[Update 1]
Apple’s Eddie Cue has stated that musicians will now be paid during the trial period of Apple Music.
<TL;DR>
Although Apple Music’s extended free trial period will cause pain early in its life, there will not be a significant impact on musicians’ revenue in the long-run, especially as Apple approaches their 100 million user target.
</TL;DR>
Background
As usual there has been no shortage of controversy surrounding the decisions of the world’s most valuable company. This time the target is Apple’s newly announced music service which is simply called Apple Music. The service is a subscription music service that costs $9.99 a month for an individual account which gives the user access to a broad library of music that can be played commercial free by the user.
Users are able to sign up for a three month free trial and this is where the controversy arises. Apple’s deals with the music industry allow this trial period to be royalty free. Musicians have criticized this move as cutting off a potentially large source of revenue, even arguing that asking the artists for a trial period without royalties is like asking Apple for free iPhones.
So far there has been no attempt to quantify the effect or value of such an extensive free trial. Let’s endeavor that analysis here.
First Some Assumptions
As with any model the first thing we have to do is establish the background assumptions that will affect our results. That way we can understand where the analysis may fall short and where its strengths may be.1
Market Size – Apple has stated that they believe they can reach 100 million subscribers to the new service and we will take that as their target subscriber size. This is either an accurate assumption because Apple is best positioned to know how well their future product may perform or it is an inaccurate assumption because Apple is known to forecast future potential results very conservatively.
User Growth – User growth assumed is based off of recent trends with Spotify’s subscriber growth rate. Spotify grew at a rate of approximately 14 million subscribers per year over the early part of 2015. For Apple we will allow the total paid subscribers to follow a variant of a power function with increasingly strong growth that peaks and then tapers off as they approach 100 million subscribers.
We should note that Apple has the potential to grow much faster than Spotify because of the advantage Apple has due to its ability to preinstall Apple Music on all iOS devices and Macs. Apple also holds the edge in advertising ability. These two facts combine to make our growth assumptions more conservative than they likely need to be. This is not a problem because more aggressive growth actually benefits the musicians therefore making our results more conservative than they otherwise would be.
Conversion Rate – Our assumed conversion from free trial users to paying subscribers is 20%. This is not based off of any particular inside industry knowledge of subscription music conversion rates. This however is not as important to the analysis as one might think.
The conversion rate is unimportant if we make just one further assumption: the usage of Apple Music by users that convert to paid subscriptions is equal to the usage of users who do not convert to paid subscriptions. This is the case because it allows us to view in relative terms the amount of revenue artists forego by allowing a free trial with no royalties no matter the actual conversion rate. To make this clearer let’s use some hypothetical numbers. Assume that the average user that finds Apple Music worthwhile streams 500 songs a month and the average user that does not find Apple Music worthwhile only streams 125 songs a month. It takes four users that will not find Apple Music worthwhile to equal the usage of one user that will.
Timing of Payments – Payment to Apple for the streaming service is assumed to happen at the beginning of each quarter and covers the cost of the entire quarter. Payment to artists is assumed to happen immediately. Obviously both of these assumptions will not hold true in the real world, but their implications do not significantly alter the conclusions from this analysis.
The Analysis
In our hypothetical situation Apple will reach 100 million subscribers sometime toward the end of 2017. At that point in time, enough of the potential market would have already converted to music suscriptions that new subscriber growth will slow. Although not identical, the iTunes Music store saw a similar trajectory with its music sales.
Adding new subscribers will be directly related to the total number of free trial users and how many of those users then pay for the service. In the graphic above we can see that adding more subscribers means many more free trial users. At the peak Apple would have 100 million free trial users in a single quarter. It is this point in the graph that concerns artists. But, we cannot know how much revenue artists are foregoing in such a scenario until we add more context.
We can gain the context we need about the impact of the free trial by scaling the number of free trial users by the number of paid subscribers. Here we can see that quarterly free trial users fall below quarterly paid subscribers after March 2017 and drops rapidly after that point. But the value of any individual user is not always the same.
The value consumed by free trial users follows a similar trajectory as the percent of paid users did. The key difference is that paid users will undoubtedly be those users that use the service the most as described in the assumptions section above. If we analyze the first point on the chart to the upper right, we see that the value consumed by free trial users is equal to that of the paid users, therefore musicians are losing 50% of their revenue as a result of this split. As Apple adds more high value paid subscribers the actual value lost by the musicians falls. This trend will continue until the value lost from the free trial nears zero. It takes a year and a half for the value lost to fall below 25% and just two years for it to fall below 10%. When Apple reaches their goal of 100 million paid users then musicians are only losing 4.67% of the revenue to the free trial.
How much do musicians currently discount their music on average below full retail? That is really the number we need to compare to our value consumed by trial users.
There is another way we could look at the value consumed by free trial users. We know that Apple is a huge corporation and no one will lose any sleep 2 if Apple’s costs rise, but I think it is still instructive for us to view this from Apple’s perspective.
Streaming media is not free. Apple will not be paying royalties on the media they stream, however it is still costly to advertise Apple Music and maintain data centers, whether the cost be space, bandwidth, electricity, or server hardware. We can reinterpret the value consumed by free trial users as the percentage of streaming costs for which Apple is receiving no revenue.
Why Not Ads?
A counter-arguement to a free trial period with no royalties would be a free trial period with royalties supported by ads. I do not think Apple wants ads anywhere near the trial period. Apple has operated iTunes Radio, a mostly ad supported service, since 2013. Although this is just conjecture, I would not be surprised if their iTunes Radio data revealed just how much people hate ads.
Listen to two potential Apple pitches. Number One: “Hey, haven’t you loved your free trial of Apple Music? We bet you’ll love it so much that $9.99 will seem like a steal.” Number Two: “Hey, don’t you hate those ads interrupting your music all of the time? Pay us just $9.99 to stop annoying you.” Yeah, the first sales pitch is the better one.
Conclusions
The Apple Music extended free trial period does cost musicians revenue. But over the long run the revenue lost will be minimal.
We can be certain that Apple used this kind of analysis when they approached the music labels with the idea of such a lengthy free trial that paid no royalties. The faster Apple can reach their 100 million user mark the less revenue is lost by the music industry. We can also imagine that the music industry was enticed by the massively skilled and equally massively budgeted marketing team at Apple which will now be full force behind streaming music. I do not think we can overestimate this power. Spotify rose to its level of prominence without much advertising. Any advertising by Apple will also have to be matched by Spotify. What do we think Spotify aims to do with this most recent round of capital raising? My guess… advertise. That is a win-win for the music industry.
Now when we hear talk of Apple Music’s free trial we can have a better understanding for how it might actually impact the music industry.
But, in the end, the negative PR Apple has sustained from this no royalty trial period may not be worth the trouble.