1 Downloadable Music Industry Ryan Herring Jinghua Luo Kevin Mack Shahram Rezaei

2 Standards Downloadable music files are generally available in three formats: MP3 (MPEG-1 Audio Layer 3) AAC (Advanced Audio Coding) WMA (Windows Media Audio)

3 MP3 Became ISO standard in 1993 Supported by a large variety of software and hardware Popular in peer-to-peer file sharing, but not in commercial downloads Thomson Consumer Electronics, which controls MP3 patents, decided to charge licensing fees for MP3 encoders and decoders in 1998 Potential lock-in led to proprietary alternatives

4 AAC Designed as an open-source successor to MP3 and became an ISO standard since 1997 Less widely supported than MP3 Apple: iPod and iTunes Sony: PlayStation Cell phones from Nokia, Motorola and Sony Ericsson Apple’s market share: iPod: 74% iTunes: 85% Dominant standard in commercial music downloads Apple has developed proprietary extension to the AAC format, leading to interoperability problems

5 WMA Proprietary format developed by Microsoft to avoid the licensing issues associated with MP3 patents Widely supported by a large variety of portable players and online music stores Direct competitor against Apple’s AAC but is still the minority

6 Prospects Standards war between Apple’s AAC and Microsoft’s WMA MP3 continues to dominate peer-to-peer file sharing until a winner from the standards war emerges AppleMicrosoft Control over an installed base of customers X Intellectual property rights XX Ability to innovate XX First-mover advantage X Manufacturing abilities X Strength in complements XX Reputation and brand names XX Key Assets:

7 Pricing Downloading a song costs $0.99, almost everywhere legal on the web. Cheaper for album Wholesale music price is ~65c/song. Originally set artificially low in a bid to stimulate demand. Apple sells 84% of all songs sold online. Plus 75% of all music players

8 Subscription Apple competitors trying subscription base music downloading

9 Switching Cost In order to increase switching cost, providers ask for annual subscription. In addition, users require installing music engines. The music engine: 5 MB, 11 MB and 32 MB for Yahoo!, Napster, and iTunes, respectively.

10 Apple, One Year after iPOD Apple’s revenue was $2 billion at end of The company's net income grew to $63 million, compared with a net loss of $8 million last year. iPod and iTunes represent roughly 9 percent of revenue, they are expected to eventually account for more than 50 percent of Apple's revenue.

11 Apple, Present (Source: CNN, October 12, 2005) In the last fiscal quarter, about 6.5 million iPods were sold. Accounting for nearly a third of Apple's revenue. 75 percent revenue gains on its iPod and record profits The company's net income rose to $320 million, up from US$61 million in the year-ago quarter.

12 Why just iTunes & iPOD? Success of iTunes Music Store (iTMS) is due primarily to: Great digital rights management (DRM) The 99¢ per track song price. iPOD’s success because of: Great Physical Design Software & Syncing Music Store One source for all kind of supports

13 Download Price Going Up? CNN, February 28, 2005: The major record labels (Sony Music, MEI Group, Warner Music, Universal Music, Bertelsmann) are in talks to raise the price they charge online retailers. Similar increase rumored last spring Apple disagrees!

14 Network Effects and Lock-In iPod's large market share means recording industry forced to sell through iTunes. Access to most songs means consumers attracted to the iPod over other players.

15 Apple's Competitors Subscription based music downloading RealNetworks (Rhapsody) Napster Yahoo! Generic MP3 players Creative Samsung Others...

16 Complements Large, cheap supply of content available through iTunes means increased sales of iPods Large, cheap supply of generic portable players means more potential customers for other content providers (Napster, etc.)

17 Microsoft, RealNetworks Partnership Microsoft increases number of Windows Media Player users Microsoft can more easily control piracy RealNetworks obtains access to MSN customers Can increase subscription orders Good example of “Co-opetition”

18 “All-in-one” Devices Cell phone, PDA, music, video, , internet all in one device Industry consolidation Apple now providing video on iPod, iTunes on cell phones Microsoft, Palm create the Treo 650 Companies can't be one dimensional

19 Intellectual Property Copyright is the primary protection for musical works Protects original works of authorship fixed in a tangible medium Copyright owner has the exclusive right to reproduce the copyrighted work Copyright protection extends to two elements in a sound recording: (1) the contribution of the performer(s) whose performance is captured and (2) the contribution of the person or persons responsible for capturing and processing the sounds to make the final recording.

20 Online Piracy When a user downloads copyrighted music without permission, the user is violating the exclusive right of the recording company and the artist to reproduce the copyrighted work. The Recording Industry Association of America (RIAA) estimates that each year the music industry loses $4.2 billion to piracy worldwide. Availability of low-cost downloadable music and threat of lawsuits are primary means of combating online piracy.

21 The No Electronic Theft (NET) Act of 1997 Sound recording infringements (including by digital means) can be criminally prosecuted even where no monetary profit or commercial gain is derived from the infringing activity. Punishment in such instances includes up to 3 years in prison and up to $250,000 fines. The RIAA is planning to use the Act to prosecute illegal music downloaders in the near future.

22 Digital rights management (DRM) DRM, often referred to as copy protection, limits what functions a user may perform with digital media. Apple, for example, reserves the right to change at any time what you can do with the music you purchase at the iTunes Music Store. For instance, in April 2004, Apple decided to modify the DRM so people could burn the same playlist only 7 times, down from 10. Microsoft, similarly, utilizes Microsoft's Windows Media Audio (WMA) DRM. The future: Sony has announced that it plans on shipping CDs with DRM built-in. DRM has become and will continue to be an essential element to control access of downloadable music.

23 Conclusion Apple Microsoft Online music stores Music labels Consumers Generic MP3 players