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MTV/Rhapsody Deal Confirms It: The iPod is Doomed

http://www.tdgresearch.com/tdg_opinion_mtv_rhapsody.html


TDG Opinions

The MTV/Rhapsody Deal Confirms It: The iPod is Doomed
Brion Feinberg, Ph.D.,Consulting Analyst

Download this TDG Press Release as a PDF

September 12, 2007

Last month, MTV and Real Networks announced a new music service partnership, Rhapsody America. By combining MTV's substantial media presence with Real's Rhapsody digital music service technology, the companies hope to compete with the iPod/iTunes combo that currently rules the U.S. market. But the kicker is the third partner in this new group - Verizon Wireless. Things are about to get interesting...

The Turning Tide

Although forecasts predict strong growth in demand for dedicated portable music players like the iPod, it is my belief that we'll soon see a telling shift in the types of devices that dominate this market. Within the next few years, demand for stand-alone portable music players will peak and begin to slowly fade into the background; within ten years, these devices will be relegated to museum shelves next to the vinyl LP and the 8-track player.

What will take the place of the iPod? Your mobile phone. Even Apple is aware of this inevitability, thus one reason for rolling out the iPhone. Yes, Apple will continue to introduce slight modifications and enhancements of the core iPod platform, but the iPhone represents the future of the iPod - just one feature on a mobile phone.

American Myopia

Given the size and wealth of the American market, it is hardly surprising that the U.S. has become the launching pad for most new technologies. Other than a few gaming systems or mobile platforms launched in Asia, nearly all media and entertainment technologies target the U.S. for initial product launch. Consequently, many analysts simply assume that as goes the U.S. market, so goes much of the industrialized world.

While this logic has some validity, it is not the case in regards to mobile technologies and services. For a variety of technology and political reasons, the U.S. has actually lagged much of the industrialized world when it comes to mobile services. For example, penetration of 3G phones in the U.S. is still significantly less than most other industrialized nations.

Making the Case for Music Phones

The battle to determine the future of portable music is far from complete, but the long-term outcome has been identified. The Diffusion Group will soon publish an analysis explaining our rationale, but here's a summary of key premises and conclusions.

1. Simply stated, mobile phones make great music players.

Many convergence technologies fail because the device in question lacks the performance, ease-of-use, or quality of more specialized, single-function devices. At this point in time, there are no fundamental technology limitations preventing the cell phone from becoming an excellent portable music player. Don't get me wrong - we aren't there yet. Today's music phones lack the ease of use of the iPod (although the latest LG Chocolate models now even include a scroll wheel much like the iPod wheel). And we still must address battery life issues. But the basic cell phone circuitry is fully capable of rendering music as well as any MP3 player.

2. Music phones are less expensive when compared to buying separate mobile phones and portable music players.

When converged devices work well, they are generally cheaper than purchasing separate products. To put it in really basic terms, if you must pay for two separate devices, you must bear the manufacturer's costs associated with two sets of power supplies, USB cables etc., as well as the costs associated with packaging and shipping. With converged devices, these costs are basically cut in half.

As well, consumers don't have to pay for two physical platforms and their unique storage and processing components. Sharing the power of these components for different uses is significantly more cost effective.

3. Convenience implies carrying one device is better than carrying two.

Consumers want to carry as few devices as possible, so one device that can deliver both music and telephony with the ease-of-use and quality of experience associated with stand-alone devices is preferable. In this case, a music phone trumps having to carry a separate phone and music player. Note that digital music capabilities do not require a larger phone (unlike converging PDA and phone services, which leads to more bulky phones that many consumers may resist).

4. Music phones will be less expensive than stand-alone music players.

Apple has established a remarkable monopoly of the U.S. portable music player space, cornering over 75% of the market; a position it earned by offering a superior product that is easy to use and delivers a high-quality music experience. To its credit, it Apple has used this position to establish artificially high prices for the iPod which it has been able to maintain despite the availability of less expensive alternatives. However, recent financial reports indicate significantly lower margins on recent iPod sales, a trend which leaves Apple with little room to lower the retail price of iPods.

In contrast, mobile phone vendors selling into the U.S. market receive heavy subsidies from mobile operators, thus leading to artificially low prices for highlyfunctional mobile devices. In other words, operators have room to increase the prices of their hardware and still remain competitive. As well, mobile operators can create compelling service/equipment bundles that paint the cost of the hardware even further below iPod list pricing.

5. Outside the U.S., music phones are already dominating.

Although the iPod/iTunes combo dominates portable music sales in the U.S., the same is not true in many other countries. In part, this trend is due to the rapid diffusion of advanced mobile devices, a development that has (to date) kept Apple from establishing a dominant position in these countries. In fact, Nokia alone sold more music phones in 2006 (70 million) than Apple sold iPods (46 million).

6. Flash memory continues to improve.

The original iPod relied on a small hard drive for storing music files. But over the past few years, flash memory has become more prominent. Using hard drives in mobile phones has not proven practical, due primarily to their size and the rough treatment many mobile phones receive. Although more expensive (per gigabyte) than hard drive-based storage, flash memory is now inexpensive enough to provide sufficient storage for most portable music needs.

A Long, Slow Decline

At the moment, consumers consider the ease of use and excellent integration of the iPod and iTunes hard to beat. Certainly no mobile phone service has to date offered a comparable experience. Given this entrenched position, the decline of this market will occur very slowly.

That being said, new mobile phone capabilities and improving PC music software such as Rhapsody are closing the gap. Nokia, LG, and Motorola still have much to learn about building good music players (can we please start with a 3.5mm stereo plug, so we can at least reuse our current headphones?). But again, these problems can be solved, as demonstrated by recent advances. And, in case you missed it, Nokia has already started positioning themselves as a music-oriented company (see its www.ticketrush.com web site).

Of course, Apple won't sit still and watch Nokia, Sony, and LG steal its market. Besides its obvious investment in the iPhone launch (you did hear about this, right?), Apple will continue to incrementally improve the iPod and even lower the price (as best it can). Despite such efforts, however, there is no denying that mobile music phones are about to change the game forever.

P.S. Verizon should leverage this new partnership to offer a variety of "free music" services to help expose their customers to the music capabilities of their mobile phones. To date, most U.S. consumers have little understanding of just how well their phone can play music and Verizon must use all means at its disposal to grow that awareness. Remember, Apple was able to build a business around the iPod because it helped to define the portable music player/online music service category (Apple wasn't the first to offer such a combination but they were the most effective). Verizon would be well advised to follow this example by initially focusing on building the larger product/service category (that is, establishing the mobile phone as a legitimate music player) rather than focusing on driving small, incremental revenues from music download services.

P.P.S. I've always thought that Steve Jobs was wrong about how much consumers want a music subscription service, with per-month subscription-based access to millions of songs rather than "permanent" access to fewer, purchased tracks. Given the domination of the iPod, the market feedback about subscription services has been masked. The move to phone-based music players, however, will even the playing field and I expect we'll see substantial interest in subscription services.

About the Author:

Brion Feinberg has over 27 years of experience working on software products and telecommunications networks. Besides his broad background in software development, consumer technology and digital networks, Brion specializes in business analysis and bringing new technologies to market.

About The Diffusion Group (TDG):

TDG is an analytics and advisory firm helping companies in the connected home and broadband media markets. Using a unique think-tank approach that blends executive-level consultants and in-depth market research, TDG generates reasoned and pragmatic insights that help clients make intelligent market decisions. TDG produces more than just research - we create Intelligence in Action®.


ENDS

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