Music Sells Everything But Music

(Because you haven’t read enough about the Apple/Beats deal, yet)

I was at the Sequoia Capital offices when the news broke that Google was buying Youtube. The atmosphere was celebratory, as you’d expect. Sequoia made something like a 40x return that day on a twelve-month old investment. On the other hand, the reaction of the business press to the $1.65B deal — by far Google’s biggest acquisition to that point — was mixed. Google “overpaid” for a highly visible company with plenty of competition and some obvious and interesting challenges ahead.

For the last three weeks my twitter feed has been filled with commentary on Apple’s acquisition of Beats Electronics. I’m surprised at how much of that commentary is negative. It seems obvious to me that $3B for Beats today is as good a deal as $1.6B was for Youtube in 2006. A very good deal, indeed.

I have access only to public information about Beats and Apple. But executives on both sides have been pretty forthcoming about what they’ve been trying to do separately and what they think they can now do together. Listening to both companies and connecting the dots, this deal is about three really big things: streaming and the cloud; making things work better for artists in a time of abundant content and cheap distribution; and making things work better for people who want to listen to music.

First, streaming. It really is about streaming. Many people seem incredulous that Apple, a company with eight million credit cards on file and a track record of creating great software, would buy a streaming music service with 250,000 users. This both understates what Beats has accomplished and misses some critical things about the dynamics of building great products.

Beats has 250,000 paying customers. From the beginning, Beats executives have been clear that they see “freemium” models for music streaming as unsustainable. They built a service people are willing to pay for, and, from a standing start, got to a $25M revenue run rate in three months. That’s a big deal.

Apple has a track record of being very selective about what they do “in the cloud.” They’ve got some great stuff, and some stuff that clearly suffers from not being a core focus for the company. I’d make the argument, though, that this is a watershed time for Apple and all of the other digital incumbents. Everything — all our content, our data, our application state, our communications — is moving onto the network, into the cloud. This is as big a change as the original shift from desktop computing to internet and mobile computing was.

There are many cautionary tales from recent business history that are relevant, here, but the one that comes most directly to mind is Microsoft’s slow but unmistakeable decline into irrelevance. Despite the fact that Bill Gates grasped the problem of “the internet tidal wave” clearly in 1995, still early days for the internet, Microsoft couldn’t find a way to evolve from a desktop computing company into an internet company.

Music, especially, and media, generally, gave Apple the leverage to become the dominant company that it is today. iTunes was revolutionary. The iPod was the first digital music player done right and embedded in an ecosystem that worked for people. The iPhone, which seems like such an obviously right piece of technology to us now, was mocked by tech and telecom executives (including Steve Balmer of Microsoft) when it launched. The iPhone was more like an iPod-that-made-phone-calls than it was like the phones that were on the market at the time. And that turned out to be the right thing. Music sells phones. And tablets. And everything else on the shelves at the Apple Store.

But the wheel turns. If Apple doesn’t get the cloud right it won’t stay dominant. It won’t even stay relevant. In the case of music, “the cloud” means streaming.

Beats Music is the first music service that led with a subscription model, focused only on streaming, and got to critical mass quickly. Apple understands that all of the disruption of the music business we’ve seen over the last decade is still only the tip of the iceberg. Beats is positioned to invent part of that future.

I’m old, so I still think about music as something I want to buy and own. For a century, we’ve lived in a technological and economic “moment” where it made sense for us to own copies of recorded music for personal use. Before about 1890, this was impossible. After about 2010, it was no longer necessary. People younger than I am expect to be able to access any music, instantly, from anywhere, and listen to it however they want. They don’t expect to pay for it, generally speaking. They don’t care about “owning” a copy of it, generally speaking. The ramifications of these changes in technology and in peoples’ expectations are enormous.

So how, in this new world, do artists get paid for making music? How do people find music they want to listen to? How do artists get exposure to people who might like what they’re doing?

The dream team at Beats has been thinking about these issues longer than just about anyone else. I recommend watching Jimmy Iovine and Eddy Cue on stage together at the code/conference. Iovine says that a central challenge, and opportunity, is to support artists in building a fanbase. Today, artists make almost all of their money touring. The economics of recorded music are already so far out of whack that producing a record is either a marketing expense or a labor of love (or maybe a little of both). But it’s not a way to make money.

So when they were building a new streaming service, Jimmy Iovine and Dr. Dre were thinking largely about how to create an economic context that would work better for artists over the long term. They hired Ian Rogers, who immediately prior to joining Beats to head up Beats Music founded a company to give artists tools for interacting with their fans. The Wired article about Ian is worth reading.

Today music, as Troy Carter has said, sells everything but music. If you’re a professional musician, you make money from concerts and t-shirts, media rights, licensing, endorsements, and special projects. You don’t make much money from your records, per se. But people love music just as much as they always have. That’s the puzzle Beats is trying to solve — that everyone in the music business will be trying to solve over the next couple of decades.

Apple just paid $3B for a company that sells $1B worth of headphones and speakers a year, has incredible credibility with artists, incredible brand recognition, and a streaming music service that’s aimed squarely at inventing the economic and cultural future of popular music. They got a team of extraordinary executives and a bunch of very capable engineers. Pretty good deal.

Some links from the past couple of weeks about Apple and Beats that I thought were interesting …. Walt Mossberg. Michael Vakulenko on Beats Music as an (economic) platform (Michael’s thoughtful piece reminded me of the Troy Carter quote I used as a headline). Ben Thompson on Apple as a fashion house (in terms of brand positioning and P/E ratios).