Is Apple (NASDAQ:AAPL) Music in serious trouble? Even as Apple mulls what could prove to be a shrewd acquisition of Tidal, a recent investor note suggests that the company is losing ground in its continued challenge to streaming leader Spotify.
Let's take a look.
Churn and burn
Cowen & Co. reports that Apple Music loses customers three times as fast as Spotify. A survey of 2,500 U.S. consumers revealed that Apple Music and Spotify have churn rates of 6.4% and 2.2%, respectively.
Since the on-demand streaming industry is young, it isn't yet clear what constitutes a "normal" churn rate. However, using other well-known subscription industries, Apple Music's churn rate still seems alarmingly high. For example, telecom leaders Verizon Communications and AT&T saw churn rates of roughly 1% in 2015.
In my time covering these sectors, I can't recall seeing any major subscription business with such a high churn rate. It's a clear red flag, especially as Apple attempts to challenge Spotify with an updated version of Apple Music.
At the same time, though, the analysis isn't necessarily as black-and-white as it might at first appear.
A more nuanced take
Spotify and Apple Music differ in their customer-acquisition strategy in subtle but important ways. Spotify's "freemium" model allows users to get acquainted with the service through its free, ad-supported tier before they become paid subscribers. Apple Music offers only three-month trials to its subscription tier.
Viewed this way, Apple Music's churn rate should be higher than Spotify's. Spotify can court paying users from its large swath of free-tier listeners. Those willing to upgrade probably find the service so valuable that they'll remain loyal.
On the other hand, Apple's free-trial model requires users to unsubscribe before their three-month preview window closes, a model that engenders a relatively high churn rate. So it should come as no surprise that Apple Music has a higher churn rate than Spotify, though a threefold difference between the two still seems large.
Does it really matter?
Another important distinction between the two services is that Apple can afford to run Apple Music at a perpetual loss, while Spotify must turn a profit, especially with an IPO looming.
As an Investor's Business Daily analysis of the Cowen & Co. report notes:
[T]he big new players in the music industry -- Alphabet, [Amazon.com] and Apple -- aren't using music as a profit driver. Rather, they use their respective platforms -- YouTube, Prime Music, and Apple Music -- as high-frequency consumer touch points that reinforce the brand, build an ecosystem, and generate traffic to higher-contributing offerings.
That's all true, but I think viewing the competitive dynamic between Apple and Spotify through a financial lens overlooks Apple's core objective in creating Apple Music. No, Apple doesn't need a profitable on-demand streaming business, and Spotify does. However, the fact that consumers appear to favor Spotify implies that Spotify stands a better chance of consolidating what once was a long-standing strength of Apple's ecosystem. This isn't something that translates neatly in dollars and cents, but Apple views music as a cornerstone of the iOS ecosystem, which does drive the overwhelming majority of its profits.
Put another way, the Investor's Business Daily article makes the mistake of viewing the competition financially, when music's strategic importance to Apple's iOS is the motivating force behind the product. As the churn metric illustrates, Apple needs to continue to improve Apple Music or risk ceding a core aspect of its Hotel California-esque ecosystem to an able competitor, to its long-term detriment.
Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool's board of directors. Andrew Tonner owns shares of Apple. The Motley Fool owns shares of and recommends Alphabet (A shares), Alphabet (C shares), Amazon.com, Apple, and Verizon Communications. The Motley Fool has the following options: long January 2018 $90 calls on Apple and short January 2018 $95 calls on Apple. 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.