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Apple’s Freemium Fight

In 2003, Apple changed the face of music with the back-to-back releases of the iTunes store and the iPod. Apple did not invent the MP3 player – several versions were floating around mid to late ’90s – nor did they place digital music on the map – Napster probably deserves that honor. What Apple did do was find a way to make downloaded music really work for consumers – and something that the record companies ultimately got used to. The rest, as they say, is history.

History that has catapulted Apple to the position of being the largest music vendor in the United States since April 2008 and the largest music vendor, worldwide, since February 2010, at least according to Wikipedia.

Except history has a way of evolving, and consumers have this strange habit of changing their tastes and preferences. And so, as the record gave way to the CD which gave way to the MP3 — in recent years, the MP3 has given way to the stream.

Consumers have adopted a new purchase paradigm when it comes to movies, television or music – instead of paying for individual pieces of media themselves to own, they are flocking to services that offer them access to media whenever they are connected to the Internet (which, in the era of smartphones, is pretty much always). And the move away from “ownership” has taken a bite out of the Apple – downloads from the iTunes store fell 13 percent last year.

Spotify – the field leader in music streaming – on the other hand, is soaring. The Swedish streaming platform released its full-year financial results last week, posting revenues of roughly $1.23 billion and a valuation of more than $8 billion. Now, most of those revenues they don’t get to keep – Spotify reportedly pays about 70 percent back to digital rights holders, but their domination of the music streaming market is powerful enough to have pushed some fairly fearsome potential competitors off the field – in the last year notably Simfy and Sony Music Unlimited.

But the competition is about to get a whole lot steeper as Spotify squares off with the company most likely to achieve the distinction of being the first trillion dollar market cap company. Of course, that company is Apple.

If recent reports are accurate, Apple’s not kidding around as it makes it moves for streaming supremacy (remember the $3.2 billion acquisition of Beats?), and seeks to leverage that, along with some of its considerable influence, to makes things a little bit tougher for Spotify and its streaming competitors.

One of the first items on that agenda is taking on the freemium model – one that allows users to access music “for free” as long as they subject themselves to ads. This is in contrast with subscription models that charge users $10 for unlimited music without ads.

The freemium model may be enticing to consumers, but it’s not exactly the music industry’s preference. They, unsurprisingly, prefer to be paid for their product rather than having it given away so that consumers will watch ads for other people’s products. Taylor Swift rather famously thumbed her nose at the freemium model when she pulled her entire catalogue from Spotify at a cost of around $6 million to demonstrate that music is valuable – apparently not a case where she was willing to just “Shake it off.” (We couldn’t resist.)

But like every coin, there is a flip side. Others complain that Apple’s attempts to tinker with the market for their own advantage are questionably ethical, while others complain they are simply an outright illegal antitrust violation.

Why A Freemium Fight?

“All the way up to Tim Cook, these guys are cutthroat,” one music industry source told The Verge.

While that might be a rather colorful description of the situation – industry observers assert that Apple’s move against Spotify – and other freemium-like services  – appears to be bit of path clearing for its own Beats music streaming service set to relaunch later this year. The streaming service came as part of Apple’s acquisition of Beats headphone makers last year.

Beats – which offered no freemium model – did not compete well against Spotify, which beat (pun intended) it to the market. Though founded by rap impresario Dr. Dre and heavily endorsed by a range of celebrities – it just never caught on.

So, according to reports in The Verge, Apple has been strongly suggesting that major music labels force streaming services like Spotify to abandon its free tiers. That, of course, could really take a big bite out of Spotify’s user base. While the service has 60 million users – only 15 million of them are paying for the privilege not to look at ads.

By busting up the freemium tier, Apple theoretically frees up a large pocket of consumers which it can now attract with its lower subscription price and, what some predict to be, exclusive content.

Such a move would be consistent with other plays by Apple to strengthen Beats’ emergence onto the scene. Apple has also reportedly proposed to pay YouTube’s music licensing fee to Universal Music Group, if the label removed its songs from YouTube.

However, it is also worth noting that the move against freemium by Apple has also been challenged by some as an unsustainable way to support the music industry.

“I equate ‘free’ with the decline of the music business,” Sony Music CEO Doug Morris told Hits Daily Double in March. “Why should anyone pay for anything if they can get it for free? In certain instances, it’s worth a discussion. But in general, free is death.”

But not apparently for Spotify’s revenues. Of Spotify’s $1.25 billion in annual revenue $1.1 billion came from subscriptions – the 25 percent of its user base, while $113 million came via their free users – the other 75 percent.

Why Timing Is Everything

Sony’s Doug Morris is not alone – in fact the chorus of music industry executives singing out against the freemium model seems to be settling on a common tune.

“We want to accelerate paid subscription,” Universal Music Group CEO Lucian Grainge noted. “Ad-funded on-demand is not going to sustain the entire ecosystem of the creators as well as the investors.”

It’s worth pointing out that this has not always been the music industry’s standing attitude on music streaming – but it seems these days the freemium tier is not converting enough users into subscribers, or at least not doing it fast enough, and the dissatisfaction is becoming widespread.

Not to mention that 2015 might be a uniquely good summer for the music industry’s discontent – since Spotify’s catalogue of licenses will expire this summer.  This allows them to push for concessions and wave the looming threat of Apple to perhaps push Spotify off the freemium model.

Then again – Spotify does not seem overly threatened, nor does it seem all that inclined to abandon its free tier.

Spotify’s head of communications, Jonathan Prince has noted that 80 percent of its 15 million paying customers started out on a free tier.

“The idea [that] you would talk about cutting off a free service that has a clear proven path to subscriptions, when you have all these other free services out there, it just doesn’t make any sense to us,” he said.

The Legal Hurdles

It also remains to be seen if Apple’s rather aggressive moves against streaming services will make good sense to regulators. Several recent reports indicate that Apple’s recent actions have managed to catch the attention of both the DOJ and the FTC. The Verge further reported that this ball seemed to have started in the DOJ’s court, but in recent weeks it seems the FTC has taken the volley and is now leading the investigation.

Apple is quite experienced at handling investigations of this sort and has an antitrust monitor all of its own on campus – via the DOJ – after being convicted in an e-book antitrust case in 2014 (currently under appeal). It is not known if that monitor has been tapped for this situation. Apple is also facing an investigation from EU authorities – particularly the European Union’s Competition Commission – which is looking into whether Apple is colluding with record labels to end the freemium model in music.

The bigger question, however, is what will consumers do if freemium models are eliminated? Spotify was originally founded to combat a massive piracy problem in Sweden – and allowing users to listen to music for free in return for watching ads provided a valid alternative to just stealing it wholesale. Even if Apple can chase away all of the free music providers – it may just be possible that too many consumers have gone too long without paying.

Then again – when Apple made the cost of a song 99 cents – people lost interest in illegal downloads by and large. So the big question is whether, in a freemiumless world – Apple could convince us all to pay a little to dance to their Beats.

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