Apple's (NASDAQ:AAPL) iTunes service disrupted the music industry once, can it do it again?

The music streaming landscape is full of big names, specialty services like Spotify and Pandora (NYSE:P) are well established and other tech players like Amazon.com (NASDAQ:AMZN) and Google have their own offerings as well. While the depth of catalogues vary, the market seems to have agreed around $10 per month is a reasonable amount to pay for access to tunes. Can Apple stand out it such a commoditized market, and might another big tech name throw its hat into the ring soon?

A full transcript follows the video.

 

Sean O'Reilly: Apple Music tried and failed to "Shake Off" Taylor Swift, on this tech edition of Industry Focus.

Greetings, Fools! I am Sean O'Reilly, joining you here from Fool headquarters in Alexandria, Va. Happy Fourth of July to all of our listeners. I am joined today by the one and only, the patriotic Dylan Lewis. How are you today?

Dylan Lewis: What an intro. "The patriotic." I love it. I'm good. I've got a belly full of barbecue, I'm ready to do a tech show.

O'Reilly: Then we'll go see some fireworks here soon. It's going to be good stuff.

Lewis: Yeah. I might even light off a few.

O'Reilly: Do not lose a finger. So, we're talking about Apple Music. It just launched.

Lewis: Apple Music launched early this week.

O'Reilly: What's going on? Have you used it?

Lewis: I haven't. I've talked to a couple Fools around the office that have. Just some background here: It's a music streaming service that is free for the first three months as a trial. Apple is going to be paying two hundredths of a cent to a quarter of a cent per stream during the trial period. That's interesting, because that's not what they originally planned.

O'Reilly: Oof!

Lewis: Yeah. You teased that a little bit in our intro.

O'Reilly: I did. For those of you that don't know, Taylor Swift has been very business savvy with how her music is used on streaming services, because she is arguably her own country in the music world.

Lewis: She's probably one of the biggest pop stars.

O'Reilly: She's the biggest pop star right now. So for a music service to not have her stuff it's not a deal breaker, but in your mind you're like, "Maybe I don't want to use this."

Lewis: This is something Spotify already got dinged for.

O'Reilly: Right. She withheld her music from Spotify and Apple Music as part of their promotion for their service. They were not going to pay artists for the three months that people were on a free subscription. Taylor Swift was like, "No. That is wrong. Imagine going three months without getting paid. I'm fine. I make plenty of money from tours." Which she does, folks. "But if you're an up and coming artist, you rely on this thing as well as your YouTube channel. It's wrong."

Lewis: I don't know how Apple thought they were going to get away with it.

O'Reilly: If I were at Apple or one of the music production companies, I would have been like, "All right. What do we have to do to get Taylor Swift in here?"

Lewis: Yeah. It's a PR nightmare as you're getting ready to go launch a service.

O'Reilly: Yeah. So, she wrote her own open letter on her Tumblr account that stated what I just regurgitated poorly, I imagine, and within 24 to 48 hours Apple backed down and started paying all artists even during the three-month trial.

Lewis: Yeah. They did a nice about-face following that.

O'Reilly: And Taylor Swift is now more important than the United Nations, Barack Obama, definitely Putin ...

Lewis: She's the key to world peace.

O'Reilly: Yeah. She really is. If aliens show up to Earth and they say, "Take us to your leader," we'll just say, "All right. Go see Taylor Swift. She's got this mansion ..."

Lewis: She brought Apple to its knees. Yeah. That's the story for the free trial period, which will be the first three months of the service. Beyond that it will be $10 a month for individual users; $15 a month for what they call Family Accounts. Some interesting notes and details that have come out so far on the service -- this is currently only for Apple devices, or devices that are running Apple OS. Android versions should be coming out sometime in the fall.

O'Reilly: Quick question -- and if you don't know, that's fine -- if I have a Windows-based PC and I have iTunes on it, can we play ball?

Lewis: Not that I know of.

O'Reilly: Wow.

Lewis: Yeah.

O'Reilly: Good thing I have an iPhone.

Lewis: I have to double-check on that. Some cool features: music streaming -- as you might expect -- they have some playlists curated by music experts, 24/7 radio stations called Beats 1.

O'Reilly: What's a music expert?

Lewis: I think they have a lot of prominent DJs and musicians in the space.

