Music and newspapers are now mainly online. People spend more money on virtual items in games, and maybe soon in metaverses. People say that experiences have become more important than physical products. We also try to be more ecological and use fewer resources and cause less environmental damage. Can we say that everything is going digital, thus physical products have become irrelevant and are not good business anymore?
Well, it’s not that simple.
To be clear, obviously, physical products that cannot be digitized (food, clothing, furniture, etc) will always be in demand. But what about physical products and services that have digital versions – music, books, newspapers, brick-and-mortar retail stores, etc? Is digital-only the way to go?
It may seem that way, but physical and digital products can co-exist. And many businesses might lose a lot of opportunities if they think digital-only.
Music and news should be digital now, but…
There are definitely many trends that illustrate virtual and online services growth. In the US in 2021, only 11% of music revenue came from physical products (CDs and vinyl), while 83% came from streaming. Most people read news online and fewer people subscribe to or buy print newspapers. People are changing their behavior to buy more online, and brick and mortar retail is fading. People even buy more digital art, including NFTs.
It would be easy to say that physical products have become less important and growth is especially digital and virtual. But the reality is more complex. Physical items are still a huge business; digital and physical businesses are often tied to each other; and there are also growing physical product businesses. Many services also include critical physical components.
Music is definitely now digital, but in 2021 both CD and vinyl revenue grew for the first time since 1996. Vinyl revenue grew 61% to $1 billion for the first time since 1986. It is still a small part of the whole business, but it is not a meaningless market, and it is growing. Besides, many artists and bands make a significant part of their revenue from concerts and merchandise, because the amount they earn from streaming revenue can be quite small.
Newspapers and news in general are also mainly digital. However, there are still many people who subscribe to print newspapers. In 2020, over 71 % of the newspaper revenue in the US came from print newspapers. One important reason is that print ads have much higher prices than online ads (and many advertisers are clearly still willing to pay a premium for print). Print book sales started to decline in 2008, but since 2012 they have grown again and are now at the level of 2008.
Physical items are important in our lives
The above are examples of industries that have really gone digital. But there are of course industries that revolve around the physical world, and they are doing quite well.
For example, the global textile industry was a $994 billion business in 2021, and is expected to grow 4% annually from 2022 to 2030, by which time it will be a $1.4 trillion business. The global fashion business is estimated to be $3 trillion, which corresponds to 2% of the world’s GDP. The retail side of these businesses are going more online, but it’s the selling of physical products that helps the retail business grow fast.
This year has reminded us of the importance of physical commodities such as oil, gas, grains, and fertilizers. And many of us remember their relevance only when the supply is not guaranteed anymore, causing prices to go up and impacting our daily living costs.
At the same time, after the COVID pandemic, people are also looking for unique physical experiences like top-level restaurants, exotic trips and hotels (assuming all their money doesn’t go to food and heating).
Physical and digital products together
I wrote earlier that it is still almost impossible to create digital-only luxury brands, and that fashion brands are looking for ways to work with physical and online channels and better combine user experience and data. Many digital and software companies, like Apple and wearables companies, combine a physical product and digital services (as well as data) in their offering. We even have a crypto business unicorn called Ledger that sells physical crypto wallets and cooperates with luxury brands like Fendi.
Wearables companies (e.g. Withings, Oura and Garmin), and companies such as Ledger and especially Apple are good examples of how physical components can still be a very important part of a brand. Similarly, premium credit cards, top tier customer cards and limited edition items are good examples of how physical items are used to build brands. On the other hand, physical product companies and brands are willing to offer digital services too.
Startups have mainly focused on building software and online services. VCs like that more than the physical product business. That’s because the physical product business is not simple. It requires more capital to design and build the products, and set up all manufacturing and logistics. As we’ve seen recently, there are also many risks linked to supply chains and demand forecasts.
Investors especially like companies that can create a stable growing MRR (Monthly Recurring Revenue). The business must also be very scalable – i.e., when the revenue goes up, profit grows much faster. Those things are easier with software and digital businesses than with physical products.
But digital services is also a very crowded market. It is especially hard to create strong customer relationships where customers have real loyalty to a brand and even an emotional relationship. For example, look at how easy it is to cancel a paid streaming service.
VCs once liked the model where you acquire customers quickly by giving them services for free and then later start to charge monthly fees. It can work sometimes, but often people really appreciate a product and brand much more when they must pay for it. (It also signals to other people they can afford to buy it.)
The question, then, is: are we underestimating the value of physical products? Could more startups also consider physical components for their offering? It doesn’t necessarily mean they must manufacture them in-house or handle all logistics themselves; there are a lot of services for that.
VCs and other investors should also be better at seeing opportunities to build brands, loyal customer relationships, and stable revenue with physical components included in the offering. We still mainly live in the physical world. People like and need physical items. Physical items are also something to signal what you own and use. Given all that, we cannot afford to ignore physical products in the business.