Apple's iPhone and iTunes and Amazon's Kindle are onto something very big.
Their approach to making the digital future financially viable represents as much of a psychological break with rampant free content practices as a template for conditioning consumers to pay for relevant content and valuable applications, especially for mobile devices.
Just as important, they dodge reliance on media advertising that will remain in flux as it evolves into interactive marketing and e-commerce. By 2012, the growth of user payments for applications and content will likely outstrip the growth of online advertising (at twice the rate, or an average annual 17%). Although user payments will remain just under 60% of total U.S. offline media, it will top 30% of online media spending in 2012, which advertising will continue to dominate.
This could begin to upset Google's dominance, since it commands more than 30% of the online advertising market but virtually no user payments or billing relationships, according to James Mitchell, analyst at Goldman Sachs. While it likely will remain the primary aggregator of all that is free on the Web, Google has the resources and traffic to only gradually emerge as a major participant in online content and apps through YouTube and the Android Market.
Despite having less traffic and market time, Apple's iPhone apps and Amazon's Kindle stores will generate more net revenue than Google's YouTube by 2010.
The impact of accelerating pay models cannot be underestimated: Newspaper publishers and studios will reconsider charging for online content, while enticing consumers to pay for the value and convenience of premium content and applications. Consumers' love of their devices and what they load on them could cripple the Freemium paradigm. The anticipated sale of half a million new 3G iPhones this weekend further expands the installed base and increases paid app transactions.
Diminishing the stranglehold that advertising buyers and sellers have on the media marketplace would be a dynamic change. It could force Madison Avenue to become more efficient and creative in connecting with target consumers and utilizing interactivity to its full potential.
Mitchell's intriguing math makes a surprisingly strong argument for why user payments will become a lucrative, reliable second-revenue stream generating 10 times to 30 times higher yields than advertising. A $2 download fee (on the likes of iTunes) could generate more revenue than the highest cost-per-thousand impressions (CPMs) broadly achieved on the Internet, which is about $20, or a mere $0.02 per impression. A TV episode could generate 33 times as much per viewer from user payments as from advertising, Mitchell contends in a new "Broadband 100" report.
As Internet usage becomes more sophisticated and ubiquitous, content will be released through many different pay windows, and online apps and services offered through many different tiers -- all supported by subscription fees, micropayments and other evolving monetization methods.
The risks are high in the absence of such efforts. At stake is as much as $300 billion in collective market cap of the media companies that are leading content providers, according to Media Metrics analyst Laura Martin. "Today, consumers are living in a fool's paradise. They have the best of both worlds: free, professionally produced [high-quality] content delivered over the Internet paid for by old business models, plus huge amounts of free user-generated content," Martin said. Striking the right balance between advertisers, viewers, platforms and technology will not be easy.
Digital books, music and video represent "a must-win for Amazon versus a nice-to-win for Apple and Google because physical media represents the majority of Amazon's revenue and earnings," Mitchell said. The speed and decisiveness of Amazon's Kindle and paid e-book downloads is undeniable. Kindle books could represent 20% of Amazon's total book unit sales by 2012, up from the anticipated sales of 42 million Kindle books generating nearly $400 million in revenues in 2009.
The difference between downloadable books comprising 20% book sales -- or 40% at a higher margin -- could result in as much as a 24% earnings swing for Amazon in 2010, Mitchell points out. The digital brass ring that eventually will boost Amazon's digital bottom line is that while unit pricing may be lower for e-books, dollar margins and earnings are higher.
Apple's market-leading user payment success is already familiar just three and a half years after its ground-breaking pact with Disney/ABC. iTunes could be 8% of Apple's total revenue in 2009, generating nearly $3 billion from music generally downloaded for $1 and TV episodes for roughly $2 each. Apple's App Store gross revenues could be 4% (or $1.7 billion) of the company's total revenues in 2010.
While it is not an Internet company, Apple has an ownership grip "on the entire hardware, software and content distribution stack and the tight integration between these three layers to monetize digital media and create barriers to entry for competitors," Mitchell observes.
Amazon has played to win in the interactive sandbox, creating an unparalleled template for affinity sales and profits. It also has excelled in moving physical media into the digital world by integrating efficient payment, process and delivery with the best of social networking and intuitive customized preference.
Like Amazon, Apple's hedge to the eventual explosion of open mobile operating systems and devices is rapid global expansion during the worst recession in decades. But their success in domestically shifting the focus to user fees surely will be the wind under the sails of other efforts. Time Warner already is pushing hard to tame the Web with a new pay paradigm of its own. TV Everywhere is a one-time payment for access to content and services on any connected devices and platforms, utilizing the billing and authentication systems cable, Telco and satellite providers have in place for 90% of the U.S.
Maybe free isn't such a done deal after all.