Is Nokia monkeying with music’s future?

By Mickey Alam Khan

June 4, 2008

She hears a good deal

That’s the question Forrester Research posed in a new report on the implications of Nokia’s decision to offer unlimited music subscription services through the handset.

Nokia’s ambitious “Comes With Music” program is a great deal for Nokia handset owners: they get to keep what they’ve downloaded even after the subscription has expired. Not only will Nokia sell more handsets, but consumers will stand to own a massive – albeit device-limited – music library and the music industry will get a short-term revenue infusion by sharing proceeds with Nokia.

“But a lack of clarity over subscription renewal pricing and where money is flowing between business partners means it is difficult to predict the long-term profits from this scheme,” said Paul Jackson and Charles S. Golvin in their report.

“Nokia needs to make clear all the pricing details to support its argument that this is indeed a better, or the only viable, alternative for its music-label partners than today’s declining physical sales and lower income from paid downloads and subscription services,” the authors said.

A Finnish handset maker, Nokia is now covering all its bases in mobile. The Espoo, Finland-based company has launched a mobile ad network and is heavily involved in mobile games and video. With its latest effort, there’s no doubt that “Comes With Music,” or CWM, will change the rules of the consumer music market.

... And a lot of baggage

Nokia on April 22 said that Sony BMG has agreed to join Universal Music Group in supporting its upcoming CWM program. With these record labels on board, Forrester estimates that CWM will have 60 percent of the global music catalog under its belt at launch later this year.

The current models to buy individual track downloads involves transactions with Apple’s iTunes and Nokia’s music stores or via subscription services such as Rhapsody or Napster. CWM is different.

Music to consumers’ ears
Here’s how it works. Consumers buy a Nokia CWM handset, which most likely will be the more expensive Nseries phones or a music-focused Nokia 5220 XpressMusic.

CWM handsets may also cost more compared with a standard device or Nokia and its partners may subsidize the music to gain a wide audience.

Once the consumer has the Nokia handset, he or she can download tracks from the library either to a computer or sideload the songs to a CWM phone or directly to the phone over the subscriber’s wireless carrier network.

The Nokia handset owner pays nothing for the downloaded music in the first year. Thereafter, the consumer can pay a fee to continue the service. Nokia hasn’t announced the pricing structure or the frequency of renewal.

Also, consumers can pay an unspecified track upgrade fee to Nokia to burn the downloaded music to a CD, freeing them of DRM constraints.

So the three key differentiators between the CWM service and other mobile music downloads as Forrester has identified are an all-you-can-eat plan with no limits and retention of the music after the subscription has run out or is cancelled.

On the downside, consumers can only play back music through a single computer that has been authorized along with the individual CWM handset. With Nokia reauthorization, subscribers can substitute handsets that are broken or lost or computers that don’t work or have crashed.

Nokia is positioning the CWM service as a bridge between a track-download store and music services integrated into Ovi, the company’s all-in-one portal for computer and phone services including music, video, gaming and normal phone functions.

Discontent
As described in the report, Nokia believes it has potentially changed the future of music buying and consumption forever.

CWM can work. But not many parties in the mobile ecosystem will benefit, according to the Forrester report.

“Forrester’s take is that this service could indeed be very popular with consumers buying a new handset, provided it is really cheap,” Messrs. Jackson and Golvin said. “Those consumers who listen to music on their phones already use many different options to access and listen to music.

“It will certainly be popular if it ever launches in emerging BRIC [Brazil, Russia, India and China] markets, where mobility and digital music are still a wide-open growth opportunity,” they said.

However, the potential for content industry disruption and consumer confusion is huge, per the report.

First, Nokia will certainly win more handset sales, but at what cost? Let’s say that CWM handsets sell for a moderate price premium, especially in markets where digital music download is nascent. Consumers will opt for these devices over competitors.

For instance, 7 percent of U.S. and 17 percent of European online consumers already use their mobile phone for music playback. Nokia claims that a significant number of these consumers are dumping their dedicated MP3 players for Nokia’s Nseries “multimedia computer” handsets.

“What is as yet unclear is how much Nokia will pay the music industry for this,” the report said. “Nokia could break even on a flat, one-off fee plus a share of hypothetical subscription revenues.

“But if the deal obliges Nokia to pay for usage/downloads over a certain predefined level – always a poor bet with an unlimited usage service – its success could turn into a major money sink for Nokia. In further discussions, Nokia assures us the service will be profitable on its part.”

Second, as Forrester sees it, consumers get both a good and a bad deal.

Nokia has lowered one of the final barriers to subscription services, which is music disappearing when the subscriber stops paying.

