Michael Bornhäuser, CEO of DRM provider SDC ag, and Barney Wragg, Senior Vice President of eLabs at Universal Music, talked to the press yesterday about the digital download industry.
The big picture is that Universal's revenue from recorded music is dropping, by around 5% last year, but that income from downloads is growing fast. Worldwide, pure digital sales now form around 3% of recorded music sales, while in the UK the figure is more like 6%. This is helping to compensate for falling revenue from physical media like CDs, which declined by 8% last year.
Why the decline? Mainly because too many people are getting their music for free. CDs are easy to copy without loss of quality, and digital media is freely exchanged over the Internet, especially in the youth/young adult market which is also the largest market. Therefore Wragg is fully committed to DRM as the main hope for controlling these lost sales.
The obvious question is whether the industry can ever return to growth, which would mean new digital sales more than offsetting the continuing decline in physical sales. Wragg stated bravely that he believed this would happen. He is putting his faith in new kinds of sales, rather than simply hoping for a booming iTunes and Napster. Nobody would have predicted the size of the ringtone market a couple of years ago, so perhaps there are even more significant new product types on the way. Videos are a growth area.
Bornhäuser by contrast is purely on the digital download side of the industry, so sees nothing but growth. SDC stands for Secure Digital Container, a Java-based DRM system which supports any format and runs on any Java-capable device.
Value for money
I am one of those people who considers most paid-for downloads a poor deal for the customer. You get a file of lower quality than what is on a CD, with no packaging, with DRM encumbrance, and often at a higher price. Wragg argues that downloads are a good deal, because you actually get more rights. He stated that "You are committing an offence when you rip a CD." So if you purchase a CD you only have the right to play it as a CD - this is in the UK; it may not be true in every country. By contrast, if you buy a download, you have the right to play it on your computer, on devices, and also to burn a CD.
You can see his logic. At the same time, the market for iPods and other MP3 devices rests partly on the fact that you can take your existing CDs and listen to them on the devices. So there is at least a de facto acceptance of this practice. Most people feel intuitively that if they pay out for a CD that they are entitled to free personal use. As far as I know, nobody has ever been pursued in the courts for copying a legit CD to a computer or device for their own use; but who knows, perhaps this could happen.
Still, the CD is a big problem for the industry. It can't live without them; but they play straight into the hands of the pirates. Wragg described how individuals turn up at car boot sales with a laptop and a stack of CD blanks, offering to burn CDs on demand for a modest price. We didn't discuss the issue further; but I imagine the industry is longing for the day when CD releases cease and all music is DRM protected.
There is also the question of flat-rate pricing on iTunes, which undervalues new releases and overvalues older material. In truth, it is a silly policy which will damage the industry if it continues. It was mentioned only in passing; but I got the impression on this and other issues that Wragg is pretty unhappy with Apple, despite its success in growing the market. See below.
Subscription versus individual download
I asked both Wragg and Bornhäuser about the future of all-you-can-eat subscriptions versus individual downloads. "Subscription will be incredibly important," said Wragg. But you have to do the sums. Personally I am a music addict; I spend a fortune on CDs and if I could transfer to a subscription at £10.00 per month (the current Napster To Go price is £9.95), then I'd make a considerable saving.
However, I am apparently not typical. According to Wragg, the average annual recorded music spend is around £25.00 to £30.00 per person. So getting that person onto Napster would be a good deal from his perspective.
On the other hand, drill down a bit further and it doesn't look so good. If the biggest spending people like myself go to subscription, while the low spenders stay away, then Wragg gets the worst of both worlds. That's not an implausible scenario.
Wragg also sees a problem in selling subscription to the older market (we are talking 25+, not pensioners). He says that typically a person acquires their taste in music in their late teens and early twenties. They build up a collection, then listen to it for the rest of their life. This is the music that is emotionally important to them. Subscription has little appeal, since they already own the things they want to hear.
I find this a rather depressing analysis, because is says we are deeply conservative creatures when it comes to music, but there is probably some truth in it.
What all this means is that simple subscription probably will not take off. Wragg considers that enhanced subscriptions will be the way to go. He wasn't specific about the enhancements, but I imagine it is things like access to otherwise unavailable material such as live performances and outtakes, videos, interviews, biographies, who knows what, or enhanced services only available to subscribers.
