Dealing with (Internet) Reality: A presentation to the ICA in London on September 18th, 2003. . . . Dealing with (Internet) Reality John Buckman, CEO of Magnatune & Lyris John @ magnatune.com http: // john.redmood.com / ica.html . . . Who am I ? - started selling software at age 14, sold $30k worth of shareware - Lyris is email software for discussion groups and newsletters - CEO/Owner of Lyris, now at $12m annual sales, over 40 employees . . . Who am I (2/3) - launched Magnatune in May 2003 - Internet-based record label with focus on 50/50 revenue split with musicians - Use two licenses - Creative Commons license for free content / evaluation - Traditional software license for purchasers . . . Who Am I (3/3) - www.piazzolla.org - www.lutesociety.org - With my wife Jan: - www.jsbach.org - Doris Lessing Web Site - Fay Weldon Web Site . . . Key Points - Free content is increasing in quantity and quality - Why? Because free is a competitive advantage that's hard to fight - Free content works best for: - small players who need little income - large players who can subsidize a loss in one area to profit in another . . . Key Points - Dongles are the best DRM, and the only likely one to survive - Piracy always abounds where likelihood of purchaser dissatisfaction is high - Attacking potential dissatisfaction is the key to fighting piracy . . . Key points - All electronically distributable media (music, photos, artwork, writing) will become shareware, just as software has. . . . Key Points - Best marketing strategy is convincing potential customers that purchasing from you is social activism, contributing to the social good - Come on, be a rebel! - Help change the world - Make the person receiving the money into a cause - Explain how their purchases are concretely helping . . . Learn from the lessons of software vs piracy (late 80s) - other creative media will likely play out the same way - non-copy protected software was a competitive advantage - copy protection frustrated legit users - installation, backup, moving between computers were common problems . . . Hardware 'dongle' was the only accepted mechanism - dongles still common in certain software genres, such music creation software, where piracy is rampant - de-dongled versions widely available - cost of software ($800+) makes evaluation not possible - Example: "pro tools" fought piracy by making older version of its software available for free combined with flexible dongle . . . Downside to Dongles - heavy thought-leadership losses to non-dongled - in general, smaller, upstart companies are not dongled and receive favorable treatment for it - piracy may help smaller players because it helps advance their format as a standard - people prefer the underdog, and if the underdog can make a moral claim to superiority, as can be made w/o DRM, this greatly enhances their pitch - hence the "we are not evil" pitch . . . Users increasingly requiring "evaluation before buy" - Almost all software is shareware now - officially "trialware" - All software can be downloaded and tried out for a limited time - Microsoft Office ships for free on Macs, limited to # of days usage - Justice dept would prevent this on windows . . . "Building a standard" - Many companies have limited feature versions of their software - Adobe Acrobat, Microsoft Word viewer - Both helped standardize a format, sell additional value - Read-only versions of applications are very popular and savvy . . . "Doom" - Best-selling game of all time, "Doom" sold more copies than Windows 95, and was shareware - Run the first 10 levels for free, pay to continue - Allowed traditional distributors free rights to sell the 10-level CD - Massive distribution ensued, free marketing & promotion, really hurt the competition . . . Low prices help discourage piracy - Music software example: most pirated programs are plug-ins for $400+ - Same holds true for Photoshop plug-ins: - Both are expensive, often not useful after purchase - Music/books share this trait: the percentage of dissatisfied users is higher for creative goods than dependable goods - piracy always abounds where likelihood of dissatisfaction is high . . . Analysis: UMG Price Reduction - Music shipments dropped 15% this 1st half of the year, 2x last year's drop - UMG had tested $2 price breaks on selected artists, and found that it increased sales - Recent price reduction by UMG of 30% (from about $12 to $9 wholesale price) off wholesale is expected to be followed by other labels, but it's unclear what effect this will have on retail prices . . . UMG (2/3) - UMG were paying average of $1.20 per CD for product placement, that they are now halting - Not often stated: UMG expects 25% of floor space in exchange for