget that Apple had its own online radio service before it acquired Beats.  But, online radio wasn’t enough.  Same holds true for Samsung.  

As for Rdio, Rhapsody and others, they too either will be acquired (likely this year) or whither away -- nibbled at little by little by the big dogs.  Same holds true for other online radio services like Pandora, Songza, 8tracks and others.  They just can’t be alone.  They are social creatures that need to partner up. The M&A market will heat up again soon -- and don’t be surprised if the next major move is Google swallowing up Songza (which has been in the rumor mill for some time).