Itunes: Revolutionizing the Music Industry
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July2010 iTunes: Revolutionizing the Music Industry "This will go down in history as a turning point for the music industry. " Steve Jobs, Apple's CEO, April 2003 "The iTunes Music Store is pushing us into thefuture ofhow music is produced and consumed. " Doug Morris, Universal Music Group's CEO, June 2003 Apple's New Adventure Steve Jobs, CEO of Apple IDe.,announced in June 2003 against the most optimistic forecasts and facing the skepticism of alI of those that didn't believe in the success of the newest Apple's online music store, iTunes, that it had sold online more than two milIion songs in its first weeks.! If any doubts still existed, AppIe reported total sales of five million songs by the end ofthe second month, assuming the chalIenge to be the number one online music store in the world. Apple was able to create the most promising legal digital music service in -the inarket, labeled as a revolutionary concept by industry analysts. "Everyone in our industry is looking for a soIution, and Apple is leading the way with iTunes Music Store" said Roger Ames, CEO ofWamer Music Group2. Even more enthusiastic, Steve Jobs was sure that iTunes would change not only how music was sold and distributed but also the way artists reIeased and marketed songs and how they were bought and used by fans.3 With over 12 million songs in its catalog and around 25% ofthe online music distribution, iTunes assumed to be a winner. Is iTunes the solution to the digital music industry? Industry Configuration The music industry has historicalIy been divided into three major domains: production, marketing and distribution. Music artists create music, which is marketed and distributed by a network of record labels, distributors, retailers, broadcasters and DJs/Clubs. The system is relatively simple: Record companies (known as record labels) discover artists through their A&R (Artist and Repertoire) divisions, artists sign contracts with record companies granting companies exclusive rights to their music, and This case was prepared by Vicente Gomes da Silva under the supervision of Professor Ilídio Barreto. Cases are not intended to serve as endorsements, sources ofprimary data, or illustrations of e.ffective or ineffective management. iTunes the record company does the work of promotion and distribution of the music, offering to artists a share of the profits once the costs associated with producing the music are covered.4 The music business involves many intermediaries between the artists and their audience. The cost added by each intermediary leads to a greater cost to the end- consumer, and some record companies are setting mechanisms to fight against this situation. The so-called big four (Universal, EMI, Warner and SONY/BMG) have been selling albums containing almost just solos, while some other smaller record companies were trying to cut the "middleman" in order to reduce costs ofpromotion and distribution.5 Record labels have always been a dominating force in the market, specially the big companies, which have the advantage of scale. In addition to marketing clout, they own a large back catalogue ofmusic, built by binding individual artists to long-term contracts, which can be repeatedly reissued. They are also bolstered by music- publishing businesses, which collect royalties on already published songs used in recorded music, live performance, films and advertisements. In sum, artists either were "lucky/resourceful enough" for a big record company to spot and sign with them, or they had to be content with operating in niche markets.6 The way music was sold by record companies had generated some controversy among music lovers. The artists were forced to try to produce an attractive album, which, at the sarne time had to be commercially viable but mainly composed by "fillers" (songs that seem that are there just to fill out the CD) and two or three potential hits. 7 _The. customers, even when they were aware of this strategy practiced by the record companies, had no choice if they wanted to listen to their favorite artists. "People are 8 sick and tired ofthat," says singer song-writer Seal . However, some problems related to music selling seemed to be getting to an end. Music retailing changed with the appearance of e-commerce and, companies like Amazon.com and CDNow, begun to sell CDs over the internet, solving some convenience and logistic issues of customers but still, the core ofthe problem (customers being charged excessively for CDs) remained unanswered.9 The emergence of digital music distribution, which corresponds to the downloading of music in digital format from the Internet to a personal computer, appeared as a response to that situation. Using Internet audio technologies such as MP3, Real Audio and Microsofs Windows Media Player, music could be converted into software (digital files) and transferred over the net.lo The digital