Ian Rogers, the head of Apple's (NASDAQ:AAPL) online radio strategy, has resigned only two months after leading the launch of Beats1 Radio, the flagship station of Apple Music. Rogers, a music industry veteran who worked with the Beastie Boys prior to joining Beats, will leave Apple to work in a completely different industry in Europe, according to the Financial Times.
Beats1 Radio stands out from Apple's genre-specific radio stations because it features exclusive content, interviews, and guest presenters. It enables Apple Music to stand out from the competition while relying less on music that requires royalty payments. Prior to his departure, Rogers poached popular DJ Zane Lowe from BBC Radio 1 and signed top artists like Pharrell Williams and Elton John to host their own shows.
Within the first month, 11 million people signed up for a free Apple Music trial -- giving it lots of momentum to challenge Spotify, which has over 75 million active listeners, and Pandora (NYSE:P), which has nearly 80 million. But now that Rogers has unexpectedly left Apple, can its online radio efforts remain on track?
Why Apple Music matters
Apple launched iTunes over a decade ago, and it became the largest music retailer in the world by 2010. However, a shift toward streaming started with the arrival of Spotify in 2008. According to Nielsen, sales of digital tracks in the U.S. fell 13% annually last year as the number of streamed tracks surged 54%. Today, Apple sells up to 85% of all digital music downloads on the planet, but Spotify has an 85% share of all paid streaming music worldwide.
Apple adapted to this shift by launching iTunes Radio in September 2013, which gained 20 million active users in just over a month, although it wasn't clear how many used the free and subscription-based ad-free tiers. However, Apple hasn't provided updated numbers since then, and the introduction of Apple Music suggests that iTunes Radio wasn't popular enough to challenge Spotify.
Apple claims that 79% of its 11 million Apple Music trial users still use the service and will likely pay $9.99 per month after the initial three-month trial concludes at the end of September. However, industry analyst MusicWatch claims that the retention rate is likely only 48%. Moreover, the firm claims that 61% of current Apple Music users have reportedly turned off the auto-renewal option for the service, which could result in a big drop-off in users in October. Ian Rogers' departure is curious because it comes right before that transition, indicating that the service might not have been as successful as Apple had hoped.
More challenges ahead
Apple Music's main advantage is that it connects streaming stations to digital purchases on the iTunes Store, giving it considerable clout in negotiating royalty fees with record labels.
However, royalties still swallow up over 70% of Apple Music's revenue, according to Apple executive Robert Kondrk. That puts it squarely between Pandora, which paid out 50% of its revenue as royalties in the first six months of 2015, and Spotify, which paid out 82% last year. Neither Pandora nor Spotify is profitable, which raises doubts that Apple Music can make a meaningful contribution to the company's bottom line.
Another challenge is that listeners prefer ad-supported free music over subscription-based music without ads. Spotify's 20 million paying listeners represent less than 30% of its total listeners. The majority of Pandora's nearly 80 million active listeners also don't subscribe to its ad-free Pandora One service. Without a free tier, Apple Music will lack an entry-level option (besides ad-supported iTunes Radio in the U.S. and Australia) to attract new listeners.
Apple was also recently hit by antitrust charges in the U.S. and Europe regarding allegations that it leveraged the market dominance of iTunes to persuade record labels to remove their songs from Spotify's free tier. To make matters worse, Taylor Swift called Apple's decision to not pay royalties during the initial three-month trial period "shocking" and "disappointing," forcing the company to agree to payments in late June. Those PR missteps could adversely impact Apple Music's reputation with customers, artists, and record labels.
The key takeaway
Last quarter, Apple's iTunes revenue rose less than 4% to $2.7 billion, due to the slowdown in digital downloads, and accounted for just over 5% of the company's top line. If Apple Music is a hit, sales growth could return and fuel more music purchases on iTunes.
But if Apple Music flops, it could fall further behind Spotify, Pandora, and other streaming rivals. It will also lose another potential way to diversify its top line beyond the iPhone, which accounted for over 60% of Apple's top line last quarter.
Leo Sun has no position in any stocks mentioned. The Motley Fool owns and recommends Apple 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.