Allofmp3.com
I enquired whether allofmp3.com is a significant problem and what is being done about it. In case you didn't know, this is a download service which operates from Russia. You can download songs without any DRM, and the price is a small fraction of what iTunes or Napster charge. The site claims to have an agreement that makes the service legal in Russia, but of course most of its market is international. There has been some debate about its legality; but Wragg maintains that the site is entirely illegal. He says that the problem is significant, but that Russia will in due course cooperate with the music industry and shut it down. He is pinning his faith on the fact that Russia values its overall commercial relationships with countries like the UK and USA which suffer most from this operation.
I put it to Wragg that one of the reasons people like allofmp3.com is that it offers in some ways a better service than the legal operators. For example, there is I believe a choice of bitrate all the way up to lossless. He was dismissive: it is easy for them because they don't bother paying for their material. It still strikes me as an important point. I understand the need for DRM; but I'm not clear why customers who want to do the right thing have to put put with the inadequate bitrate on offer at iTunes, for example. Of course lossy compression is just another way to protect content, since it is then hard to convert to other formats without generational loss, but it still strikes me as a poor deal.
I asked what would stop allofmp3.com simply moving to another country if it were closed down. Wragg said there will be no place to go; but I doubt this is the case. On the other hand, if it became just another piracy site it would lose much of its appeal.
Apple and the DRM wars
One of the biggest issues holding back the digital market is lack of DRM interoperability. Buy on Napster, and it won't play on iPod. Buy on iTunes, and it won't play on most mobile phones, PDAs, non-Apple MP3 players or or non-Apple streaming devices. Many people find this unacceptable when they realise the implications, and refuse to purchase any DRM-protected music. Perhaps they go to allofmp3.com.
Wragg's position is that he favours interoperability. "I do not think we will see one DRM dominate", he said. He answer is federation; agreements between the DRM providers, mobile operators, device manufacturers and other interested parties that allow systems to support multiple DRM standards.
Another possibility is that purchasing an item in one DRM-protected format gives you the right to download it in another. Digital World Services' Dual Delivery is an example of this, where you download over the air onto a mobile, using SDC's DRM, and this triggers an email with a link to a further download in WMA covered by Microsoft's DRM standard, which you can use on your PC or dedicated music device.
I asked Wragg why Universal Music was not putting pressure on Apple, as the market leader, to open up Fairplay to other licensees and to support WMA DRM on the iPod. "We are putting pressure on Apple," he said, but added, "What can we do?" I remarked that Apple needed the content providers as much or more than the content providers need Apple, and mentioned the Sony case - apparently in Australia Sony/BMG is refusing to have its content included in the iTunes store. Wragg's answer is that it is more important for Universal Music to participate in the download market even if the terms are not to its liking, rather than to withdraw. Nevertheless he reiterated that he and his colleagues are lobbying for interoperability.
Clearly the central issue here is whether Apple can continue to prosper with its (generally) go-it-alone lock-in strategy. Bornhäuser says it cannot. In Germany, he says, the Musicload online store, which uses his SDC DRM, has pulled ahead of iTunes, and now claims 65% of the download market versus Apple's 30%. Apple is dominant in the US and UK, and because of the huge size of the US market in particular gives the impression of overall market leadership, but this is not the case everywhere, especially in France and Germany.
It's also important to recall that digital sales overall are still a relatively small part of the music industry's revenue. While all realise that this is the future, it is early days and far from mature.
Numerous factors will influence the direction the industry takes. Let's watch what deals are made between the key players: DRM providers such as Apple, Microsoft, SDC, Sony, Real; content providers such as Universal and (again) Sony/BMG; mobile operators like T-Mobile, Orange; handset manufacturers like Nokia, HTC, Sony (again); and internet giants like Google, AOL, Microsoft (again), Yahoo. Let's also watch what happens in the home, with Microsoft's Media Center and XBox 360; Sony's PlayStation 3; Apple when it moves seriously into this market. Finally, let's watch the devices: some day, other manufacturers will come up with designs that can match or beat the iPod's ease of use. For video, for example, Sony's PSP is already ahead.
The key question for consumers is how to enjoy the benefits and convenience of digital media while avoiding lock-in to one manufacturer or digital store. The starting point is to be aware of the issues.
Copyright Tim Anderson 28th October 2005. All rights reserved.