O'Reilly: OK. Like, do they get Calvin Harris to do it because of the whole Taylor Swift thing?

Lewis: Yeah. Maybe that was part of the deal. They also have some social features that connect artists with fans. It's called Connect, interestingly enough. It's not without problems, though. They're still working the kinks out. I know one of the major issues that some of the power users -- people that our audiophiles have run into -- have this add-on called iCloud Music Library. It's similar to what iTunes Match was, where it was taking what is in your existing content library and matching it up with files on the cloud so you can access your music anywhere.

It would also make it available for offline listening. Some users are running into issues during that matching process where it's wreaking havoc on their local iTunes library. So, what is saved on their computer, messing with some metadata, some of the album art, curated playlists, things like that. So if you're in that camp you might want to consider not running the matching if you're interested in Apple Music. Let them get that ironed out.

O'Reilly: I would argue that the music industry is still in the process of figuring out how to live in the digital age. Like, "How do we pay the artists?" That's probably the source of the issues. Who are the major players in the space? Just give everybody a quick update.

Lewis: We have Apple Music, and like I said it's $10 a month for the individual and $15 a month for the family. Obviously, Spotify is one of the big players in this space. They have a free, ad-supported version, and then the premium costs $10 a month. Some of the other big tech names that you'll recognize are Amazon, which has its own service via its Amazon Prime offering. So it's bundled within Amazon Prime's $99 annual subscription. There's also Pandora, which is a slightly different model because it doesn't allow for on-demand listening.

It's more of the music genome, curated playlists. That's free, ad-supported, and then Pandora One is $5 a month. Google Play is also in on the action with a free ad-supported version and unlimited, on-demand for $10 a month. Other notable ones on the side right now are Tidal, which Jay-Z is offering at $10 a month for premium, $20 a month for Tidal Hi-Fi -- which is high-fidelity listening. Again, appealing to the audiophile market.

O'Reilly: Does it come with the special headphones or anything?

Lewis: I don't know about that. I don't think so.

O'Reilly: Tidal is having a rough time right now, aren't they?

Lewis: Yeah. It's a really niche-y market to appeal to.

O'Reilly: It really is. Yeah. I remember that announcement when he made it. He was basically surrounded by the most successful artists of all time.

Lewis: Yeah. I think audiophiles might appreciate the lossless listening, but for the most part ...

O'Reilly: I would not pay double the price for ...

Lewis: Yeah. Especially if I'm going to be listening to music on my Metro commute, where it's going to be loud and ringy anyway.

O'Reilly: Yeah. Where you've got to deal with the crazy guy next to you that's screaming. Yeah.

Lewis: So, just something interesting to note.

O'Reilly: Ten dollars a month seems to be the price point.

Lewis: Yeah. That's where people are anchoring. I guess it's because that's what the market has decided is "reasonable." That's crazy, because you go back to the late '90s and early 2000s, $10 would buy you three-quarters of a CD.

O'Reilly: Yeah. Clearly the user is benefiting 15 years later, not factoring inflation.

Lewis: Oh, yeah. The value proposition is fantastic.

O'Reilly: Yeah.

Lewis: In terms of what people are generally willing to pay and what the breakout is for some of these free platforms that also have a premium model, Spotify has roughly 75 million monthly active users, and about 20 million paying subscribers. Roughly 25% of their users are paying.

O'Reilly: It's so speculative, but I've got to wonder if Apple will get this right, or what things are going to look like in five or 10 years.

Lewis: Yeah. They are the company that totally disrupted the music industry to begin with anyway.

O'Reilly: It is.

Lewis: So it's not crazy to see the possibility of them doing it again.

O'Reilly: I offered my sister money for her original iPod because I think it's a historical relic. It was a game-changer. This whole thing is just crazy. When was the last time you bought a CD?

Lewis: No. I buy vinyl.

O'Reilly: "What's a CD?" You would. Very cool. Well, we'll talk about the impact on Apple. But before we do, we want to take a little break, get our notes together, and make our listeners aware of a very special offer for all Industry Focus listeners. If you found this discussion informative, and you're curious what tech stocks The Motley Fool's award-winning Stock Advisor newsletter has picked, we have a very special offer for you.