retailer getting the new low price - New pricing not applying to Latin or Classical music . . . UMG (3/3) - Unclear what effect will be on artist royalties. - My legal sources say it will help, by moving more CDs at the top-level price - Most non-legal analyses are negative ("little guy will suffer yet again") - Possible that retailers will soak up the 30% margin as additional profit, and UMG CDs won't be cheaper - Many cases of this in USA with import tariffs on domestic vs. foreign goods selling retail at the same cost . . . Legit distribution is always easier for end-users to find - Advertising reaches their audience - Most law favors legal distributions -- - ie, get valid domain names, band photos, other marketing goods - Pirates always have to flee or use obscure legal points to hide - User chooses: - go to "www.metallica.com" - or go to Kazaa, search for Metallica, wait hours and listen the 1/3rd of the songs that actually downloaded? . . . iTunes Analysis - 50,000 songs sold a day at $1 - $1,500,000 per month - $18m in sales per year - 30% commission on sales = $5.4 - Infrastructure costs, 20 employees = $2m/year, IT + bandwidth = $1m year . . . iTunes Bottom Line - Totals: - $5.5m in revenue - $3m in cost - $2.5 in profits - Compare to a steak restaurant: - 250 tables, one location - $5m in annual revenue - $1m in annual profits . . . Will iTunes Score with the PC? - However, if the iTunes phenomena can be repeated in the PC world, then numbers are 20x what they are for Apple hardware, and we should get: - $100m in revenue - $10m in cost - $90m in profits . . . Compare iTunes to iPod - 1 million iPods sold at $350 average = $350m total - Likely wholesale price discount is 30% - Thus Apple has made $245m from iPod sales . . . Apple ,s Real Strategy - Use innovative media offerings to sell high margin, big ticket hardware . . . Hardware Companies & MP3s - PCs need "the next big thing" - Music trading is it. - Online music, and mp3 file trading sells hardware - Hardware manufacturers are generally ok with media piracy as it is the new big thing - Intel has been strongly against controls on p2p, taking anti police-state stance . . . Historical industry positions - Piano roll was theft of sheet music - Cable TV was theft of broadcast TV - VCR was theft of films - Industry would prefer total control but experience tells us that both government and the public won't settle for it, and that larger markets are created in systems of imperfect control . . . DRM needs to provide similar rights to physical goods - Circle-of-trust sharing: close friends, family, coworkers - But how to keep the circle from expanding through successive "degrees of separation?" . . . Best solution: dongle needed for use, but unrestricted copying - can be shared - prevents multiple simultaneous copies - Easily explained, works dependably - can be resold - allows simple 'upgrades' and other downloads - dongle can be restored if lost . . . Dongles - Problem with dongles: highly desired products are cracked - You may notice that easily downloaded & evaluated software is less trafficked than pure shelfware . . . Users expect as-good-as-pirated media when buying - Why buy when you get something of higher quality pirated? - DRM has an extremely bad reputation among users - Typical example: buymusic.com requires name & password key for each song played - Resale is not possible, thus lower value to consumer, shouldn ,t price be lower? . . . DRM unlikely to work long-term - Non-complying players (ie, winamp) always become widely available - Basic technical problem of any media that is human perceived can be captured and placed on an unprotected media - In software, copy protection has never thoroughly succeeded because the software has run at some time, thus reside in memory, and therefore be copied and modified . . . Why People Pirate - Most people pirate to 'try things out' - They haven't thought about buying it, but they want to check it out - Pirating is not easily compared to shoplifting, more easily compared with in-store browsing - Sometimes, they simply don ,t value to goods very highly . . . Porn. What we can learn from sleaze. . . . Always useful to watch how porn is making money - Why? Because theirs is a high profit business with a largely undifferentiated product - Porn always spends the most money to develop new markets, and when it works, that market gets flooded - Porn has always been pirated, and they have to find business models that face that fact . . . Porn is using p2p - To distribute better quality video that would be cost far more in bandwidth than profit - free to download, but when you try to play, windows media asks for a credit card - The BBC announced it will be