Micropayments Redux at the iTunes Music Store

by Scott Loftesness on May 23, 2003

in Scott Loftesness, Writings

By Scott Loftesness

I’ve been playing with the new Apple iTunes Music Store with my Mac OS
X iBook—including buying some new (actually, old) music! In addition
to rediscovering some favorite songs, I’m also exploring how Apple has
tackled the micropayments problem using old-fashioned credit cards.

First Impressions are Lasting Impressions

During my first session of playing with iTunes right after downloading
the upgrade, I fell victim to Apple’s recommendation engine—you know,
others who liked this particular artist also bought x, y and z. In my
case, I somehow ended up at the Everly Brothers aisle in the store—like
a lot of times on the Web, you can’t recall how you got there but there
you are. After listening to a couple 30-second cuts of that oh-so-sweet
Everly Brothers harmony, I bought a few of their old songs for 99 cents
a track. 1-Click and they’re here. I can listen to them as many times
as I want, move them around my local home network, and burn them into
my own CDs. Very cool. I may have those Everly Brothers CDs somewhere
around the house but a) I can’t find them quickly and b) it takes me longer
to rip the songs off the CDs than downloading the tracks from the Music
Store. Like most consumers, I’m willing to pay a fair price for convenience!

The iTunes Music Store doesn’t have every song ever recorded—it
is missing a number of major recording artists, as well as many emerging
talents—but with over 200,000 songs from the world’s 5 largest recording
labels, Apple’s catalog is comparable to other online music catalogs and
complete enough that I could find much of the music I like.

I also wasn’t bothered by Apple’s approach to "digital rights management"
of my purchased content. It’s so lightweight as to be perceived as not
even being there for honest folks who simply can’t be bothered with trying
to share music over peer-to-peer file sharing networks. I can mix and
match my downloaded music tracks into an infinite variety of playlists
and effectively burn as many CD’s as I want. It’s a near perfect tradeoff
of protection for the music industry while giving me the freedom and convenience
I need with my music.

Apparently, there are lots of other Mac users just like me. Apple issued
a press release about success the iTunes Music Store during its first
week of production. It that week, the Store sold over 1 million songs
with over half of the songs sold being sold in bundles called albums.
A little later, Apple announced over two million songs had been purchased
over the sixteen days since the Store debuted online. Once again, over
half of the songs purchased were purchased as albums. Apple says these
album sales help demonstrate to the music industry that individual per-track
song sales won’t seriously undermine album sales.

What’s behind this success? In my mind, it’s not any one component so
much as it is the combination of:

  • Adequate catalog. Large enough to carry something that meets
    everyone’s personal tastes (just like the local music shop.)
  • Full quality sampling. A 30 second preview of what you’re buying
    before you buy it.
  • Per track or per album sales model. Doesn’t require a subscription
    or long-term financial commitment (just like real life.)
  • Lightweight rights management. Gives consumers the flexibility
    to legally use the music they buy (just as if they bought the physical
  • One-click purchasing. Complete simplicity, as licensed from

While Apple didn’t invent downloadable premium music, the company understands
the importance of offering convenience and a truly great consumer experience.
And I appreciate being treated like a music fan—not a potential criminal.

Deconstructing the Model

But is there a business here? Let’s do the math on the Store’s early
success. If we say that an average album has 10 tracks and that 1,000,000
of the 2,000,000 songs sold were in albums, then there were about 100,000
album purchases since the Store opened. That leaves 1,000,000 individual
song purchases.

The 100,000 album purchases should generate roughly $1,000,000 in revenues
for Apple. Likewise, the 1,000,000 individual songs generate about an
equivalent amount of revenue. For a total of $2 million in revenues for
Apple from the Music Store’s first sixteen days in business—for an
average gross revenue of $125,000 per day.

Interestingly, Apple’s average sale amount would be $2 million divided
by 1,100,000 or about $1.82 with the distribution being totally bi-modal
around $10 and $1. That’s except for one other factor: Apple’s Music Store
fine print says purchases may aggregated within a 24-hour period so that
they’re posted to your credit card account as a total for the period,
not as individual song purchases. This technique helps drive the actual
average ticket amount much higher. For example, in my personal case, I
bought one track on Monday for $0.99 and 5 tracks on Friday for $4.95
for an average of $2.97.

