Making money selling music without DRM: the rise of eMusic

Introduction

The Holy Grail of online music sales is the ability to offer iPod-compatible tracks. Like the quest for the mythical cup itself, the search for iPod compatibility has been largely fruitless for Apple's competitors, whose DRM schemes are incompatible with the iconic music player. For a music store that wants to succeed, reaching the iPod audience is all but a necessity in the the US market, where Apple products account for 78 percent of the total players sold. Perhaps that's why eMusic CEO David Pakman sounds downright gleeful when he points out that "there's only two companies in the world that can sell to them—Apple and eMusic."

It's rather a startling point—given the worldwide success that Apple has had selling iPods, one would think that music stores would do whatever it takes to make their offerings iPod-compatible. Attempts at bypassing or emulating Apple's FairPlay have not been successful, however, and FairPlay is (famously) unavailable for licensing. So what's a music store to do? To eMusic, the answer was simple: you offer songs as high quality, variable bit rate MP3 files instead. DRM is removed, consumers are happy, and the vast white fields of the iPod are ready for harvest.

It sounds like such a simple idea, but in the context of the music business, this is radical, French Revolution-type stuff. What's perhaps even more interesting is the fact that eMusic's decision to offer unprotected MP3 files was not an ideological one; the idea made great business sense, and has established eMusic as the #2 retailer of downloadable music behind the iTunes Music Store. The fact that it opened the way for iPod compatibility was really just a bonus, since a couple of years back, it was much less clear that Apple would come to dominate the market in the way that it does today.

"It's really not a philosophical decision; it's a practical one," says Pakman. "Early on, the belief was that we had to sell music in the only universally compatible format that existed. TiVo was just about to come out with MP3 playback on their machine and we didn't know if that was going to be big. There were a bunch of MP3 players on the market, including the iPod, and that market was growing. There were MP3 car stereos happening. There weren't any phones, but you can see that's where it was going. Everyone was putting MP3 in their device, so why not sell in a format that works in all those places?"

Indeed, when put this way, it sounds amazing that no one else (apart from some dubious Russians) has released music that will play on the widest possible array of devices. There's a reason this doesn't happen, of course: the music labels won't allow it. Actually, the major music labels won't allow it—but there's a whole ecosystem of independent music labels that want nothing more than wide exposure and fair compensation. What eMusic has done is to construct a business model built around indie music—and they're now selling 5 million tracks a month doing it.

That's because indie music doesn't (necessarily) mean bands with a fan club of six. A good chunk of the best work being done today comes from indie musicians like Bloc Party, the Drive-By Truckers, Gomez, Interpol, Belle & Sebastian, Tom Waits, Nick Cave, Pedro the Lion, Dolorean, Calexico, Arcade Fire, Spoon, Dar Williams, Ron Sexsmith, Modern Skirts, and Ryan Adams, all of whom are carried by eMusic. The company has built itself into an indie music powerhouse that now offers more than a million tracks and 175,000 subscribers, and it sells its songs for about a quarter each. Though in no danger of eclipsing Apple's one billion track sales, the company looks well-placed to cater to the over-25 music lover, a group not always well-served by the major labels.

But things haven't always gone so well for the company...

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Back from the dead

Three years ago, eMusic was owned by major music player Vivendi Universal. Despite the presence of a large corporate parent, the site was in trouble. As Pakman puts it, the business model was "broken." That's because eMusic was offering unlimited downloads to users who paid the monthly subscription fee, but each download cost the company 8¢ in mechanical rights fees. You can do the math—anyone who downloaded more than 125 tracks was actually costing the company money. Plenty of people were downloading more than 125 tracks a month. On a fat broadband connection, this was not difficult to do.

Vivendi Universal unloaded the business, which was scooped up by Dimensional Associates, a private equity company that also owns independent distributor The Orchard. Pakman is a managing director of Dimensional, and he now overseas the day-to-day operations of eMusic as well. To revamp the service, Pakman and his team made substantial changes which began by moving the entire operation to New York City. They rebuilt the entire front and back ends of the website to make the appearance more professional and to produce an analytics-driven business that could easily figure out what changes resonate with customers and what do not. They rebuilt the management team to better focus on niche marketing. And—crucially—they capped subscriptions (currently US$9.99/month for 40 downloads, US$14.99/month for 65 downloads, and US$19.99/month for 90 downloads).

The new site was relaunched in September 2004. In addition to its new look and new pricing structure, eMusic developed tools to make it simple for users to discover new music. Some were obvious, like the decision to license metadata from the All Music Guide, or the incorporation of a browsing engine that lets users easily drill down into increasingly precise categories.

One surprising move, however, was to hire several distinguished music critics to serve as "curators" for the site. These included people like Michael Azerrad, a former Rolling Stone editor and authority on indie rock; Justin Davidson, a Pulitzer-prize winning critic; and Kevin Whitehead, NPR's jazz critic. The move added extra costs, but also became a way for eMusic to distinguish itself from other sites, which make it simple to buy music, but discovering new material more difficult. As Pakman puts it, "If you're going to sell music beyond the commercial mainstream, you have to act as a really good guide for customers."

