One of the most fascinating things about the consumer technology industry is the range of business models in evidence among the various companies. Though software may indeed be said to be eating the world, what’s fascinating to me is that almost no business models are based on selling software. Instead, we’re seeing the rise of two dominant business models in almost all of consumer digital media: subscriptions and advertising. And as these take over on the content side of the industry, they’re more likely to take increasing share of other parts of the industry including hardware as well.
Subscriptions Take Over Video and Music Consumption
The two best examples of this shift involve video and music consumption, which have both seen dramatic changes in the balance of spending coming from purchases and rentals versus subscriptions in the last few years. Take the US home video market, for example. The chart below shows how dramatically the digital revenue has moved from purchases and rentals to subscription streaming led by companies like Netflix over the last few years:
Whereas in 2011, over 70% of the spending was driven by purchases and rentals of video, by 2016 that balance had turned on its head, with a growing majority of spending going instead to streaming, with purchases still making up around 20% of the total and rentals dwindling almost to nothing. And of course, all this happened while the physical market was in rapid decline and the digital market in rapid growth, meaning that the underlying spending on subscription streaming grew far more rapidly.
A similar shift can be seen over the last few years in the music industry, where digital consumption has also eclipsed physical media, and where subscription streaming has come to drive the large majority of digital revenues:
Even including physical media, in the first half of last year, streaming accounted for nearly half of total consumption, and the vast majority of that came from subscriptions. Among digital revenue alone, it accounts for a significant majority.
Even in TV, These Two Models Vie for Supremacy
Even if we go beyond pure digital business models and look at more traditional TV business models, we see that these two models continue to vie for supremacy, with subscriptions arguably winning the upper hand lately as brands such as HBO eschew advertising, and as affiliate and retransmission fees rise. Whether consumers pay the subscription prices directly to the content owners or to intermediaries like pay TV providers, the dominant model – in the US at least – is a regular monthly payment for a bundle of content, with advertising providing a strong secondary source of revenue.
However, though TV ad revenue continues to grow for some networks, I suspect it’s nearing its peak, and the coming years will see a slow decline, driven by falling ratings, increasing avoidance of ads either through DVRs and other skipping technologies, lower ad loads on digital platforms, or simply engaging in other activity while ads play in the background. That’s going to drive the balance of revenues even more towards subscriptions, but the pay-per-view model continues to be a tiny minority of spending, leaving these two models dominant.
Online, Advertising Dominates
When it comes to other online content and services beyond video and music, advertising dominates, across news and other sites and services like search, email, maps, and so on, with free services provided as part of ecosystems monetized in other ways the main alternative. Getting consumers to pay subscription fees for online services continues to be very tough, and although minorities will do so either out of privacy concerns or principle, the vast majority use the free, ad-supported services.
Subscription Aggregation is Growing
As I’ve written previously in the narrower context of TV, the fragmentation of services offered in place of traditional big pay TV bundles is going to create an opportunity for aggregation and aggregators. But that opportunity goes beyond merely TV. We’re already seeing Apple and Amazon emerge as the leaders in subscription aggregation, with Amazon offering a huge range of subscriptions of many kinds through its Subscribe with Amazon service, and others more directly tied to a Prime subscription, and Apple offering both its own subscription services such as iCloud and Apple Music alongside third party subscriptions from MLB At Bat to Netflix through the App Store.
Amazon has tens of millions of Prime subscribers and is reportedly driving many of the signups for services like HBO Now through its platform, while Apple said on its last earnings call that it has over 165 million paid subscriptions combined for first party and third party services running through its payment systems. These companies are recognizing the rise of subscriptions as a business model and acting as storefronts for a wide range of services offering this business model.
The Subscription Model Will Expand
The next logical step is for subscriptions to expand into more areas which have historically had business models more oriented to one-off purchases. We’ve already seen this happen in the US smartphone market through the adoption of leasing and installment plans offered by the wireless carriers. Among these carriers, these models have now become dominant, as the chart below shows:
And of course we’re starting to see some device vendors jump on board with this model too, with Apple offering the iPhone Upgrade Program, which is essentially an iPhone subscription, and we’re seeing subscription models pop up for other hardware too. It’s only a matter of time before buying a bundle of hardware, software, and first and third party services become a big chunk of the market, further cementing the role of those companies that can offer such an aggregated service.
Advertising Will Continue to Offer an Alternative
Even though I believe that subscriptions will continue to grow in importance as a business model, that’s not to say ad-based business models will fade away. In fact, they’ll continue to offer an alternative for those who for financial or other reasons prefer to pay less for the hardware and services they use in exchange for being targeted with advertising. We might well see an income-based divide emerge on this basis, with lower-income people gravitating towards ad-based business models while wealthier sectors of society go further down the subscription path. This income divide is already evident among Amazon Prime subscribers and is likely to grow over time.
This means that the ecosystems which focus on subscriptions rather than advertising are ironically going to attract the customers advertisers would most like to reach, which will cause an interesting paradox and may both open opportunities for sub-based companies to offer limited advertising, while it may make it more challenging for ad-based business platforms to attract premium ads. All of this will continue to evolve and exist in a complex balance with a lot of mixed business models for years to come. But my bet is that subscriptions and advertising will come to be the two dominant business models in consumer technology, while subscription models dominate the high end of the market, with some really interesting implications.