So, what starts out looking like a micropayments transaction at 99 cents
per track, actually beefs itself up because of this smart daily aggregation
of purchases. As a result, the fees Apple pays for its Music Store credit
card processing are actually a much smaller percentage of the sale amount
that it might at first appear.

Most credit card merchants pay their merchant acquiring bank a combination
of a per transaction fee plus a percentage of the purchase amount. As
an example, let’s say Apple’s merchant agreement for bankcard acceptance
is priced at 2.2% plus 15 cents per transaction. On a 99-cent purchase,
those fees would total 17.2 cents or 17.4% of the purchase amount. On
my 5-track day, my $4.95 aggregated purchase cost Apple 26 cents or 5.3%
of the purchase amount.

Of course, as a consumer, I could care less what it cost Apple to process
these payments. While some in the payment industry may have angst about
the costs associated with handling small purchase amounts, consumers know
that the system just works and, when something as convenient as the Apple
iTunes Music Store is the merchant, small purchase amounts work just fine.

Future Prospects

How big a business might the iTunes Music Store become? It’s already
running at roughly a $50 MM revenue/year run rate coming out of the gate.
And this is only from the small community of Mac enthusiasts like me who
just have to play with almost everything Apple does. Let’s say that opening
the Music Store up to Windows customers adds 10X the volume—that
would drive annual revenues into the $500 MM range, perhaps higher.

While some analysts have questioned the relevance of iTunes to Apple’s
bottom line, I believe the upside is substantial. As a standalone business,
the market capitalization of iTunes might be $1 to $2.5 billion depending
on a potential investor’s view of the likely growth rate. Not bad for
an online business that didn’t even exist a month ago.

Break On Through To The Other Side

Although the iTunes Music Store is off to a strong start, it’s easy
to see why music industry executives see the Store as an experiment. Extending
platform coverage to Windows users is a given and will drive purchases
to the next level. But to maximize the Store’s full economic potential,
Apple will need to push hard on a number of fronts:

  • Catalog size. With some notable additions—and some high-visibility
    exclusive tracks—the Apple catalog is still more or less comparable
    to other online music sites. While 200,000 plus tracks might sound comprehensive,
    there are actually over 20,000,000 tracks listed in the full CDDB (Compact
    Disk Database). Apple needs to strive for full catalog coverage. Would
    Amazon have been successful if it came out of the gate with only 1%
    of the books in print for sale?
  • Age restrictions. By restricting purchases to individuals 18
    years and older, Apple is blocking an important demographic segment
    of the music buying public. Indeed, until Apple opens up the Store for
    teens, the peer-to-peer file sharing services are likely to remain the
    dominant sources of music. Apple would be wise to explore co-marketing
    arrangements with RocketCash, Visa Buxx, and other teen-oriented payment
  • Market coverage. With 60% of the worldwide spending on music
    done outside the U.S., Apple needs to open up the Store to exploit the
    full reach of the Internet. We suspect that a more international audience
    will demand a more comprehensive catalog.
  • Features. While song-specific recommendations (based on what
    others have purchased) are a great start, there is so much more that
    Apple can do to drive sales. Beyond recommendations based on aggregate
    downloads, Apple could use branded playlists to drive purchases. In
    addition to searching by artist, albums, composers, and songs, extreme
    fans will want to browse and search by their favorite producer, vocalist,
    or supporting musician.

Has Apple broken the code on micropayments? Yes and no. The success of
the Store demonstrates that there is a broad market for premium content—sold
ala Carte, immediately accessible, and fairly priced. In this sense, the
Apple iTunes Music Store is the best micropayments proof point to date.
Its success should encourage others to pursue similar models or to provide
a cross-merchant micropayments infrastructure. The door is wide open.

Publication History

Initial Publication Date: May 27, 2003

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