• by Diane Mermigas , March 21, 2008

It has become a familiar predicament for digital media innovators: how to leverage and grow new markets. So it is not surprising that Apple is seeking to boost the sale of iPods and iTunes content downloads by altering its pricing arrangements. Continuing to charge consumers, by any other name, could be a long-term mistake.

Eventually, Apple will learn--just as AOL did--that walled gardens and mobile interactive consumers don't mix. An unlimited bulk subscription for iTunes access to music and video may resemble an access charge more agreeable to consumers than individual download or rental fees. After all, consumers are accustomed to paying hefty bulk rates for cable TV service and may never have a la carte content options. While owning prime digital real estate has given companies like Apple the power to launch and kill trends, that gatekeeper clout is being tested as mobile devices and content services become ubiquitous.

As a result, Apple cannot ignore the signs from research firms such as eMarketer, which reports that mobile consumers prefer free content access and would be more receptive to sponsorships than advertising. Those surveyed said they could be enticed to endure ads by free downloads and electronic coupons. Apple also should listen to its own customers; 85% use the iPhone to browse the Web, 31% of whom use it to watch mobile video (including YouTube and television shows) and 20% o use it to access their social networks. Three-quarters of iPhone users listen to music on their smart phones. The statistics underscore the emergence of smart phones as the universal screen of choice to key demos.

Apple is hardly the first dominant market player trying to keep pace with business models that change as rapidly as the competition. Google has been a master at mining and partnering its dominant search position every which way to sell advertising and other services. A small but representative move was connecting Google Calendar to Nokia phones in much the way it seamlessly syncs with BlackBerry devices.

Apple's quintessential catering to the digital proletariat has worked so far. iTunes is second only to Wal-Mart in domestic music retail sales, with more than 50 million customers and 4 billion songs sold since it began in 2003. The profitable content download service has helped to drive the sales of more than 140 million iPods and 4 million iPhones. The growth of iPod sales recently has stalled in the face of increased competition and mainstream adoption.

With streaming music now a commodity, Apple is feeling the heat. A growing number of online retail and social network giants, including Amazon and MySpace, operate or are planning their own paid download or ad-supported free streaming music services. Music labels such as Universal Music Group are working directly with Nokia and other device manufacturers to offer consumers pre-loaded subscription services built-in to handsets. The $80 per handset license fee Nokia pays to music labels is as much as four times what Apple has talked internally about paying. Labels shutting Apple out of some DRM free music licenses hope to pressure iTunes into a more economically predictable subscription model.

There are pure economic reasons for considering a business model change.

Under the current arrangement, Apple theoretically makes an average $2 per each of an estimated seven music downloads per device--about the same as it would make from an annual $10 limitless download subscription--or $100 for a lifetime. In other words, Apple and other device gatekeepers are limited to income from commoditized content downloads, which makes sponsorship or advertising more appealing. Mobile gaming, still in its infancy, has embraced free, sponsor-supported content for the majority of the 98 million mobile users worldwide playing on their handsets, according to M:Metrics. Ad-supported mobile games will triple into a $16 billion global business by 2012, per Juniper Research.

With streaming video the next big thing in portable devices, Apple and others must create more sustainable business models. Apple TV, TiVo, Microsoft Media Center and other home hub convergence devices will soon be haggling over the same access and economic issues as streaming video floods the mainstream. Working out the logistics with music and video license owners is not a big deal anymore.

However, leading device makers, social networks and other virtual content brokers may be underestimating how quickly streaming music and video will become commodities that will forcefully change the economics from premium paid to free. For instance, while the new ad-supported Hulu service for online television programs has so far resisted licensing deals for iPhone and other devices, the several million in initial income generated should soon have partners NBCU and Fox begging for more.

There also is an underestimation by many players of the many new ways consumers will have their digital music and video-soon to grace the common likes of email, instant messages, chat rooms, blogs and video games. In fact, Apple may lose at least some of the digital licensing to The Beatles vast music library to Activision's Guitar Hero. With consumers more wedded to their mobile phones than to their televisions, according to the Pew Internet and American Life Project, and overwhelmingly downloading content by search name of content or artists, according to eMarketer, it appears Apple and other self-anointed digital gatekeepers have a lot of rethinking to do.