September 30, 2004, 12:00 AM

Tuning In

How retailers are capitalizing on the digital music phenomenon.

It`s not difficult to pick up on the early rhythm in digital music sales. As the music recording industry shoots for a comeback after years of declining CD sales, a growing number of retailers are dancing to digital music tunes along with computer manufacturers and pure-play digital content providers like Napster and Real Rhapsody. It`s a party no one seems to want to pass by.

But with so many dancers, can the band play on for all of them? That will depend on individual strategies, some of which already raise doubts, including Apple Computer Inc.`s heralded iTunes Store and its restriction on downloads to its iPod portable media player. But with sharp growth projected over the next few years, now is the time to enter the digital music market, insiders say.

"From the beginning, we`ve been consistently surprised on the positive side with how our customers have reacted to this market," says Kevin Swint, director of entertainment categories for Wal-Mart Stores Inc.`s WalMart.com, which launched a digital music business in March following a three-month test. "We think it will have a positive effect on our entire business."

Cross-group appeal

The approach Wal-Mart and other retailers are taking with this fledgling market is a case study in how they can leverage their multi-channel might in kicking off a new market to a wide audience. Wal-Mart initially had doubts about the potential of the digital music market, particularly as a market that would grow beyond a small slice of consumers.

But digital music quickly showed itself to be popular with all groups of Wal-Mart customers. "At first, we thought the market would skew toward young males, but now it reflects our overall customer base across age and income groups," Swint says. "There`s very little difference between the digital music customer and the overall WalMart.com customer."

Wal-Mart`s experience notwithstanding, others note that the market presents an opportunity to attract customers in demographic groups who may be disinclined to develop as regular shoppers. "Digital music presents a great opportunity for retailers to build new relationships with consumers in the millennium generation," says Jeff Cavins, president and CEO of Loudeye Corp., which provides digital music content to several marketers, including Apple.

Digital music sales are expected to nearly double this year from last to more than $270 million, then grow another sixfold by 2009 to $1.7 billion, surpassing online sales of music CDs, according to Jupiter Research. By contrast, online sales of CDs will grow to $817 million this year, up 15% from last year, then hit $1.3 billion in 2009, Jupiter says.

But those numbers don`t give the full picture of market opportunities, says Cavins. There are about 100 digital service providers, or digital products retailers, in the world today, and the U.S. has the smallest number of them even though it has the largest volume of digital music sales, he says.

A new opportunity

That void between U.S. demand and the number of digital service providers, he and others say, presents plenty of opportunity for retailers-from Wal-Mart down to tiny niche merchants-willing to investigate the best way to serve the market.

"Mom-and-pop recorded music stores have been replaced by big-box stores, but big stores don`t necessarily provide the services you get from the small entrepreneur in retail," says Paul Zullo, president, CEO and co-founder of Muze Inc., a company that provides song samples as well as information on recorded music and artists to both online and brick-and-mortar music retailers. Muze now is expanding into providing streaming audio clips as part of its new Store-Plus turnkey e-commerce platform, with search engines embedded with information on music recordings, to small retailers in niche markets.

Muze currently offers Store-Plus only to retailers within the mind-body-spirit category, which specializes in selling music, books and other products related to interests ranging from Yoga to surfing. Muze charges a few hundred dollars as a set-up fee, plus $100 a month.

Buy Music Here, another digital music provider to small retailers, provides an online music store with more than 220,000 song tracks, plus reviews, song track listings and streaming song previews from Muze, for a set-up fee of $995, plus $295 per month. For an additional $195 per month, it offers up to 41,000 video titles and 5,600 DVD titles.

But while even the smallest of retailers may have an opportunity to play in the digital music market, Apple, Napster, Wal-Mart and others will set the pace, experts say.

Exercising clout

Wal-Mart`s interest in digital music, combined with its clout as a market leader, puts it in a position to affect digital music sales as it has affected sales of CDs. "Wal-Mart`s increasing importance as a CD distribution channel has both forced prices down without increasing overall volume and shrunk the total number of retail outlets," Jupiter Research says in its "Market Forecast Report: Music, 2004-2009."

The world`s largest retailer is already acting on its clout to spread digital music sales further into its customer base with ambitious programs in cross-selling digital music and household products in Wal-Mart stores as well as on WalMart.com. In a marketing alliance with The Gillette Co., for instance, Wal-Mart is offering free downloads of digital music with everyday products like toothbrushes and batteries. "We see this as a unique way to introduce people to digital music," Swint says.

Wal-Mart, which sells digital music through its own branded Wal-Mart Music Downloads service, buys its digital music content through the Liquid Digital Music unit of Anderson Merchandisers, which also supplies Wal-Mart with CDs.

Best Buy Co. Inc. is also playing digital music in a multi-channel environment, providing direct access from BestBuy.com to both the Napster and Rhapsody digital music services and offering packages of media players, CD equipment and stored value cards in its stores.

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