David Kellam

I usually whole-heartedly agree with John Gruber’s posts. This time, I think he’s got a little sloppy towards the end of his argument. Specifically:

People who are already buying from iTunes would continue to. People who refused to buy from iTunes because of DRM might start. And people who bootleg would continue to bootleg. This situation would be better for the music industry, not worse.

Gruber’s argument here doesn’t go far enough, and it makes a big difference to the likelihood of getting the Big 4 to agree to a DRM-free world. Talk profit. Specifically, the net increase in additional users purchasing songs and increased volumes of songs being purchased by existing iTunes (etc.) users as a direct input to the profit function.

“People who are already buying from iTunes would continue to (do so)”. False.
You need to talk in marginal numbers, comprising:

• loss of sales (customers and customer downloads) due to greater ease of piracy
• increased sales due to easier use of legally-downloaded music (as opposed to fear/hatred/dark side of DRM)

I would argue that the iTMS has been the most successful because it is the easiest to use. It’s still a nightmare. Anyone who has dealt with reformatting iPods, moving computers, etc. would attest to the ‘too hard’ nature of such processes for average consumers. Even if you don’t agree on that, there’s at least a significant marginal increase in utility as a result of no DRM. We already have some evidence for a relationship (probably non-linear) between utility and willingness to purchase legal music, on-line or off-line. For many consumers, buying a CD, ripping it and then adding it to their personal audio device of choice is of greater utility than buying something off the iTMS.

There also exists a general insensitivity to price, within a non-free non-inconsequential band. If only 10% (a guess) of people are buying legal music, chances are they’re a less price-sensitive bunch than the entire market. So the chances are they could afford and would willingly pay more. They won’t, due to market forces (price of CDs in comparison, competition in a high-margin industry), but knowing that they would is important. Knowing that your customers are primarily purchasing based on something other than price is the key to unlocking this whole mystery.

allofmp3.com has already shown people are willing to pay for (probably) illegal music (OK, they claim the site is legal in Russia, but I’m sure you could get stung on some kind of parallel importing/failure to pay customs rules, let alone the risk of going through such proceedings) because it’s easy to use. They’re banking on price sensitivity, but they’re really baiting people because of their ease of use, lack of restrictions –> increased utility.

So as thousands have already said, Apple does have an interest in expanding the size of the market, given they have very little room to grow in gobbling up more of the pie. We do also need to consider fixed costs vs marginal costs. Sure, Apple is paying a hefty percentage to the record labels for each song, but there are significant fixed costs as well (e.g. iTMS staff salaries, marketing expenses, R&D amortisation, etc.). Given iTMS is hardly making any money (which is fine for Apple due to its status as an economic complement of iPods), Apple could be looking at it from a MES (minimum efficient scale) operations perspective and looking to drive further profitability from the iTMS. After all, if you own a business, you might as well try for a profit maximising result, even if you don’t have to.

Apple thus far has focussed on two things: becoming the power broker in the online music industry, and establishing the economic link between music sales and availability and iPod sales. Both of these serve as barriers to entry and protection against competition. Apple established the 2nd point long ago, but is only now in a position of sufficient clout that it can dictate terms to the record companies. The music execs have started to realise online sales are the way of the future. Their costs are lower and their profit higher. Their only concern is a flawed assumption that piracy kills the business model. They’ll soon wake up to this too. When they do, Apple is looking to be in a position to accept the supplicant grovelling to their new masters. And it will be a happy day for consumers.

This entry was posted on Wednesday, February 14th, 2007 at 9:18 am and is filed under Technology. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.