But does it make money?

eMusic CEO David Pakman

As a private firm, eMusic doesn't break out its financial information, but it's clear that its subscription model is working. In the 18 months since the relaunch, the company has clawed its way to the #2 position among digital download services (this does not include streaming music). Pakman claims that eMusic has 12 percent of the market compared to Apple's 61 percent, and that his company has now sold more than 60 million songs. Since eMusic does not sell individual downloads but only monthly subscriptions, its members download a lot of music when compared to iTunes, for instance. As Pakman puts it, "An iTunes customer downloads one song a month, on average; an eMusic customer downloads 20 songs a month, on average."

The subscriber base has also grown from "the low five figures" to 175,000, and has an average age of 39. That's unusual in a music business that generally caters to a young audience, and eMusic sees its willingness to appeal to the 25+ demographic as one key to its success.

"There's a customer in the music industry who has been ignored for the last seven or eight years, and that's the 25 and older crowd," says Pakman. "That customer is not targeted by the major labels at all, with very few exceptions, like the Norah Jones record, the Ray Charles record. Everything else is pop and rap for the 14 and 16 year old crowd. Our belief is that the 25 to 54-year-old market is severely underserved by the music industry. They have high amounts of disposable income, low amounts of time, and there's very little competition to reach them. As a result, they tend to be frustrated former music fans that are just dying to be talked to. That's our customer."

It's too easy to claim, though, that the independent labels have cornered the market on intelligent music; just think of U2 and Radiohead, for instance, two seminal bands that have been on major labels for years. If eMusic's model has a weakness, this is it—not enough of the good major label music.

Pakman has no interest in licensing complete major label catalogs, a move that would make eMusic a direct competitor to iTunes. But he does admit to some interest in a selection of material from the majors. "There's definitely stuff in the major-label catalogs that we could do very, very well with, but it's not the front-line product," he says. "The stuff that I think would be interesting for us, and where we would be a big help to the majors, is all of their music that's not selling on iTunes: deep catalog, classical jazz, electronica stuff, lounge stuff, roots rock, Americana, blues."

That seems unlikely to happen in the near future. The majors are terrified of piracy and so insist on strict DRM controls to safeguard their music. The indie labels that eMusic works with generally don't have that fear. "The indies have always viewed the world differently," says Pakman. "You know, the indies struggle for attention, for customers, so the notion of someone actually digging a track and e-mailing it to 10 of their best friends—doing self-promotion—that's music to the ears of the indie record labels. Whereas an RIAA member says, 'We've got to sue that guy.'"

Brave new world

For the foreseeable future, eMusic will continue to offer independent bands, but Pakman believes that there's still tremendous room for growth in his market. Though it may sound like a niche product, eMusic's offerings are not totally outside the mainstream; bands found on the site account for almost 30 percent of sales in the US music market. It's figures like these that lead Pakman to believe that his company is poised for massive growth, and he's set his sights high: one million total subscribers in the next two years.

To get there, the company needs to get the word out. With the site now working well, the editorial staff in place, and 1.3 million tracks available for download, the main obstacle to growth is the fact that few people are familiar with eMusic. To change that, the company has recently gone on a media blitz. The campaign features TV commercials, ads in magazines like Paste, and eMusic starter packs in stores like Circuit City.

The company has also inked some interesting deals designed to grow its brand. The most intriguing of these is a partnership with Westin hotels, where eMusic will produce all of their lobby programming, will create music samplers to be placed in every guest room, and will have the eMusic logo and a trial offer on every room key.

eMusic has been growing well, but Pakman makes clear that his company's model does not require a huge subscription base to flourish, and that if he gets only halfway to his target of a million subscribers, the company can do quite well. "Even at a few hundred thousand subscribers," he says, "we'll be the largest retailer of independent music in the world. We'll basically be the king of selling one-third of the music market, and hopefully, the ultimate resource for discovering music for people over 25. That's a huge ambition, but it's also within our reach."

eMusic is a classic long-tail business which can add huge amounts of content—even the truly obscure stuff—without increasing the company's warehousing costs or licensing fees (which are only paid out when songs are sold). And eMusic does have some crazy stuff on it; it might not sell well, but it can move a few copies and keep fans coming back to pay that monthly subscription fee. It seems to be working, too. Customers can leave at any time with no penalties, but their average stay at eMusic is about a year. That's good news for Pakman, and it shows that his strategy of introducing people to new music is working.

Conclusion

Here at Ars, we spend a fair bit of time lamenting the burden that DRM schemes place on consumers who want to do the right thing (pirates aren't buying DRM-laden music in the first place), so we were excited to find a company like eMusic that takes a different approach.