A Surprising Trend That Should Disturb Apple Shareholders

People just aren't buying music like they used to. For the first time ever, digital music sales declined on a yearly basis, with individual track sales down 5.7% in 2013, according to Nielsen data. While it's possible consumers just weren't impressed with the music released last year, the growth of music streaming services like Spotify, Pandora (NYSE: P  ) and Google (NASDAQ: GOOGL  ) Music All Access is likely having some effect.

As Apple's (NASDAQ: AAPL  ) iTunes remains the backbone of its ecosystem, a shift away from digital purchase is a major threat to Apple's legendary consumer loyalty.

Subscription models challenge digital purchases
The growth of subscription-based music streaming services is an obvious problem for companies that rely on the sale of digital songs. For about $10 per month, a subscriber to Google Music All Access or Spotify can play songs from a catalog of millions of tracks. While there are notable omissions (AC/DC, Led Zeppelin, Garth Brooks), for the most part a subscriber to one of these services no longer has to buy music.

The number of subscribers is still relatively small, but rapidly growing. Last March, Spotify announced that it had 6 million paying subscribers, up from just 1 million in early 2011. It's likely that it has even more than 6 million today.

Google's competitor, All Access, is nearly indistinguishable. Google hasn't released its subscriber numbers, but the search giant seems to care a lot about music subscription services -- it is widely rumored to be planning a similar product that would be sold through YouTube.

Apple takes a different approach than Google
Apple has its own music streaming service -- iTunes Radio -- but it functions much differently. Unlike Google Music All Access, iTunes Radio is free, but it doesn't let users play songs on command. Rather, Apple's iTunes Radio is more like Pandora than Spotify -- it's an Internet radio service, not an on-demand catalog of music.

But to some extent, iTunes Radio could still be weighing on digital music sales. For someone who simply wants to listen to music -- not necessarily caring about the individual song playing -- Pandora is a perfect solution. Before Pandora, someone who wanted to listen to digital music either had to buy it or obtain it illegally.

Still, the Pandora experience doesn't completely replace music ownership the way a Spotify or Google Music All Access subscription does. In fact, for some, it could encourage music sales -- Apple went out of its way to make it easy to purchase songs heard through iTunes Radio.

Will Apple's ecosystem unravel?
Apple doesn't make much money on iTunes sales. Historically, it maintained that its aim was to run near break-even. Although that's changed in recent quarters, the overwhelming majority of Apple's revenue and profit still comes from the sale of its actual products.

Rather than make money, iTunes music primarily serves to keep customers loyal. While a music collection purchased through Apple's digital storefront can be transferred to another company's ecosystem, it's far from easy. If you've bought a lot of music from Apple, it's just easier to stick with the company's products than it is to switch.

Hedge fund manager David Einhorn, long an Apple bull, continues to argue for Apple on this basis. He told CNBC last November that Apple's ecosystem is a unique advantage, helping to drive recurring sales. That's true, which is why declining digital music sales should disturb Apple shareholders. It also helps to explain why Google has begun to push its own music subscription alternatives -- the less digital music Apple sells, the more likely its customers are to consider alternatives.

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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On January 09, 2014, at 10:53 AM, SimchaStein wrote:

    See Asymco or Apple2.0 to get the real perspective. App sales are going through the roof.

  • Report this Comment On January 09, 2014, at 11:05 AM, larryw101 wrote:

    Hey Sam,

    Do you have any idea of how much you make a fool of yourself by bashing Apple every week and in some cases every day? This is your 3rd Apple bashing article in the past week alone. You are never correct in your writings and base your opinion solely on your hate of Apple. Give it up and get alive already, LOL

    I honestly think you do this all for personal attention. You are by far the worst author I have read on Motley Fool. Get a life, maybe join an activity or do something else with your time . You are consumed in trashing Apple. You make such a fool of yourself. But maybe that's what you want.

    PS. Where are your credentials in your profile? That's right, you don't have any. EOM.

  • Report this Comment On January 09, 2014, at 11:07 AM, melegross wrote:

    People could listen to free digital music years before Pandora. There have been free digital music stations since Real began this ages ago. Apple has included Internet streaming music for quite some time.

    What Pandora does is different, as is what iTunes Radio does.

  • Report this Comment On January 09, 2014, at 11:17 AM, steyoun wrote:

    The author has showed his bias by talking about iTunes music slowing/declining and totally ignoring the fact that iTunes apps have exploded this year.

    The amount payed to developers in 2013 was 8 billion, which was greater than all previous years combined (7 billion). Also remember apple takes a 30% cut of all app revenue and apps are much more stickier than music.

    The fact that the author ignores apps incredible growth, which already accounts for more revenue than music in the iTunes store makes me wonder what the Motley Fool editorial staff is up to.

    My friend keeps encouraging me to subscribe to Motley's portfolio advise, but I have a hard time when I see these kinds of articles being posted on their site.

  • Report this Comment On January 09, 2014, at 11:21 AM, Mathman6577 wrote:

    iTunes revenue increased 25% from fiscal 2012 to 2013. That is a slowdown?

  • Report this Comment On January 09, 2014, at 12:02 PM, Waldo wrote:

    The ONLY thing that disturbs me is Sam Mattera's constant droning on Motley Fool with hit piece after hit piece. He does prove himself a fool on a regular basis. Does he actually get paid (maybe Samsung floats him some Drahkma now and again) to write this drivel?

  • Report this Comment On January 09, 2014, at 12:41 PM, anash91 wrote:

    Apple could just offer a subscription service to Itunes like emusic and offer free downloads every month up to a certain amount and discounts off additional tracks, or an app where you can stream music from an Ipod.

    Apple can benefit from this change.

  • Report this Comment On January 09, 2014, at 3:33 PM, ScottAtlanta wrote:

    Thanks for another great article.

  • Report this Comment On January 10, 2014, at 1:07 PM, Jjkiam wrote:

    While music may be migrating from an ownership model to a utility type streaming model; there is no reason to believe that Apple is particularly vulnerable to this development. As you mention they have their own streaming service to derive revenue from. They also have far more than music on the ITunes platform and I don't think their video revenues are going away anytime soon. In fact I would imagine that Apple might be considering expanding the product offerings on ITunes to provide even greater revenue growth!!!

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