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Why music won’t be Facebook’s next billion-dollar business June 27, 2011

Posted by David Card in Uncategorized.
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Last week Om broke a big story on Facebook’s plans for music. We’ll likely see more details at Facebook’s upcoming developer conference, but as Om describes it, Facebook’s scheme sounds cool, and music is a natural fit for the dominant social network.

Om described a Facebook music dashboard that will accommodate multiple third-party digital music services from companies like Spotify, enable music streaming while still in Facebook, and incorporate sharing, recommending and syndication technologies like Connect and Like buttons. Such a platform has great promise for increasing Facebook usage, especially since music, unlike video, encourages background listening. A platform like this one also offers potential user lock-in through habitual usage or a third-party music collection locker. And all without Facebook having to do complicated licensing deals with record labels and music publishers.

But it will be tough for the company to cash in big on music for the following reasons:

  • There is a limited subscription market. Facebook probably wants a cut of revenues from digital music partners. But on-demand music services like Rhapsody and Napster have never gotten more than a million subscribers each at $10 to $15 per month prices. Spotify, which needs to sign all the labels before entering the U.S., has a lot of momentum in Europe, but it faces the same tight market. I go into detail in this post, but it will be difficult to convince music fans to change from a model where they mix radio and personally owned music to a rental model. Total, there are probably five to seven million prospective customers.
  • Facebook doesn’t charge rent. Remember the portal tenancy deals AOL used to extort from startups back in the day? Some music startups – I’m talking about you, Spotify – have paid up-front fees (funded by VC firms) to music rights holders, and they might do the same for premium positioning on Facebook. But Facebook has never directly charged its partners for placement or for using its platform, choosing instead to cultivate an ecosystem of companies with Facebook advertising nearby. Apps companies, social games, retailers and brands all get this free ride. And a music “real estate” model wouldn’t be sustainable without big digital music revenues.
  • The margins in music sales are low. Years ago I did analysis that suggested royalties and credit card fees ate up about 85 or 90 cents of a 99-cent single. Like PayPal, prepaid Facebook Credits could cut the credit card costs by a third, but not if Facebook wants its usual 30 percent cut. Albums or bundles of singles can also reduce the impact of per-transaction credit card fees, but they’re not the dominant digital music package.
  • It hasn’t prepared for the best advertising opportunity. The most natural music ad opportunity is in audio ads that play between songs, like in radio. Radio networks (CBS, Clear Channel) and Pandora are working hard on online audio ads, but it’s a small market so far. Facebook could do ad insertion and create an audio ad network, but it would have to start from scratch. But it hasn’t even done anything similar for the much larger display ad opportunity in apps or on its Likes network.

Facebook’s best business opportunities around music build off its existing advertising business. The company is getting smarter about brand advertising; for example, it recently launched an advisory council to better schmooze with brands and agencies. But it hasn’t created any fancy ad formats or sponsorships. Youth marketers like Pepsi, Coke, and Nike would jump on a rich-media sponsorship app that deeply integrated music sharing or listening, like the old My Coke Music. Facebook’s audience would be much bigger.

If any of its music partners can make money, Facebook will no doubt wean them off viral communications that run in its News Feed. Then it could steer them toward complementary advertising, just like it did with social games companies like Zynga. But that’s “if” they make any money.

Question of the week

How can Facebook make money off music?

Updated: 4 reasons Pandora could win the fight for digital music June 20, 2011

Posted by David Card in Uncategorized.
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Updated. After nearly 11 years as a “startup,” personalized radio provider Pandora finally went public last week, raising over $230 million and debuting with a valuation of over $3 billion. It may be a labor of love, but with its focus on radio, Pandora has a better chance for mass adoption than some of the other new digital music services. Yes, I’m talking about those from Apple, Amazon, Google, Turntable and the will-it-ever-launch-in-the-U.S. Spotify. Pandora delivers a better radio experience while most of the others are aiming at a mythical “jukebox in the sky” that many users won’t need. Plus, other digital music services are trying to change, rather than enhance, well-established music listening and buying behavior.

True believers in digital music dwell on that vision of the jukebox in the sky capable of delivering any song to any device on demand, usually powered by a subscription “rental” business model. Rhapsody and Best Buy’s Napster have come closest to delivering that model in the U.S., but neither has ever been able to attract over a million subscribers at a $10 to $15 per month price. Spotify is building the same thing in Europe, with an ad-supported freemium twist to incite trial.

Chances are that Google’s and Amazon’s cloud-based music lockers — which today only give a user streaming access to his own uploaded collection — have plans to expand into the on-demand space. Apple appears more conservative. Today Apple is a digital retailer with a brand-new service for synchronizing local, rather than cloud, music storage.

On-demand streaming at the price that current royalties require faces a limited market opportunity in the U.S. I’d estimate it is five to seven million subscribers. Here’s the reasoning behind that seemingly conservative number. Pandora quotes convincing data that shows 80 percent of music-listening time is spent with radio rather than one’s own collection, and most of that listening is done in the car. I did surveys at Jupiter Research that showed that music is a relatively passive background activity for most people, and that their tastes aren’t very eclectic. Most people listen to the same genres and artists they listened to in high school or college.