But CWM’s restrictions may outweigh all-you-can-eat plans. Consumers may continue the ease of buying a CD or simply buying a track from an online or mobile music store.

Third, carriers may see more benefits in emerging markets than in mature ones.

“The operators seem oddly absent from Nokia’s positioning of CWM,” the authors said in the report.

“While they are expected to sell the handsets – perhaps even reducing their subsidy a bit – little else is likely to flow their way, particularly in mature markets with large data-plan penetrations and prevalent flat-rate pricing,” they said.

On the other hand, CWM could be a key early digital content business in emerging markets, more piracy-proof than other services and one that drives adoption of slightly higher-end devices and data plans.

However, even here the service may not improve long-term loyalty or promote the use of other carrier services.

In mature markets, the best hope for this type of service is tiny revenue increases and churn reduction, per the report. TDC’s recent debut of its Play unlimited music service in the Danish market is an example.

Finally, other mobile technology firms will find it hard to replicate CWM.

Nokia has several advantages that its rivals don’t: scale, market share and its presence in media-enabled phones for many years.

“If CWM sparks consumer interest, rivals may be stuck, unable or unwilling to go against operator plans for music services but lacking the spending power to get the music companies on board,” Messrs. Jackson and Golvin said in the report.

Once smitten, twice shy
It is clear that CWM is a Nokia-centric solution that helps the handset maker to build its direct-to-consumer relationships without the involvement of service providers.

Forrester also acknowledges Nokia’s smarts in dangling the idea of an annuity-type revenue stream in front of the cash-strapped music industry with declining sales from shrink-packaged music.

“However, unless the music labels have negotiated an extremely favorable fee structure with Nokia, we think they should consider whether that short-term positive cash flow – and uncertain long-term subscription revenues – will be worth the long-term impact of universal-access music subscriptions,” the report said.

“In common with other PC-based music subscription services, which have failed to gain traction, we believe that a successful CWM rollout will have similar and more widespread side-effects for music.”

So expect the reinforcing of twisted economic incentives. This is true of the existing subscription plans, but CWM exacerbates it. As Forrester puts it, why would a music label invest in new artists when there’s little economic benefit from discovering the next Elvis?

Essentially, if many consumers pay a monthly rent for music and that rent doesn’t go up regardless of how much music they consume, there’s little reason in promoting new talent. How much business is driven by new artists versus the back catalog?

On the flip side, CWM might help independent labels. Not only will they have less competition from behemoth record labels, but unlimited exposure for their music could generate more profitable artist tours and merchandizing, which is LiveNation’s model.

Another side-effect is that once consumers feel they have paid for the music through a subscription model such as CWM, they may feel entitled to those tracks even if they can’t share it beyond the Nokia phone or designated computer.

Consequently – and this is Forrester’s reasoning – these same subscribers won’t feel guilty about visiting a peer-to-peer file-sharing site to download DRM-free copies of music that they feel they already rightfully own. In other words, the relaxed consumer attitude toward piracy is maintained.

Equally lethal to the music business is the cap on the number of music purchases that listeners will make if they turn to CWM.

“If Nokia does its job and makes the handset the central device in a consumer’s life, the need to acquire music through other means will disappear entirely,” Messrs. Jackson and Golvin said.

“While that’s a success for Nokia, it’s a complete failure for the music industry – which has just sealed off its ability to reap huge profits from a new hit artist,” they said.

Sounds of music
Forrester has several suggestions for Nokia on the CWM issue.

First, Nokia should open the books on the financials of the deal with the music industry.

“No matter which way Forrester looks at it, someone has cut a poor deal here,” the report said. “Put bluntly, either the music companies have sold the crown jewels in perpetuity for a short-term pittance or Nokia has offered too much both upfront and in recurring revenues to the music companies.

“Needless to say, this suspicion of a poor deal and the potential long-term financial liability is bad for all involved: Rumors are already circulating around exactly what the deals might have involved. Nokia should make every effort to clarify the deals as far as confidentiality clauses will allow.”

Next, Nokia should get the other half of the Big Four record labels – EMI and Warner Music Group – to join Sony BMG and Universal Music Group if it has to offer a complete music experience. It also needs some key independent labels as well.

Finally, the music industry should admit what it’s been up to.

After years of decline, negative public relations around suing fans for file sharing and doggedly sticking to an obsolete business model, the music business has been partnering frantically to save itself.

“We applaud their consumer-friendly aggressiveness,” Messrs. Jackson and Golvin said.

“The industry should roll with this momentum and go on the PR offensive: Admit a new focus on 360[-degree] deals; set out a vision of a blend of ad-supported, device subsidized and traditional digital services; and, most controversially, admit that they are desperately looking for a way to break Apple’s stranglehold on the market.”