distributing massive amounts of its back-catalog for free via p2p as a broadcasting medium -- great example of large company subsidizing loss in one area to gain in another . . . Porn & p2p - Distribute shorts for free, which are then greatly distributed, and which have their advertising on them - To enable "try before you buy" at a low cost - since conversion rate from evaluator to paying customer is very low in porn, distribution must be vast and cheap . . . Porn & p2p - very poor video quality version of some videos made free as teasers - availability of high quality free demos make piracy irrelevant - to avoid requirement that they age-verify their audience . . . Lessons learned from porn's use of p2p - Best way to fight piracy is to provide easy found, decent quality legit content, - then demand for pirated content is lower, - and its availability is less than legit stuff - Most p2p content is inconsistently available - Making your content available on many servers at once will increase how often it is found and shows up on the download lists . . . Use p2p for free advertising and try-before-you-buy - songs that fade away, or short radio edit that they would hear anyway - one or two songs from the album - voice-over (best if by artist) 1/2 way in the middle - never at the beginning of a track, while the user still has their mouse button on the play/stop button - prominent enough to not make people want to buy, but not so prominent that they are annoyed and delete it - provide the entire album at 128k mp3 at lowest-quality encoding . . . P2p and books - leave off the last 1/3rd or 2/3rds - very popular in level- or narrative-based games - use a viewer format which is introduces page-flipping delays - example - Amazon's book preview feature, and iUniverse's viewer . . . P2p Benefits - Bandwidth cost savings can be considerable - Obvious use: distribution of movie teasers over p2p - Another distribution channel that already has a large audience - Competition (e.g. the pirated content) is poor quality, hard to find, many p2p users are frustrated - Way for content producers to differentiate themselves in a very crowded market -- very inexpensive marketing experiment . . . P2p worldwide stats - p2p downloads are 5x more music than CD sales (though is is debated as possible equal) - However, huge increase in file sharing since demise of Napster has not caused an equivalent negative effect in CD sales - 30% of computer-owning households have CD burners . . . Shareware and other alternative business models - Shareware is usually direct-to-consumer - Shareware vital stats are: - conversion rate - distribution size - pass-along rate - average sale price . . . Shareware vs. shelfware - Usually through a (reseller) channel - Vital stats are: - royalty/margin - production cost per unit - production size - return rate . . . Shareware / Donation-ware Results at Magnatune - After 14 weeks in business - Top third of artists making $100 to $200 a month in royalties - People have choice of paying between $5 to $18 with 50% going to the artist - Average per-item purchase price is $8.08 - Average checkout transaction is $9.18 . . . An Online/offline mix is very powerful - Example: buy a physical good, get access to special things online, such as bonus songs, mixes, lyrics, photos - For authors: interviews, short stories, essays, photos, source material - Take advantage of both media: offline is the mass-audience product, online is fan products - Don't underestimate the power of evangelical fans - Learn the lesson from Star Trek: it doesn't matter how many fans you have, it's how much they'll fight for you . . . Community - sense of belonging / community is a primal human drive - leverage it - can cheaply be provided online - The most successful .coms have community at their core: Amazon.com, eBay - fans of a particular book / film / music have more in common with each other than their neighbors - provide the connective glue and you'll have huge marketing power - "think different" - be part of this elite group . . . Become a cause - Avoid using 'conquer the enemy' (ie, Linux vs Microsoft): this is ultimately negative energy - ie: Apple's "why 1984 won't be 1984" anti-IBM ad - 'helping the little guy" "squeezing out greedy middlemen" "level playing field" "connecting creative people with their fans" are all popular and positive - fighting the system, standing up for creative people - read "Atlas Shrugged" by Ayn Rand . . . THE END - 3 excellent papers by Stan Liebowitz - Will MP3 downloads annihilate the record industry: the evidence so far - The Economics of Betamax: Unauthorized Copying of Advertising-Based Television Broadcasts - The Impact of Reprography on the Copyright System