distribution ofmusic grew out ofthe unauthorized file-sharing phenomenon of the late 1990s and emerged as an efficient method for sharing digitally stored information such as music files. I I Thanks to the technological advances, many creative 2 iTunes industries like music, film and entertainment had to restructure the whole distribution modeI, in which the consumer has assumed a preponderant role. IndividuaIs begun to have the ability to shop, store, manage, and play music files, as well as copy, share, redistribute, and even modify them.12 This emergence of a new marketplace for music distribution represented an attractive business opportunity for many legal download servicesbut also to the proliferation of illegal file-sharing softwares. The MP3 technology was adopted in large scale by music lovers due to the simplicity by which transferring music could be done and led to the emergence,in the beginning of 2000, of portable music players that played MP3 downloaded songs. Digital Music Distribution Models Previous to Apple's iTunes, two distinct ways were available for online music distribution. Free to share services, like Napster or Morpheus, that ran on peer to peer (P2P) technology which allows transferring music or other type of files from one system to another and, subscription-based services, like Pressplay, RealOne's Rhapsody or MusicNet, which implied a subscription fee to registered users plus a charge for each song downloaded. The P2P services became very popular due to the ease of use and the number of songs available but the most relevant reason for their success was definitely because they were entirely free. However, these services opened the doors to "music piracy" since they violated music copyrights and the intellectual property rights of music conipaníes by making available at no cost, songs for download that were "property" of record labels.13 The use of P2P technology was extremely critidzed by artists and record companies because users of these services were downloading music without payrnent or express permission ofthe rights" owners. Commenting on this, Dennis Mudd, CEO of MusicMatch said "P2P is a great technology for getting around copyrights".14 The Recording Industry Association of America (RIAA) was the face ofthis insurrection when it started suing for copyright infringement this type of services. ln 2001, Napster was considered the first victim ofRIAA and had to shut down after courts ruled.15 However, other similar services like Kazaa, Grokster and Morpheus kept coming up and, according to a market survey conducted by RIAA, an estimated 2.6 billion copyrighted files were traded over P2P networks every month.16 The subscription-based services appeared in an effort to fight the file swapping services and begun to work with record companies with a revenue sharing agreements in order to provide a wide selection of songs. Indeed, sorne major record labels launched their own 3 iTunes subscription services but instead of trying to cooperate to attract customers, they started to compete for the dominance of the digital market. 17 The subscription fee varied according to the services offered. PressPlay for instance, a joint venture rolled out by Universal and Sony/BMG, charged a monthly fee of $9.95 for providing unlimited steaming/downloading of songs. However, songs could just be copied to a CD (10 songs per month) by paying a higher monthly fee of$17.95.18 Rhapsody charged a monthly fee of$9.95 with an additional 75 cents per song to bum a CD. Despite the existence of a broad set of subscription services, the selection of songs did not include the majority ofbig label artists but mostly music from independent artists and, some of these services did not allow downloading songs ônto portable players.19 Motivated by the many restrictions of subscription services, music buyers continued unsatisfied with the way music was being distributed by these services. Record companies unsuccessfully attempted to provide a "pay per song" services but the high prices jeopardized this adventure. Meanwhile, a federal court decided in favor of P2P networks like Morpheus and Grokster stating that these services were legal technological tools that could not assume the guilt for the action oftheir users20.This situation led to severallegal actions against individual persons involved in illegal downloading and, some industry experts felt that these actions could avoid the proliferation of file swappers.21 Still, according to Ipsos- Insight, a market reseárch firm, every month, 21.266: 128 people in the U.S. used peer-to peer music services. Another research firnl, Big Champagne, estimated that every month was possible to find 3.4 unique MP3 music files through Kazaa and Grokster.22 However, convicted that the illegal services provided a bad quality service and that users only used these type of services due to the lack of a legal altemative, Jobs saw the opportunity to develop a new, legal and attractive music store.