Note: Originally posted on Xconomy San Francisco - June 13, 2011. Updates at the end.

The ascent of smartphones and tablets is causing a seismic shift in the way media companies reach consumers. As an iPad and iPhone owner, I now consume the bulk of my media online. Whether it’s the Kindle App, Netflix, HBO Go, or Hulu, media companies have rapidly realized that they can use the new platforms to increase engagement with their existing audiences while also reaching new consumers who have grown up with Internet-based media as the norm rather than the exception.

Yet the advent of these new platforms and the services around them also raise the challenge of disintermediation. To be specific, look at the subscription initiatives recently launched by Apple, and to a lesser extent Google, governing how media companies can sell their digital wares via mobile app stores. In the iTunes App Store, media companies can now sell subscriptions, with Apple taking a 30 percent fee. Additionally, the original set of rules stipulated that a media company using the App Store could not sell that same digital subscription at a different price on their own or on any other store—though very recent reports suggest that Apple is backing down from that provision.

As the founder and CEO of both eMusic and Vindicia, which provides subscription billing services, I’ve learned a lot about subscription business models and how best to compete against free (especially when free is illegal). For me, this experience reaffirmed the central role that relationship management plays in the relative success of media companies.

As a backdrop for this discussion, it’s useful to understand a couple of basic media business concepts. First, media companies succeed not just because of great content, but because of the compelling experience they provide consumers. Netflix, for example, has set out to make the task of being entertained with video content dramatically easier. The Netflix Prize, designed to encourage the creation of better recommendation algorithms, was just the beginning of Netflix’s effort to solve the “I have access to everything—now what?” problem. In the newspaper and magazine world, publishers are realizing that they must make the experience of consuming their content more enjoyable if they want to compete with services like Twitter, Facebook, Flipboard, Instapaper, and Google Reader that intermix their stories with those from other sources. The positive experience is what creates long-term customer stickiness.

Second, owning the customer relationship is critical to a media company’s long-term success. Engaging directly with customers can shape and improve the overall experience (see the point above), but it also provides media companies with the means to cross-sell and up-sell as appropriate.

So, while there is plenty to like about Apple and Google’s subscription initiatives, not least the rapid and broad market penetration of iOS (and Android) devices with compelling and convenient single-click payment options, it’s not hard to understand why media companies would have questions about the role Apple and Google are assuming as self-appointed middlemen.

Media and content companies realize that successful consumption of their content and services via these devices is partially driven by the platform itself—whether a byproduct of the curation capabilities of the storefront/device or the pricing policies of the platform. Media companies need to explicitly take these factors into account as they build their acquisition strategy on these different devices.

And whenever a third party enters the scene, it raises the question of who owns the customer relationship. Independent of whether the publishers believe that a 30 percent fee is appropriate or whether forced price parity violates the notion of true competition, the question is whether Apple’s terms are detrimental to media companies seeking to own that business relationship. According to reports confirmed by Apple executives, about 50 percent of App Store subscribers choose to share their information with publishers. The collective wisdom is that publishers should be excited about this number, since it’s far greater than any other Internet-based opt-in rate. My take is that a number of larger publishers believe that they normally would obtain a much higher rate if they had a direct relationships with these subscribers.

The reaction among media companies to the Apple’s subscription requirements has been predictably varied. Companies like Next Issue Media, the joint venture formed by Hearst, Conde Nast, Time, Meredith, and News Corporation, have explicitly decided to start with the Android platform to sidestep a confrontation with Apple. But other companies like Bonnier, the publisher of Popular Science, and even some of Next Issue Media’s parents have gone full bore with subscriptions on the Apple platform. Finally, the Financial Times, which has an extremely successful digital model, has been very explicit about their desire to own the customer relationship, and remains “in negotiations” with Apple to sort out this critical issue.

While the focus of the App Store subscription plan has been very specific to media and content companies, the same issues and challenges around subscription and content control exist within other areas in our new cloud-centric world—especially when it comes to cloud services delivered via and to mobile devices. We’ve already seen Steve Jobs apparently claim that the most onerous parts of his attempted remediation wouldn’t affect SaaS companies. In this case it remains particularly hard for Apple to remain a middleman. The value of the iPad is heavily based on the content and services that I can access. If content companies choose not to support the iPad because of the underlying subscription terms, then as a consumer I have to wonder about the value of the device itself. One of the major value propositions of the iPad for me, for example, is not having to also own an e-book reader. If I have to move to Android to continue to enjoy my excellent relationship with Amazon (Prime is brilliant!) then all of a sudden the Galaxy Tab 10.1 begins to look very compelling indeed.

My prediction is that these economies will move closer to the world we’ve seen in pay for performance advertising. Media companies will happily write a check to Apple for even 30 percent of the first year net value of the subscriber that Apple sends the companies’ way, but those subscribers will have their primary relationship with the service.