Likewise, although everybody listens to music, nearly half of Americans don’t buy any, and of the remainder, 25 percent account for 75 percent of the spending. A relatively small number of heavy buyers spend $200 a year, while all the other spenders buy the equivalent of a CD or two. Even a $5 per month service is historically more than most people will spend on their own music. Yet satellite radio provider SiriusXM has over 20 million subscribers paying $13 to $17 per month.

So here’s why Pandora may catch on faster and ultimately gain more customers than some of the other contenders:

  • It’s catering to the masses. Most people listen to a programmed mix of artists organized by genre (i.e., radio). Pandora has genre channels as well as personalized channels that are even more tuned to a user’s favorites.
  • It has a radio business model, with premium upside potential. While Pandora has a $12 $36 per month subscription service, 85 percent of its revenues come from its free, ad-supported product.
  • It doesn’t depend on people shifting from ownership to rental. Users can still buy all the music they want to own from iTunes or Amazon. The “on-demand access to everything” pitch from Spotify or Rhapsody is geared to making people shift their yearly music spending to monthly rental. And it’s still more expensive.
  • It doesn’t need to integrate everything. Though it seems appealing to bundle music discovery, passive and on-demand listening, and collection management, that hasn’t proven to be a killer combo for Rhapsody.

Pandora’s product and business model are aligned with existing consumer behavior, and they are adapting to mobility well. Pandora itself doesn’t have to work as hard as companies trying to justify the jukebox in the sky, and it doesn’t require as much effort from its audience as some of the new social music experiences. Pandora is taking the easy path in digital music.

Question of the week

Which digital music service will gain the most traction?

How Groupon could turn a profit June 6, 2011

Posted by David Card in Uncategorized.
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Groupon’s prospectus for an IPO valuing it as high as $30 billion stirred controversy around the company’s explosive growth and huge losses. Silicon Valley wants Groupon to look like a technology company, but right now the company is basically in the Yellow Pages business, and until it starts successfully using data gathered from its sales and massive customer base to offer better personalization and targeting, profits will be scarce.

Groupon revenues grew from zero to $713 million in three years — and $645 million in 2011’s first quarter — but it lost $456 million last year and $147 million in the first quarter of 2011. Aside from international acquisitions, the big expenses driving those losses are staffing, especially in sales, and marketing spending. According to its S-1, Groupon has over 3,500 salespeople and over 900 editorial staff writing up its clever, quirky offer emails. It spent over $250 million on marketing in 2010 and a whopping $208 million in this year’s first quarter.

Looking at Groupon’s quarterly data, I see a flat to slightly down trend in deals sold and total revenues per subscriber. Meanwhile, marketing spending per new subscriber added is more than doubling. With competition increasing and the novelty of daily deals wearing off, customer acquisition costs will only go up.

While the cost of entry to any single daily deals market is low, the cost of scale across cities and countries is enormous. Groupon’s spending on growth hasn’t produced any economies of scale nor network effects. It has yet to show that adding additional consumers or merchants increases more than proportional value to its network, or that it can lock in either type of customer.

Groupon needs to increase its revenue per customer, both on the consumer and merchant side. Its 83 million subscribers have bought 28 million Groupons from nearly 57,000 promoted merchants. Number two daily deal player LivingSocial has 28 million subscribers. So Groupon should be better able to achieve a network effect by analyzing all of its data on consumer interests and purchases to craft better, personalized offers and deliver them to targeted audiences. That should generate more purchases per customer. Groupon’s data analysis should lead to better marketing insights on customer habits and preferences that it could deliver as a service back to its merchants.

But deal aggregator Yipit interprets declining sales per customer in a mature Groupon market as signs that Groupon’s personalized offers aren’t working well yet. Groupon needs to shift some of that customer acquisition spending towards big data analysis to make sure its network effects kick in. It’s about to face big, data-savvy competitors.

How the competition stacks up

Groupon’s business is not for the faint of heart, or, really, for new startups. Its competitors are the big guys, each of which has a major differentiator or two, balanced by a weakness:

  • Google has buying intent data from search and the analysis skills to apply it to offers. Google can also supply a variety of other marketing and advertising services to merchants along with daily deals. That’s why I thought a Google-Groupon merger made sense, because Google has only a small local sales force.
  • Amazon, which has an investment in LivingSocial and is testing reselling deals, is also wise in the ways of data. Of course, Amazon is the dominant force in e-commerce. But so far, daily deals are more about marketing than buying, and Amazon only dabbles in advertising.
  • Facebook has a distribution channel for deals but no local sales force. So it is aggregating deals from other companies and focusing on entertainment-oriented offers that appeal to groups of friends rather than deep discounts.

What’s next?

In addition to dialing up the data analysis, Groupon needs to add more services for its sales force to sell. But unlike Gilt Groupe, which is getting deeper into online retail (a business that scales less efficiently than technology-driven marketing), Groupon should add products for its merchants. Just like Yellow Pages companies such as YP.com and Superpages, Groupon should buy search and display advertising for its merchants: The company is well equipped to do the targeting analysis that would baffle a local small business.

Groupon should also help its merchants with their customer retention and loyalty programs with “brick and click” points and check-in programs. The company is testing mobile offers, but why not just buy Foursquare? Groupon could maintain the brand and probably triple Foursquare’s audience while adding its local sales force to Foursquare’s budding national advertiser business. By adding data-driven products and services for both its consumer and merchant customers, Groupon should be able to squeeze healthy profits out of its massive sales.

Question of the week

How can Groupon cut its losses?