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Apple Inc. Is Desperate to Keep Selling You Music

By Adam Levy – Mar 24, 2014 at 2:00PM

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On-demand streaming, exclusives, and Android apps. Apple is getting desperate.

The Apple (AAPL 0.83%) music store is struggling mightily. By struggling, I mean iTunes only generated $7.5 billion in revenue last year, that's growth of 39% from fiscal 2012. There is one part of the iTunes juggernaut that probably didn't see much growth last year, and that's digital music downloads. Digital download revenue declined 2.1% in 2013, and Apple dominates the market.

A 2.1% decline in sales doesn't sound bad -- chalk it up to a terrible year in music -- but it represents the first time digital music sales declined year over year. What's more, the trend is accelerating in 2014. Digital album and track sales are down 13% and 11% so far this year, respectively.

Streaming services like Spotify, Pandora (P), and Google's (GOOGL -0.15%) Play Music All Access and YouTube are to blame. Global streaming revenue climbed 51% last year according to the International Federation of the Phonographic Industry, or IFPI.

So Apple execs are looking at ways to shake up its iTunes music division. Here are three options they're exploring.

On-demand streaming
After releasing iTunes Radio last fall, Apple has quickly gained a significant share of the Internet radio market, as it's on pace to overtake iHeartRadio in popularity. Still, Pandora remains well ahead of the competition.

Despite its success, Apple is still looking for ways to boost its popularity and profitability. The company is reportedly looking to feature the product more prominently in the upcoming iOS 8 with a stand-alone app. Some speculate that a stand-alone app will attract more advertisers, and Apple's recent acquisition of Burstly is aimed at improving iAd, which powers the advertising on the platform.

Nonetheless, ad-supported streaming is difficult to profit from. Just ask Pandora. The company reinvests all of its cash flow on sales and marketing to attract more advertisers. Google has had success with YouTube, but benefits from its long history of advertising as well as its scale.

Google was smart to offer a premium-only service last summer when it released All Access. Apple could offer a similar service to subscribers that could offset declines in permanent downloads. The biggest differentiation in such services (All Access, Spotify, Beats Music) is user interface -- a space where Apple excels.

Android apps
In addition to a more robust streaming service, Apple is reportedly considering offering official apps for Android. Google already cross-pollinates its brand with iOS and Windows Phone versions, but Apple has, for the most part, kept its software on its platforms.

Some analysts believe the popularity of Android is holding back iTunes sales. Considering there are already third-party iTunes apps floating around the Google Play Store, Apple may be better off making its own app and controlling the market.

Apple extended iTunes once before when it released the software for Windows. The PC market is much different from the smartphone market. Consumers upgrade smartphones much more frequently, and Apple has a considerably larger share. Moreover, Apple dominates the high-end market -- i.e. people are more likely to pay for additional content.

Extending iTunes to Android seems like a short-term solution to the problem.

iTunes exclusives
Beyonce's self-titled album released last year was a big hit for Mrs. Carter and iTunes alike. Apple received an exclusive window for the album, which allowed it to become the fastest selling album on iTunes ever, with 828,773 album downloads in just three days.

Apple is looking to make similar deals with record labels that give it an exclusive release window where users can download the album in its entirety before they can buy it in stores. Such a deal could be mutually beneficial as labels can use Apple's ability to promote albums in the world's largest digital music store.

Some labels already partner with Apple to offer pre-release streaming on iTunes radio. This is a growing trend for artists and labels that want to prevent illegal downloading of pre-released leaks. Apple could leverage such deals into exclusive windows for album sales.

No head start
Apple led the way when music purchasing transitioned to digital downloads, but it's falling behind in streaming. The success of iTunes Radio shows that it's capable of making a dent in the industry, but if it gives the competition enough of a head start -- like Pandora -- it probably won't be able to catch up.

Streaming is rapidly increasing in popularity, and it's directly competing with iTunes music sales. Apple is sure to shake things up, but some of its ideas are certainly better than others.

Adam Levy owns shares of Apple. The Motley Fool recommends Apple, Google, and Pandora Media. The Motley Fool owns shares of Apple, Google, and Pandora Media. 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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