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Subscription wars: Big Tech ups the ante

As Apple enters the fitness space and Amazon pushes into podcasts, the heft of technology giants is threatening to undo the progress of smaller incumbents
September 23, 2020

The Covid-19 pandemic has cemented Big Tech’s position at the top of the food chain. While most other companies have been squeezed by this crisis, the so-called ‘FANMAG’ stocks – Facebook (US:FB), Apple (US:AAPL), Netflix (US:NFLX), Microsoft (US:MSFT), Amazon (US:AMZN) and Alphabet (US:GOOGL) – have reasserted their dominance across the likes of e-commerce, streaming and video conferencing. Yet these technology titans are not content to stop there. Increasingly stepping onto rival turf, one particular battleground is emerging – subscriptions.

Another bite of the Apple

While there was an iPhone-shaped elephant in the room at Apple’s recent virtual product event, there were still some notable developments. It introduced a new bundled subscription service – called ‘Apple One’ – that combines its offerings across music, TV and gaming, among other things. Split across three tiers – one for individuals, another for families and a ‘premier’ package – users can pay between £15 and £30 a month to access Apple’s digital services, saving money versus paying for them individually. Apple is hoping this ‘one-stop-shop’ approach can entangle more people in its web.

The move is part of a wider strategy to reduce dependence on the iPhone – Apple’s flagship handset accounted for 55 per cent of net sales in 2019. As the smartphone market becomes increasingly saturated and consumers hold onto their phones for longer, iPhone sales are plateauing. So, Apple has been shifting to digital services to future proof its business. Beyond the initial sale of a piece of hardware, it can generate additional recurring revenue from this installed base by upselling subscriptions for the things users can do on their devices. As Tien Tzuo, chief executive of subscription software company Zuora says: “Apple gets to have it both ways: sell the hardware for tons of mark-up, and then layer on the service revenue.”

 

Revenue from services has been rapidly increasing, climbing 16 per cent in 2019 to $46bn. Twice as profitable as hardware, services enjoy a gross margin of 64 per cent  versus 32 per cent for physical product sales. 

But services is a competitive space – Apple TV, alone, contends with Netflix, Amazon Prime Video and Disney+, to name but a few. Amid a dizzying number of choices, there is the risk of ‘subscription fatigue’. Research from Barclaycard Payments indicates that two-thirds of UK homes are signed up to a regular subscription service, with an average of seven contracts per household. Individually, we spend around £46 each month on subscriptions, with entertainment platforms proving most popular. During a recession, consumers may curtail their number of subscriptions, although a bundle that is considered more value for money could prove more resilient.

Swedish streaming giant Spotify (US:SPOT) is certainly worried Apple One will cannibalise its subscribers, accusing Apple of “using its dominant position and unfair practices to disadvantage competitors and deprive consumers by favouring its own services.” There could potentially be another antitrust investigation on the way.

How regulators will react remains unclear, but the move has pleased analysts who have long been clamouring for Apple to set up a Prime-like bundle. As customer ‘stickiness’ increases, analysts at Morgan Stanley argue that Apple should be “valued like a technology or consumer platform, rather than a more cyclical hardware company”. That could go some way to justifying its lofty valuation – the shares are currently trading at 29 times consensus 2021 earnings.

 

Survival of the fittest

Within the premium tier of Apple One is the new ‘Fitness+’ service that is set to launch later this year. Offering virtual workouts, it syncs with Apple’s smart watch, allowing users to track their performance in real-time. The service is emblematic of Apple’s push into health and wellness-related spaces – chief executive Tim Cook told CNBC last year that his company’s “greatest contribution to mankind” will be in healthcare. It is a timely release amid the boom in home workouts sparked by Covid-19. Analysts at investment bank Needham estimate the pandemic has accelerated the shift to home gym set-ups by three to five years.

Peloton (US:PTON) has been a big beneficiary of that trend, swinging into the black for the first time. The company had been aiming to be profitable on an adjusted cash profit basis by 2023 but generated $118m of cash profits in the year to 30 June. This came as it sold more bikes and treadmills and more than doubled the number of ‘connected fitness’ subscribers – those who use its hardware – to 1.1m. Peloton ultimately hopes to reach 100m subscribers, although the timeline is unclear.

 

The emergence of Fitness+ could give it reason to sweat. Apple’s service is cheaper at £9.99 a month versus £12.99 for Peloton’s basic digital membership, and Apple can promote Fitness+ to its huge customer base. In addition, users could find Apple’s offering more accessible – many of its workouts require little to no equipment, whereas Peloton is more based around a bike or treadmill, ideally one it has supplied. While it recently lowered the entry-level price of its equipment, the cheapest bike would still set you back £1,750.

In public, Peloton does not seem intimidated. Chief executive John Foley says Apple’s move is “a legitimization of fitness content.” Some argue Peloton’s provision on hardware gives it an edge. “While the Fitness+ software design will be superior to Peloton's, Peloton's bread and butter, a $39 monthly All-Access Membership, is still in good shape as they have the hardware-software integration advantage,” says Gene Munster, managing partner of venture capital firm Loup Ventures. But further trouble could be ahead. Rival Echelon Fitness recently caused a stir when it said it had developed an “Amazon-exclusive connected bike” – a claim Amazon has since refuted. But it speaks to the fact that another Big Tech player could easily enter the market and spoil Peloton’s party.

Upping the tempo

While a ‘Prime bike’ remains elusive, Amazon is making waves elsewhere as its Music service introduces podcasts in the US, UK, Germany and Japan. It has some catching up to do with leaders Apple and Spotify – Amazon will start off with 70,000 titles versus Apple’s catalogue of over 1m shows and Spotify’s 1.5m . But Amazon has deep pockets and has lined up exclusive new original content from high profile names such as actor Will Smith. It is tapping into over 55m existing Music subscribers and is looking to harness its smart home speakers – the Echo has a 53 per cent share of the US market.

Amazon already owns podcast platform Audible, but combined with this latest effort, it could thwart Spotify’s designs on the podcast market, driving up the cost to acquire new subscribers. Currently, around a fifth of Spotify’s 299m monthly active users listen to podcasts, with the rest using the platform for music. But music record labels are the gatekeepers of content and high royalty costs mean Spotify’s gross margin is only 25 per cent.

 

 

Podcasts have traditionally been hard to monetise. There are low barriers to entry and distribution has typically relied on ‘RSS feeds’ which allow the same podcasts to appear across multiple apps. In effect, that means that something like Apple Podcasts behaves more like a directory rather than a Netflix-style platform for exclusive content. In terms of generating revenue, advertisers commit less spending when they do not have much information on who the audience is.

Apple has thus far been happy to act as a benevolent hub, but Spotify is investing hundreds of millions of dollars to become the sole distribution platform for an array of podcasts. It acquired sports and pop culture podcast creator The Ringer earlier this year for €170m and secured an exclusive partnership with the Obamas.

Amazon is wise to the fact that exclusive podcasts offer a potential data goldmine as adverts can be tailored to who is listening, what they listening to and for how long. Much like Apple, its subscription services can further ensnare consumers within its ecosystem.