September 30, 2008, 12:00 AM

Facing the music

Selling music on the web has gotten tough for everyone but Apple. New business models keep emerging.

Five years ago, Apple Computer Inc. was the first to put the two key pieces of the digital music puzzle together. It’s been reaping the rewards ever since.

A revolution in music delivery ensued after Apple Inc. created the iTunes online music store in 2003, providing an easy way to download songs to Apple’s iPod portable music player introduced two years earlier. Today, Apple commands more than three-fourths of the growing U.S. digital music market, according to NPD Group, a research firm that covers music. What’s more, Apple says the 5 billion songs it has sold make it the largest music retailer in the world.

So what do retailers do when the Internet and a single company team up to turn their market upside down? Anything they can-as illustrated by today’s scramble for a viable business model by online music merchants. There are new strategies aplenty, including competing on price, pushing subscriptions, giving the music away free in hopes of making money in other ways and being more user-friendly than Apple.

“Apple solved a problem. They put the device with the music,” says Janice Anderson, CEO and chairman of Muze Inc., which provides retailers like Best Buy and Overstock.com with information on digital music and content. “Now we have a whole new channel of music distribution, and with it, revenue is down and consumption is up.”

Indeed, the U.S. digital music market is projected to grow 39% this year to $1.6 billion in sales and to make up 34% of all domestic music sales by 2012, according to research firm JupiterResearch, recently acquired by Forrester Research Inc. But that growth is more than offset by slumping U.S. sales of CDs, which declined 18% last year and will fall by a similar percentage this year, according to NPD. CDs still make up most of the music market, with sales of $9.6 billion according to Jupiter.

If there’s one consensus about the changing music scene, it’s that the status quo won’t work. That’s clear to music e-retailer CD Universe, which has seen CD sales decline about 5% each month for over a year, according to marketing director John Salai. “We’re seriously considering selling digital downloads sometime in the next year,” he says.

If it does, CD Universe will be joining a crowded marketplace that includes the largest online retailer, Amazon.com Inc., the largest retail chain, Wal-Mart Stores Inc., and a host of e-retailers, including RealNetworks and Napster.

Apple’s weak spot

All these merchants have their eyes on Apple’s dominant market position and many are going after what they deem a weakness in Apple: the DRM, or digital rights management, technology that limits what consumers can do with the music they download from iTunes. ITunes playlists can be copied to a CD only up to seven times. ITunes music tracks can only be added to iPod portable music players and transferred to a maximum of five computers simultaneously.

Amazon last year launched an Amazon MP3 store which now offers more than 5 million DRM-free tracks that can be downloaded to portable music players, often called MP3 players. Consumers can play the songs on just about any MP3 player or computer-including Apple’s iPods and iPhones-and can copy and share music without restrictions.

“We felt it was very important to offer a DRM-free format,” says Sam Heyworth, group product manager for Amazon MP3. “When we made the decision to launch the store we wanted to offer a convenient and easy-to-use experience.” Amazon has moved into second place in digital music behind iTunes, but it’s a distant No. 2 with less than 10% market share, according to NPD, which does not release detailed estimates.

Wal-Mart also entered the music download arena last year, with the launch of a web store selling DRM-free music. In May, Napster, which was purchased by Best Buy Co. last month, followed suit with its online store that offers more than 6 million tracks sans DRM.

Rhapsody, RealNetworks’ digital music service, partnered this summer with MTV Networks and Verizon Wireless to extend access to digital tunes by expanding DRM-free music selections, offering full-length song samples and purchase options on social networking sites, and integrating with mobile phones. The “Music Without Limits” Rhapsody service offers more than 5 million songs.

Apple has responded to the competition by offering about half of its 8 million songs without DRM through its iTunes Plus program. The tracks are priced at 99 cents-it lowered the price from $1.29 last year-the same as other songs on iTunes. The catch is that iTunes users must upgrade music already purchased-if it is available-for an additional 30 cents per track.

Pennies count

Given that many consumers download thousands of songs, a few cents a track can make a difference. And several retailers are competing with Apple on price.

Amazon offers many songs for 89 cents and many albums for $8.99 or less, compared to iTunes’ common $9.99 album sticker price. Wal-Mart’s prices also are a tad less at 94 cents a track and $9.22 for many albums.

However, while Napster sells downloads, its main goal is to tune up sales with a different model: music subscriptions.

Napster offers subscriptions in several flavors, including a basic service that streams unlimited music to any web-connected computer, and Napster To Go, a portable service that, in addition to streaming, allows users to download music to a mobile phone or MP3 player and keep the songs for a monthly fee. A little less than half of Napster’s 708,000 subscribers use Napster To Go, says Christopher Allen, Napster’s chief operating officer.

But Napster, along with RealNetworks’ subscription streaming service, have both experienced limited success, mainly because they are not compatible with iPods.

What’s more, taking a bite out of Apple is costly, and Napster is losing money. The company posted a net loss of $16.5 million on revenue of $127.5 million for its 2008 fiscal year. However, Napster says it’s working to change the tide. Last quarter it cut its marketing spend 80%, focusing more on online spending, but still had a record number of consumers sign up for free trial subscriptions, Allen says.

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