A Surprising Trend That Should Disturb Apple Shareholders

Companies like Pandora and Google are putting pressure on Apple's ecosystem.

Jan 9, 2014 at 10:45AM

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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Sam Mattera has no position in any stocks mentioned. The Motley Fool recommends Apple, Google, and Pandora Media. The Motley Fool owns shares of Apple and Google. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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