Can Apple Save iTunes?

In its earnings announcement last week, Apple said, “Apple leads the digital music revolution with its iPods and iTunes online store.” Had that sentence been written in the past tense it would have been more accurate.

The Wall Street Journal reported on Friday that worldwide music sales at Apple’s iTunes store have dropped 13% to 14% since the beginning of the year. If Apple had been leading the digital music revolution, it would not have had to pay $3 billion for Beats Music and it would not now be trying to persuade the companies that own the rights to recorded music to cut their royalty rates.

Shares of Pandora Media Inc. (NYSE: P) got beaten up Friday, even though the company did slightly better than expected in earnings and revenues. Where it failed was in subscriber growth and listener hours. That failure raised fear among investors that Pandora could be threatened by the new iTunes/Beats Music product that Apple is expected to launch next year.

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What tips the scale for Apple are 800 million active iTunes users. Pandora’s user count was less than a tenth of that. Spotify, a privately held streaming music service, claims around 40 million users and 10 million paid subscribers. Apple’s potential universe is huge, and if it can market a subscription streaming service successfully to those 800 million iTunes users, Pandora, Spotify and the other streaming services are going to be in real trouble.

Right now, neither Apple’s own streaming music service, iTunes Radio, nor Beats Music can credibly claim any real success on its own. Nor is there any guarantee that a marriage of the two will perform any better. The odds are definitely stacked in Apple’s favor, though.

Two things need to happen. First, Apple needs to badger the record labels into cutting their royalty rates. This will not be easy, especially because the labels believe the late Steve Jobs got the best of them back in the day and they are not about to let that happen again. Second, the iTunes/Beats product has got to offer something that consumers really want and that they can’t get anywhere else. Whatever that “something” is, it won’t be cheap. But if Apple wants to lead the digital music revolution again, the company will pay.

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