We're offering the lowest price out there for Industry Focus listeners. It's $129 for a full, two-year subscription to Stock Advisor. You'll get two stock recommendations every single month with insight from our team of analysts. Just go to focus.fool.com to take advantage of this deal. Again, that's focus.fool.com. If Dylan wasn't an employee of the Fool and didn't get a free subscription, I'm sure you would totally jump on that, right?

Lewis: Oh, heck yeah. Absolutely. Great offer.

O'Reilly: So, Apple's the biggest company in the world. Does this matter? I was thinking it was an ecosystem thing. That's it.

Lewis: Yeah. You always wonder with these things they're rolling out, "Is this going to be a drop in the bucket, or is this going to be this explosive new product?"

O'Reilly: It needs to be at least $10 billion to matter. That's insane for anyone but Apple. Anyway, go on.

Lewis: If you want to take a simplistic view of this, obviously there's not going to be much of a revenue impact for this quarter -- Q3. That's only because it's a free trial for most of the people that are using the service. There is no revenue opportunity there. There might be some ad stuff on the side, but it's going to be ...

O'Reilly: They'll start making money at Christmastime.

Lewis: It's going to be absolutely negligible. As of 2014 -- this is the most recent data I could get -- there were roughly 800 million iTunes accounts that were active. Conservatively I'll say 5% to 10% of those people are converted over to paying Apple music subscribers.

O'Reilly: That was the other question I had, was cannibalization.

Lewis: Yeah. I think they're monetizing people that would otherwise not get monetized. That's my general feeling. I'm not comfortable saying they're going to convert 20% like the Spotify breakout is now. A lot of the people that are currently using iTunes are using it just to host music. They're not buying things off that platform. I think, just to be on the conservative side, let's say they convert 10% to paying Apple Music subscribers.

That's roughly 80 million subscribers, a mix of individual and family accounts, maybe the average subscription winds up being $11 a month. That puts Apple Music's annual revenue around $10.5 billion, which would be a 4% bump on trailing-12-month company revenue of $212 billion.

O'Reilly: Spreadsheets would have to be adjusted in Wall Street for Apple.

Lewis: There's something there. Yeah. In terms of the agreements they've entered with some of these music industry staples, Apple passes along roughly 70% to 73% of revenue to music rights owners, depending on the region they're in, and the listeners are accessing from. Maybe 1 to 2 billion gets passed out of the bottom line after some other costs. Again, maybe a 4% bump to Apple's trailing-12-month income.

O'Reilly: Yeah. You have an interesting thought regarding Amazon, which I'm very curious to hear your opinion on.

Lewis: Yeah. This is something I hinted at earlier when we were talking about the competitive landscape. My feeling is, if Amazon decides to really commit to building out its music library, it could totally destroy this space. You look at the catalogs that are available right now, and Apple is around 30 million, and Spotify is in that neighborhood, too. They have these very robust music catalogs. Amazon isn't even close.

I think they're in the low single digits in terms of what's available right now for listeners. But if you look at the value proposition, these services like Apple Music and Spotify, if you're on a premium account, it would run $120 for the year. You can get Amazon Prime for $100, and in addition to the music streaming you'd be getting unlimited cloud photo storage, free two-day shipping from Amazon, unlimited Kindle Book borrowing, and streaming online video.

O'Reilly: I'm glad you brought this up, because I'm a happy Prime customer. Not to plug anything. I don't own shares in Amazon. Although apparently I should. I use their music occasionally. I have the app on my iPhone, I stream over Wi-Fi music, and that's my only complaint. I really got the Amazon Prime for the free two-day shipping on diapers because I have 1 1/2-year-old son.

The Amazon is a nice throw-in, and I use the Prime streaming service on my television, and I would actually be willing to pay $4 or $5 extra a month if they got that music catalog. Amazon would own me. It would get nuts.

Lewis: That's a really comprehensive offering. The problem is, they're not there yet. I think The New York Times did this cool comparison across the major players in the music industry space right now, and they used four albums as a proxy for...

O'Reilly: The Beatles' 1 album was one of them, wasn't it?

Lewis: It was The Beatles, Abbey Road; Bruce Springsteen, Born in the USA; Kendrick Lamar, Good Kid, M.A.A.D City; and Taylor Swift, 1989.

O'Reilly: Boom.

Lewis: It was "Do these services have all four of these albums?" That's a good cross-section.

