Apple Inc. Readies Its New Music Service to Challenge Spotify and Pandora

Attention Spotify and Pandora (P): Apple(AAPL 0.16%) is coming for you.

If the intentions of the most valuable publicly traded company in the world were not already clear, the company recently made moves that shows these streaming music companies remain firmly in its crosshairs.

Planning a new offensive
Apple reportedly purchased the London-based data analytics firm, Semetric. The tech giant commented on the buyout in its usual tight-lipped fashion, "Apple buys smaller technology companies from time to time, and we generally do not discuss our purpose or plan," but many observers interpreted this as another move to prepare Apple for its long-rumored streaming product.

Semetric specializes in entertainment, and particularly music industry, analytics. Its robust music report functionality has been widely viewed as exactly the kind of back-end functionality that could help the still-forthcoming music service gain favor among artists. In that sense, this move is likely one part defense and one part offense for Apple.

Semetric has actually worked directly with Spotify in the past to share information and analysis on the popularity of recording artists and user listening statistics. By reducing the amount of information Spotify can offer artists while also improving the analytics portion of its own forthcoming music service, Apple will have created a differentiating factor between its itself and the competition.

While not entirely clear the degree to which this kind of reporting matters to artists, it makes intuitive sense that they would gravitate toward the streaming platform that offers the best information, all other variables being equal.

Why Apple needs a streaming service
This storyline should matter to Apple investors for a few reasons. For starters, rolling out a new streaming service will help stem the sharp decline in music revenue Apple experienced as Spotify and Pandora rose to prominence. Last October, The Wall Street Journal reported that iTunes music sales had dipped 14% since the start of 2014, a reflection of the shift in consumer preference toward streaming versus owning digital music. By creating a new subscription-based streaming option, Apple hopes to offset the recent financial decline of iTunes.

On the other hand, digital music represents a small fraction of overall sales at Apple: the iTunes, software, and service segment only contributed roughly 10% of total revenue in fiscal 2014, and that number included non-iTunes items such as the App Store and AppleCare. So while the dollar sums at work here are huge in an absolute sense, they are unlikely to move the needle for a company this size.

Why else then, does this matter for Apple?

There is an important ecosystem argument to consider here. One of the primary tactics Apple uses to create customer loyalty is the "stickiness" of its ecosystem. Apple users are faced with a real switching cost of lost music, movies, and apps if they move away to another platform. As such, the rise of third-party music options such as Spotify and Pandora have reduced the magnitude of switching, a dynamic Apple would understandably want to reverse.

Still in the dark
There is plenty we still don't know about this upcoming streaming service. However, it will be fascinating to see how the company manages the rollout later this year. 

Apple will not be able to simply cut Spotify or Pandora out of the App Store, considering their tens of millions of users worldwide. The company will thus have to beat these rivals through product quality. By far the most important aspect of a streaming service is the breadth and depth of its artist catalog. How will Apple beat the streaming incumbents? Will it pay more to draw artists exclusively into its streaming service?

This is just one of the fascinating subplots I see in the upcoming battle for the future of streaming music. Apple is late to the game, so it will be eager to beat back the progress Spotify and Pandora have already made. So while the launch likely remains months away, Spotify and Pandora should probably both take heed now: Apple is coming for them in a big way.