This story has many chapters left, but the central theme around customer ownership will continue to influence and drive the relationship between the media and content markets and the platform companies. In the second half of 2011, more light will be shed on how these relationships evolve to the mutual benefit of consumers, media companies and the platform players.

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While this piece was being edited and posted at Xconomy, Apple changed track to allow Apps to be available to subscribers via iTunes without the "must carry iTunes account" rule. It remains to be seen how the Facebook Credits story plays out.

The Need For Scale Means Niche Media Will Need Subscription Models to Survive
Originally published May 31, 2011 on AdAge Digital.

Late last year, Nick Denton posted a preview on Gizmodo of the now-known-to-be-controversial redesign of the Gawker family of sites. His overview highlighted a lot of hard-learned wisdom about the state of news and information delivered via the Internet.

Nick explains that the underlying trends include the fact that the advertising model is under pressure from ad networks and Facebook. Ad networks have allowed garbage inventory from garbage aggregators to lead to garbage click-throughs that make the media buyer look good by driving down the cost per click. Add in Twitter and Facebook creating a new paradigm of personal blogging that leads to improved news aggregation, and the pinch of the two is strong considering the dollars that can be generated per page view and the attention that can be wrestled from the social networks by a content aggregation and editorial site.

These issues amongst others have lead Nick to state that micro-targeted content is dead. "The power of the scoop, rediscovered," is how he put it. How the world saw it was Gawker going after the "gutter" stories that other outlets wouldn't touch. Whether it was angering Steve Jobs over making public the iPhone 4 prototype or airing Brett Farve's dirty ahem "laundry," the Gawker properties were able to use these sensational scoops to build a new base of readership an order of magnitude higher than their previous daily audiences.

Challenges With Today's Advertising Model

This is the fundamental problem with the present-day advertising model. To build the necessary scalability to attract and retain advertisers who support the underlying business, online media companies have to forgo niches. These are the business imperatives for advertising-supported media businesses.

When eMusic owned and managed RollingStone.com, I loved it when we had an in-depth review of some great new indie rock band that explored their artistic vision and influences and added to our understanding of the popular history of rock. But I knew that my ad sales team could easily make their number when Britney Spears was on the cover, even though a Big Star retrospective would be more engaging for the audience.

Advertising drives content creators to create mass markets by publishing for the lowest common denominator. This effect is one of the major reasons we founded Vindicia. Much human thought doesn't involve audiences of 20 million Internet viewers. The services around compelling human thought require a sustainable business model – allowing those "smaller" communities and services to thrive.

Today much economic discussion happens on a few blogs, and we should be thankful that the tenure system in higher education supports the time and infrastructure necessary to let Tyler Cowen debate economic thought with Paul Krugman in public, with Russ Roberts chiming in via text and podcasts. However, pity the content category that can't live off the largess of academia.

That's why services like deviantART, Boxee, Star Trek Online, and Next Issue Media look to premium services to create an experience that doesn't cater to the lowest common denominator. How exactly would the Star Trek Experience be believable via the corporate sponsorship of 'Thunder Bolt by HTC on Verizon" (to borrow a recent Gizmodo advertiser)?

Premium content providers face twin challenges: the understandable consumer perception that the digitization of a product should lead to a lower-priced version, and the effect of piracy on such content. I've often referred to this as the "Napsterization" of digital content and services.

The Market for Premium Digital Content and Services

We all like a good deal and it's hard to feel bad in the short term about the free lunch (ads ignored!) that we all get at Gawker, Huffington Post, or Instapundit.com. However, that masks a longer-term issue in that the best engine for the creation of intelligence, wisdom, and wealth that we've found so far is the underlying profit motive. We, as consumers of thoughts, ideas, and entertainment, have to want a lot of that experience to be far from the lowest common denominator. We have to ask entrepreneurs and visionaries to fight the battle royale between the ad model and premium digital service model.

The good news is that a simple survey of the landscape shows that the evolution of valuable premium services is occurring. Netflix is driving the conversation about how premium video will be used. Boxee is now a significant part of the conversation about what the day-to-day experience of the home media environment will be.

The math is extremely relevant here. Advertising businesses need 10's of millions of daily viewers to support a $10M annual business. Subscription and virtual currency businesses need but 100,000 subscribers paying an average of $10 a month to reach the same revenue. Lost is the other part of, for example, the traditional newspaper business. Advertisers, just like online daters, tend to prefer those audiences who have shown they can afford their products by paying for something in the first place.

We're in the early days of the growth of premium digital services. I often think about the parallel to the Internet advertising market in 2003. Subscription and virtual goods/currency services are going to begin to scale as broadband has penetrated worldwide. And as the last recession is easing, people begin to accept as conventional wisdom that many digital services are worth paying good money to keep them above the lowest common denominator.

ABOUT THE AUTHOR
Gene Hoffman is chairman and CEO of Vindicia, which provides an on-demand subscription billing solution for digital merchants. Prior to Vindicia, he co-founded eMusic, and led the acquisition of the company by Vivendi/Universal in June 2001.