O'Reilly: No, it's awesome! My dad's got Bruce Springsteen, we've got Taylor Swift, you got Beatles; everything.

Lewis: Yeah. Amazon didn't perform well compared to the others. Their library is very limited. I think they had one or two of them. Granted, some of the others only had three, but if they want to they can really come in and disrupt this space, just because their offering is so much more comprehensive than the others.

O'Reilly: And they don't care about making money immediately.

Lewis: Right. For them it's truly an ecosystem.

O'Reilly: It is.

Lewis: Where they just want people in so they can order more on Amazon. That's the whole point of Prime, to boost the average orders that people have.

O'Reilly: They so have got me.

Lewis: I think one more interesting thing to note in the competitive landscape here -- and this is something I thought was super-interesting and had no idea about until I was doing some research for the show -- was this news piece I came across yesterday from The Verge. Apparently Facebook (NASDAQ:FB) has held talks with major labels about getting into music.

O'Reilly: I swear to God. I think the presidential election in the year 2032 is going to be the Democratic Party, the Republican Party, and Facebook, and they're going to be running a candidate.

Lewis: It's funny you mention that, because Facebook rolled out "I Voted" buttons.

O'Reilly: Oh, God.

Lewis: Last election cycle. They said people that were exposed to them ...

O'Reilly: This is bigger than the relationship status on Facebook.

Lewis: It boosted voter turnout.

O'Reilly: Oh my gosh.

Lewis: That's a beautiful thing. On the flip side ...

O'Reilly: Yay, democracy. Yay.

Lewis: You see the possibility for manipulation there.

O'Reilly: Naturally.

Lewis: Back on track. Facebook's reached out to some of the major labels. They met with Sony, Universal, Warner -- the big three in terms of representation, pretty much. There isn't any clear indication on what Facebook is planning on doing. It's more that they're beginning to have these talks.

O'Reilly: They're having the conversation.

Lewis: Yeah. So, I think it's interesting because Facebook -- it's hard to operate in this space without a paid subscription model. People that are using Facebook aren't accustomed to paying on that platform.

O'Reilly: No.

Lewis: Except for, maybe, people that are playing Farmville, or those free games that upgrades that you pay for.

O'Reilly: Even that.

Lewis: Yeah. The company isn't doing anything to monetize video content on the user side. Everything is ad-based.

O'Reilly: Right.

Lewis: So I don't know if they'd be able to leverage that approach over to streaming music.

O'Reilly: That's so tricky. I wonder what they're -- of course, I'm still trying to figure out what their game was with the WhatsApp.

Lewis: For them, similar to getting people on the platform and getting people stuck in an ecosystem with what Amazon's looking to do with music. I think it's probably pretty similar with Facebook. They're looking to keep people on the platform longer because it allows for more ad exposures, more engaged users. So the benefit there is tangential to what the actual offering is.

O'Reilly: Yeah. For consumers of music it seems like it's a great time to be alive. As investors, we don't know what's going to go down here.

Lewis: It's really hard to call the shots. There are so many big, disruptive companies in this space, and their incentives are all totally different.

O'Reilly: Right. Amazon wants you to order your diapers and stuff. Apple just wants to be part of the ecosystem. Spotify wants money.

Lewis: Yeah. You're almost seeing music become commoditized with this $10-per-month offering and saying, "How do you want to access it?" That's how you're going to access it.

O'Reilly: Wow. All right. Well, thanks for your thoughts, Dylan.

Lewis: Always a pleasure, Sean.

O'Reilly: Happy Fourth!

Lewis: You, too!

O'Reilly: For our listeners, if you're a fan of the show, we would love to hear from you with any questions or comments. Feel free to email us at focus@fool.com. Once again that's focus@fool.com.

As always, people on this program may have interests in the stocks that they talk about, and The Motley Fool may have formal recommendations for or against those stocks. So don't buy or sell anything based solely on what you hear on this program. For Dylan Lewis, I'm Sean O'Reilly. Thanks for listening, and Fool on!

Dylan Lewis owns shares of Apple and Pandora Media. Sean O'Reilly owns shares of Facebook. The Motley Fool recommends Amazon.com, Apple, Facebook, Google (A shares), Google (C shares), and Pandora Media. The Motley Fool owns shares of Amazon.com, Apple, Facebook, Google (A shares), Google (C shares), and Pandora Media. 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.