Update on the Last Story

So, that whole thing about iTunes sales "plummeting" according to a Forrester Research report? Well, it turns out Forrester meant nothing of the kind.

You see, it's all the media's fault. (Isn't it always?)

So lets go back and look at the abstract of the original report: After looking at 2,700 US iTunes debit and credit card transactions, Forrester found that 3% of online households had made an iTunes purchase in the past year. It further says that consumers who buy at iTunes spent about $35 over the last year, with half of those transactions amounting to three dollars or less.

Now its important to remember something that consumers usually don't see when they use their credit cards: the vendor pays a fee for the right to accept your credit card. Huge companies like First Data, Alliance Data and smaller companies like iPayment make a lot of money processing credit card payments. First Data, for example, took in about $10 billion last year processing credit card transactions.

Those fees, are something that Forrester is worried about. Remember, there's isn't much to carve out of the revenue of a 99-cent song sale. Most of that 99 cents goes back to the record label, some of which, makes its way back to the artist. Apple has never disclosed the breakdown, but my hunch is that it doesn't keep much. A few cents have to go to Visa or Mastercard, depending on which card is used, a few more go to the companies that run the data networks that hand the transaction itself. A few cents also have to go to the cardholder's bank. If the fees are too high, there's not much left over for Apple, in which case the iTunes store becomes a money-losing operation, at least in theory.

"Our credit card transaction data shows a real drop between the January post-holiday peak and the rest of the year, but with the number of transactions we counted it's simply not possible to draw this conclusion . . . as we pointed out in the report. But that point was just too subtle to get into these articles," Forrester's Josh Bernoff wrote in reaction to the headlines about iTunes sales "plummeting" and "collapsing" and whatever adjective indicative of downward motion that may have been used in headlines hammering the report by irritated Apple fans. More after the jump....

One thing that really did go down was Apple's stock. It shed $2.41 on Dec. 12, but picked it all back up and more today, closing up $2.91.

Bernoff's intended point apparently got lost in all the horn-blowing headlines: iTunes sales appear, based on the available data, to be leveling off. And he's not the first to say so. The Wall Street Journal last week mentioned in a story that Nielsen Soundscan has been seeing the same thing in the music download business for two solid quarters. In fact, they're down slightly, at 137 million tracks in each of the last two quarters, from 144 million tracks in the first quarter of the year.

Finally Bernoff says that Apple is incredibly stingy about the information it releases, and I agree. On one hand, Apple loves nothing more than to brag about how many songs it has sold, how many songs and TV shows are in its library, and so on. But what it won't talk about is how much revenue is derived from iTunes sales.

The reason it doesn't say how much money it makes off iTunes sales, is because it doesn't make much at all. Take a look at this data summary (it's a PDF file) from Apple's most recently quarterly earnings press release.

In its most recent quarter Apple reported $452 million in revenue from what it describes as "Other music related products and services," which in the footnote it defines as iTunes sales, iPod services, and Apple-branded and third-party accessories, like say, the iPod HiFi, and products like it.

Now here's where it gets interesting. That figure is UP 71% from the same period a year ago but slightly DOWN sequentially from the quarter just before it.

This combined figure amounts to 9.3% of sales. What I and Bernoff, and a lot of other people want to know here, is how much of that is actually derived from sales at the iTunes store? Apple won't say, and it won't say because it doesn't have to. And it doesn't have to because the figure is so small.

Let's say for the sake of argument that Apple takes home 5 cents per iTunes song sold. Then lets say that it sells a billion songs in a year -- way ahead of the volume its really doing. That would equate to $50 million a year.

Does that figure seem to low to you? Then let's double the assumption to 10 cents a song for $100 million a year. Still too low? Let's double it again to 20 cents a song, and reach $200 million a year.

For a company that reported $19.3 billion in sales for its last fiscal year, $200 million, which is probably too high a figure for our hypothetical "billion-song year" is just a tad more than 1% of fiscal 2006 sales. A hypothetical $100 million amounts to about one-half of one percent of sales. Any smaller than that and you end up in rounding-error territory, or as the accountants like to say, "not meaningful."

This is the dirty little secret about the iTunes Store: As good as it is, it makes Apple very little money. It is, for all intents and purposes, a marketing tool for the iPod profit machine. In fiscal 2006 Apple moved 39 million iPods for about $7.7 billion in revenue, and in my estimation about $3 billion and change in gross profit.

TV shows and movies may change that, but not until Apple is selling not merely many millions of downloads per year, but many billions of downloads per year.

Let's go back to the midpoint of my hypothetical scenario and assume Apple takes home a dime a download, and then assume Apple were to sell 10 billion songs in a year: That would equate to a cool $1 billion or about 5% of fiscal 2006 sales. But ten billion songs a year is a lot: That's more than 19,000 songs a minute, or 27.4 million songs per day.--buisnessweek.com