Apple's Subscriptions Service Upsets the Cart

Apple is not a shy company, and its new iOS subscription capability for iPads, iPhones, and iPod Touches is a bold grab for a cut of the digital content action. Publishers and media companies aren't happy about Apple's new scheme -- particularly the requirement they offer in-app purchase for subscriptions at the same or better price as they mak

e available outside iOS, as well as the fact that Apple gets 30 percent of all revenue from in-app digital media purchases. Media developers don't want to give Apple that much money for being a distribution channel to their readers, listeners, and viewers -- especially when Web distribution is significantly cheaper.

But this is not simply a case of a greedy, powerful Apple strong-arming defenseless media companies. Apple's move exposes a long-flawed business model at most media companies, one that Apple has clearly decided will not be its burden. I doubt that Apple cares about reforming the media industry's broken business model, but that may end up the result nonetheless. As the industry and Apple work their way through this -- you can expect some changes as the corporate dance gets serious -- we may end up with a healthier business model for online media, and thus for creators, developers, distributors, and customers.

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The Publisher's Dilemma

Bear with me as I explain the real problem, so I can then illustrate how Apple's move could lead to a better result for developers, content creators, and customers. Actually, make that problems (plural), as what ails print publishers is different from what's eating music and video streaming businesses and what concerns online bookstores -- all of whom are upset by Apple's policy.

In the print publishing world, most magazines and newspapers are sold through heavily discounted subscriptions meant to create a large base of readers. These subscribers are then sold to advertisers, through both ads and direct marketing. That's why you see subscription prices of $12 per year for monthly magazines that cost at least that much just to print and mail (roughly $1 per copy, and as much as $4 for the thick, glossy magazines). The subscription fees don't pay for the creation of the content, nor for the circulation marketing that gets the subscribers in the first place. Publishers make their money from advertisers.

At least they used to, back before Web advertising and search advertising decimated the print ad business for most publications. Today, print publications depend more on their print subscription prices, which is why they've risen in recent years. At the same time, print publications have learned the hard lesson that having given away their content for free online has trained readers to believe it has little value. And now that online advertising income is proving insufficient to pay the bills -- the money is instead flowing to Google and perhaps soon to F

acebook -- publishers want to charge for online subscriptions.

Of course, nearly everyone is afraid to start charging for online content, fearing that a world of readers used to free won't pay up. But the iPad could change that; thanks to the success of paid apps and games, publishers figured they could charge for content on the device. Apple figured the same, so it wants a cut for making all that possible. What surprised publishers is that Apple wants the same cut it gets for everything else -- and won't let publishers circumvent Apple's share by linking to their own websites rather than using iTunes as the payment system.

Apple has made it clear that publishers can sell subscriptions outside of iTunes and thus not pay Apple, but they must also sell through iTunes, where Apple does get a cut. Thus, publishers fear that most users will subscribe or renew on the iPad, where they're accessing the content. As a result, iTunes will become the default subscription vehicle, making Apple's 30 percent cut the norm. Publishers already cough up cash to firms such as Publishers Clearinghouse to bring new subscribers, but these are one-time payments, while subscription commissions to Apple would be permanent and ongoing.

Publishers that charge realistic fees for print and online content are thrown off by the potential loss of revenue. Take the Economist, for example. The weekly costs about $125 per year for a print subscription that includes free access on the Web and via the iPad. (The Economist's iPad app is one of the best.) The electronic subscription costs $110. My estimate is that it costs the Economist about $50 per year per subscriber to print and mail its issues, so the net income for the print subscription is about $75.

Compare that figure to the net income on the online subscription if sold via iTunes: $77. It's a wash, even after Apple's 30 percent cut. But the Economist's classified ads aren't in the iPad or Web versions, so that revenue is lost. The $33 that Apple would get as its cut from an iTunes sale is money that the Economist is surely counting on keeping. And from the data I've seen, it would cost $10 to $30 -- but just once -- for the Economist to get a new subscriber through other channels. The economics for the New York Times and the Wall Street Journal are similar.

