Debate over iTunes sales direction: what's going on?

Debate over iTunes sales direction: what's going on?

A couple of days ago, Infinite Loop reported on a research note from Forrester Research which said that Apple's music sales were slowing and that sales of the company's venerable iPod were failing to drive downloads from the iTunes Store. Two days after Forrester's report, investment firm Piper Jaffray has released its own report saying that no, the iTunes Store is doing just fine in terms of growth.

Analyst Gene Munster of Piper Jaffray says that through September, iTunes Store weekly sales are up 78 percent from 2005. Munster's report is based on Apple company data, according to Reuters, and shows that Apple sold 695 million tracks through September, a total of 18.5 million per week.

In contrast, Forrester's figures come from a analysis of credit and debit card purchases from the iTunes Store, made over a 26-month period ending in June 2006. From April 2004 through January 2006, Apple saw a seven-fold increase in transactions, according to Forrester, with the average transaction size growing to $6.69 from $3.55. Since the beginning of the year, the number of transactions has fallen by 58 percent, with the average transaction size dropping to $5.56. Only 3 percent of US Internet-using households made purchases at the iTunes Store during that period.

The bigger picture

Lurking in the background of the discussion over Apple's music sales is the state of the online music industry itself. When Yahoo announced it was selling a handful of non-DRMed MP3s last week, we noted that Nielsen was reporting a drop-off in online music sales. After several quarters of steady growth, Nielsen SoundScan reported that after hitting an all-time high of 144 million tracks sold during the first quarter of 2006, the second and third quarters saw sales of only 137 million.

Despite the growth the online music market has seen over the past couple of years, it still only accounts for a small fraction of overall music sales. The music market as a whole has been struggling for the past several years, with sales of physical media declining even as digital sales crept upward. The record labels have been quick to blame the decline in sales on piracy, but recent research shows that the vast majority of music found on digital music players comes either from users' own CD collections or legal downloads, not piracy. In fact, the IFPI found that the number of illegal music files available on P2P networks dropped almost 20 percent between April 2003 and the beginning of 2006.

Is it time to reinvigorate the market?

In a statement given to Reuters, Apple said that "the conclusion that iTunes sales are slowing is simply incorrect." Piper Jaffray's analysis appears to support Apple assessment. Still, the data from Forrester and Nielsen shows that there are challenges looming on the horizon for the music industry. Despite the ability to cherry pick individual tracks from an album and the always-popular instant gratification from an online purchase, a large number of consumers remain unconvinced by the online music value proposition.

There are a few steps the music industry can take to meet the challenge of lackluster growth, all of which would arguably strengthen the music industry's value proposition.

Rethink DRM

When the iTunes Music Store debuted, its DRM restrictions were much looser than any of the other online stores backed by the record labels. That said, some consumers don't like the DRM at all. As we've pointed out before, it ties listeners to a particular ecosystem of music stores, software, and hardware—good news for Apple, but not for the rest of the industry. Yahoo! Music has convinced a couple of the record labels to experiment with DRM-free music—that's a good start, but the labels need to be more aggressive when it comes to rethinking DRM.

Audio quality

Let's get one thing straight: many consumers are perfectly happy with the 128Kbps AAC files sold through the iTunes Store. A handful of stores, such as Napster, have begun offering tracks encoded at 192Kbps. But lossy is lossy, and discerning listeners want more choices when it comes to encoding. Part of what has made the IFPI's poster child of villainy AllofMP3.com so popular is that it lets the customer decide what format and bit rate he or she wants to purchase music in. If the music stores would offer more choice when it comes to encoding, they would likely attract some customers who are currently content to buy CDs and rip them using a lossless encoder of their choosing.

Pricing

99¢ per track has evolved as the standard in the industry. The labels would like to see that go higher, at least for some popular tracks, but the music stores have resisted. But there is also room to go lower. The costs associated with selling digital music downloads are much lower than that of physical media—there are no warehousing and transport costs involved. Unfortunately, those cost savings aren't passed on to consumers. If the record industry would content itself with lower margins on each track sold, chances are good that they'll make much—if not all—of that up on volume as lower prices result in increased sales.

The social

When we reviewed the new Microsoft Zune, we noted that its WiFi capability offered a lot of potential for viral marketing. Unfortunately, the Zune doesn't deliver. Shared music "expires" in three days, even if the original track is not DRMed. More importantly, shared music cannot be "reshared." Once it has migrated from one Zune to another, it's stuck there.

Microsoft isn't the bad guy here. The concept of sharing music between digital music players over WiFi is a good one, but the labels' reliance on DRM and overblown fears of piracy keep the Zune's WiFi feature from reaching its potential. The recording industry needs to overcome these fears and make it easier for music fans to get the word out to one another about the music they love.

Get back in the barn, Chicken Little

Above all, the online music business is still young. That means awkward fits and starts as it slowly matures, especially as it reaches those gangly junior-high years that we all remember so fondly. Growth patterns may not look identical from quarter to quarter or year to year, but grow the market will. Even as the iTunes Store and other music sites see sales increase, they will still remain a fraction of physical media. The CD may be old school, but it is still the preferred format for the majority of music fans and that doesn't appear about to change anytime soon.

Also keep in mind that we're talking technology here. When it comes to tech, early adopters often come from the geek crowd, and their usage patterns usually look quite a bit different from those of the general public.

The sky isn't falling for Apple or for the online music industry as a whole. Online music stores face challenges as they attempt to increase sales, but downloads are poised for growth in the long term, even if those growth patterns differ radically from those of the past two or three years.

:source: Source: http://arstechnica.com/news.ars/post/20061213-8416.html