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3 Reasons to Question Amazon's Music Strategy

By Chad Henage - Jun 30, 2014 at 9:34PM

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Amazon Prime Music sounds like a great deal for customers, but it may be a problem for investors.

While the big news recently is Amazon.com's ( AMZN 2.80% ) new Fire Phone, there is another development that has quickly been overshadowed, and investors need to make sure they understand what is going on. Amazon Prime Music is a service that fits the company perfectly; unfortunately, that's not a compliment. In fact, there are three reasons to believe Prime Music will be yet another money-losing business.

The 800-pound gorilla couldn't care less
In the music business, Apple ( AAPL 3.55% ) is still the 800-pound gorilla. The company's iTunes business generates four times as much revenue in three months as Pandora Media ( P ) expects to generate the whole year.

Though there have been many questions about Apple's iPhone business, the company's recent quarterly results showed that these worries are overblown. Apple sold 17% more iPhone units on an annualized basis than last year. With millions of new iPhones being sold every day, it's a good bet that iTunes will continue to dominate when it comes to music, video, and apps.

In addition, Pandora may be smaller than Apple's iTunes, but the company took over 9% of total U.S. radio listening in the last three months. Spotify is even smaller than Pandora based on total active users, but the company reported over 10 million paid subscribers recently.

The first reason Prime Music is destined to lose money is because it's tied to a $99 a year membership. Users have multiple choices for free unlimited streaming music, and even with advertising, Pandora, Spotify, iTunes Radio, and others are all popular.

Does this really make things better?
It's possible Amazon investors believe Amazon Prime Music will help boost the company's digital sales. This is a legitimate concern, because just over a year ago, Amazon's digital sales growth rate was in the teens. By comparison, in the current quarter, Amazon's digital sales were up by 8%, which was the slowest growth in the last five quarters.

Looking at growth from other companies in the streaming music and digital sales industry, iTunes sales increased by 10% annually.

Pandora reported 54% revenue growth in the last quarter, but even for all of 2014, Pandora expects revenue of less than $1 billion. With Amazon reporting sales per quarter of $20 billion or more, this service looks like a drop in the bucket.

The second reason Amazon Prime Music looks like a money-losing business is because streaming music isn't exactly a high-margin industry. Even with a 37% gross margin, Pandora lost money in the current quarter. Amazon's gross margin last quarter was less than 29%. The extra potential cost to Amazon for Amazon Prime Music doesn't bode well for future profits.

It's just not enough
Amazon's streaming music offering offers unlimited streaming without ads to its Prime members. The company allows users to listen to customized playlists and repeat their favorite song as much as they want.

The bad news is, all of this and more is available through multiple other formats. For instance, Spotify allows users on both their PC and iPad to play any song they want as much as they want for free. While there are ads, it's hard to argue that users wouldn't prefer a free solution versus paying $99 a year for this service through Prime.

In addition, though Pandora's One service doesn't allow users to pick individual songs, the service costs just $4.99 a month, and with more than 75 million total active users and a growing part subscribing to the One service, Pandora's popularity is still on the rise.

Though Beats Music seems more expensive at $9.99 a month, the service has an undeniable "cool" factor to it that Amazon can't hope to match. With Apple behind the company, Beats will be the most financed music service in the marketplace.

This is the third reason to believe Prime Music is going to lose money. Prime membership will have to grow in lockstep with increased usage in order to offset these additional costs. With so much competition, it's hard to imagine that happening. The bad news for investors is, Amazon Music looks like just another example of how Bezos and company plan to take over another industry and lose money at the same time.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis – even one of our own – helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.

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Stocks Mentioned

Apple Inc. Stock Quote
Apple Inc.
AAPL
$171.18 (3.55%) $5.86
Amazon.com, Inc. Stock Quote
Amazon.com, Inc.
AMZN
$3,523.29 (2.80%) $95.92
Pandora Media, Inc. Stock Quote
Pandora Media, Inc.
P

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