Granted, few magazines cost as much as the Economist, which charges a high price in return for high-quality content and is much less reliant on ads. A more typical magazine is Martha Stewart Living, which charges $24 for 12 monthly issues. The typical new-subscriber bounty for it would be about the same as its first-year subscription income, whereas if it accepted Apple's model, it would pay $8 per year and keep $16. MSL would lose money only on subscribers who subscribe via i

Tunes and renew three times via iTunes. So the get-'em-in-with-a-low-price publishers may actually prefer Apple's approach. (Interestingly, MSL charges iPad users $4 per issue and newsstand customers $5; after commissions, they each net out to about $2.75 in revenue.)

There's also the pesky issue that Apple doesn't acknowledge: When a publisher does its own direct marketing or hires a firm to which it pays a bounty, that's active marketing. Apple's not actually going out and getting subscribers; it's just processing the subscriptions of those who have already found the publisher's iOS app. In that case, Apple doesn't deserve anywhere near the reward of a direct marketing firm for each subscriber.

Still, once you get past the definition of a fair price, the fact remains that the underlying issue is that you have an industry that has devalued its own product for years by emphazing low- or no-cost subscriptions but now needs subscription revenues to fill in the ongoing advertising shortfalls. And you have Apple saying it wants a cut of those revenues for distribution on the platform it owns -- and which happens to be where publishers think they have the best shot at picking up paid subscriptions.

The Streaming Media Dilemma

In a way, companies such as Netflix and Rhapsody are worst off in Apple' s new scheme. These companies' subscription pricing models assume essentially that distribution is free. Users pay for their own bandwidth, whether to their home TVs and computers or to their iPads. That's not quite right: The streaming providers have to pay Internet backbone providers for the bits they move (that's what the Comcast-Netflix fight last fall was all about). But they didn't foresee also paying Apple.

Ironically, these businesses would have to pay a cable company to carry their streaming "channel" (the cable companies shell out for only the big outlets that draw lots of viewers, such as ESPN and Disney; the smaller channels all pay to be carried). Apple is acting as if it were a cable company, charging access to its subscriber base -- and blindsiding Netflix, Rhapsody, and so on.

The Book Publishers' Dilemma

Finally, there's and Barnes & Noble, which will need to offer in-app e-book purchases under Apple's new rules and thus pay 30 percent to Apple for each sale made via iTunes. Both Amazon and B&N charge book publishers about that amount for each e-book they sell on their websites; Apple's new rule basically takes that commission away from them for e-books sold via iTunes. Either Amazon and B&N must forgo their commissions or take it from the book publishers if they want an iOS presence.

Where the Dance is Leading

I believe that Apple's policy is shining a bright light on the media industry's dirty secret: Its business model is broken. When the iPad was first announced, media firms hoped it would provide a new vehicle for which they could charge users realistic fees -- basically relying on Apple to give them a platform where they could avoid their old mistakes. Book retailers thought they could get a free ride on iOS devices to build their sales base; the same goes for streaming media providers. Why they all thought Apple wouldn't change for that privilege escapes me.

Still, it's true that Apple is overreaching. A one-size-fits-all pricing policy of 30 percent for any digital content ignores the reality on the ground. The economics of different media segments vary. Charging developers 30 percent of an app's price was reasonable -- it costs far more to establish a presence in a retail store. The music and video industries swallowed Apple's charge because their retail sales were declining (and they pay more to retailers than Apple wanted) in favor of unpaid pirate downloads -- but they did persuade Apple to raise its initial prices, so both they and Apple netted more per sale. However, the music and video industries continue to feel ripped off.

For sales of a single-copy book, magazine issue, video rental, and the like, a 30 percent commission is probably fair. A book publisher gives a retail bookstore 50 percent or so for a physical book, after all, as do magazine publishers for their newsstand sales.

You can argue it both ways on magazine and newspaper subscriptions. Thirty percent is a huge portion relative to the usual new-subscriber bounties, and it's a much higher rate than what the printing and mailing typically costs (10 to 20 percent, based on audience size) for a print subscription. Plus, the digital production is not cheap -- it's costlier than print design and layout because of all the custom coding required -- and Apple's model doesn't account for that.

On the other hand, smaller publishers in particular face daunting costs to attract and service readers, so the Apple model likely skews in their favor -- just as the app store model favors small developers over large ones. And for publishers of all sizes, the iPad represents its best hope for new revenue.

What's fair, I believe, is that Apple charge $5 to $10 for each new subscription (not a percentage) for publications and streaming media -- but nothing for renewals -- for its passive role in signing up new subscribers. It would also be fair for Apple to charge a 5 or 6 percent handling fee for processing the transactions, including renewals, done through iTunes from that point on -- just as a credit processor does. In other words, Apple should get a bounty for facilitating the new business but no perpetual cut beyond the processing fees for handling the transactions.

As for Amazon and B&N, they should split the commission with Apple for e-book sales made via iTunes, with Apple taking 10 percent (after all, its role in the sale is more passive) and Amazon or B&N taking 20 percent. In announcing the new subscription policy, Apple CEO Steve Jobs said his philosophy was that Apple deserved a cut for the transactions it brought to the table and nothing for those that happened outside. In the case of these e-books, it took both Amazon and Apple, or B&N and Apple, to get the customer, so they should split the commission ultimately paid by the book publisher.

Rhapsody has made noises about legal issues, suggesting antitrust claims could be in the offing. The United States already lets monopolies get away with a lot, so that's a hard row to hoe. But the feds also hold platforms to a higher standard than other businesses, so at the very least a troublesome inquiry could follow. In fact, the Wall Street Journal reported yesterday that the Justice Dept. has begun an informal probe into Apple's subscription rules, and Reuters reported today that the European Union has also begun inquiries.

Apple does have one possibly strong argument to deflect such a probe: competition from Google's Android platform. Android provides a popular alternative for those who don't like Apple's terms; in fact, some publishers are eagerly developing subscription apps for Android, as well as for HP's forthcoming WebOS 2.1. Google is already offering its own One Pass checkout system for publishers to use for both their online and mobile content, charging a 10 percent commision -- much less than Apple. (But let's not forget Google's very media-unfriendly moves, such as its trying to corner the market on old books and its scraping of others' content in search results. There are two devils for media firms to dance with, not just Apple.)

Ultimately, Apple needs a thriving market of digital content to keep the iPad's value proposition strong, so it can't be so stubborn that it drives away content providers. The media industry probably needs Apple more than Apple needs them, but they still need each other to significant degrees. We've seen Apple compromise with the music and video industries, as well as with Adobe on the iOS-export-from-Flash tool that Apple initially banned. It took saber-rattling, the attention of the feds, and a public war of words.

But hey, that's business. Apple has given media companies until June 30 to comply with the new policies -- leaving 14 weeks for negotations.

If at the end of the day, media providers can finally get customers to pay reasonable, realistic amounts for quality content, everyone wins -- including customers who today are being fed increasing amounts of junk scraped from search engines and provided by unpaid hobbyists because that's how media companies handle the decline in revenues.

Apple's moves may finally jolt the media industry into pricing that makes sense for all concerned, while ending the unhealthy business models that threaten so much of that industry's very survival. Of course, Apple's moves could also have the opposite effect: Publishers could lower subscription fees even more to reduce the "iOS tax" and try to make up the reduced revenue elsewhere. That would likely mean cutting content creation costs and filling their e-publications with too many ads; if so, we can expect crap such as The Daily iPad publication (with which Apple chose to launch its subscription service) becoming the norm. Let's hope not!

This article, "Apple's iPad subscriptions: Troubles all around," was originally published at Read more of Galen Gruman's Mobile Edge blog and follow the latest developments in mobile technology at For the latest business technology news, follow on Twitter.

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