The past few years haven’t been pretty for music retailers competing with Apple, which is dominating the scene with its iPod and iTunes e-commerce site. Online music retailers are tuning up their businesses to compete.
By Katie Deatsch
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.
Some question whether consumers will subscribe to music in big numbers. U.S. subscription sales will total only about $596 million by 2012, while downloads will rise to $2.8 billion, Jupiter predicts. Jupiter adds in its report that subscription services seem most appealing to niche audiences and specialty music retailers.
Giveaway game plan
Selling music at any price may be a challenge when some consumers, especially younger ones, are accustomed to downloading music, movies and TV shows for free from peer-to-peer file-sharing web sites. These sites enable one consumer to upload a file, which can then be downloaded by others.
It’s illegal to distribute copyrighted material this way. And some of the peer-to-peer pioneers, such as Napster, have gone legit, charging for music and paying royalties to the music labels.
Still, Jupiter estimates 21% of U.S. adult web users are music “freeloaders” who either stream or download free music, rip or burn CDs, or create music collections on their PCs regularly. They also spend on average less than $50 on music in a three-month period, Jupiter says.
To find a revenue stream while still serving consumers reluctant to pay for digital music, a smattering of free and legal ad-supported sites have popped up. These include Internet radio station Pandora and streaming music service Last.fm.
Another site called SpiralFrog offers 800,000 songs that consumers can download to their hard drives for free. Users can transfer the tracks to most MP3 players that use Windows Media Player, but the songs aren’t compatible with iPods or Microsoft’s Zune, says SpiralFrog’s vice president of marketing Matthew Stern.
The catch? The songs, like Apple’s iTunes, are DRM-protected and won’t play if a user doesn’t come back to the site and view more ads. After 30 days, users must re-register before downloading more songs. After 60 days, they can no longer listen to the songs they have downloaded.
Stern says SpiralFrog is going after younger music aficionados—listeners likely already getting much of their music for free, but illegally. SpiralFrog is giving away music, but legally and in a way that pays the artists, publishers and record labels, Stern says.
Musicians get into the act
Retailers aren’t the only ones noticing the shift in consumer behavior. Artists are starting to use their songs more as marketing tools and less as revenue generators.
Small or new bands are giving their music away online via their web sites or MySpace pages to create buzz, and big-name artists from Coldplay to Radiohead have toyed with offering free music as a way to promote their work.
Concert promoter Live Nation has responded to declining CD sales by offering musicians alternative ways to profit from their work. Last year, the company started signing what it calls 360 Deals with megastars, paying them hefty sums up front—often over $100 million—in exchange for a cut of the profits from nearly all aspects of their careers, including touring, merchandise and recordings. The company has signed deals with such big names as Madonna and Jay-Z.
While it’s clear music is going digital, not much else is settled. CD sales are declining, but it’s unclear how bands, retailers and record labels can make up the lost revenue. Apple is the digital music leader for now, but its market share is coveted by fierce competitors. Free music is available online, but it’s uncertain if it will keep consumers from buying music that costs less than a buck.
“The thing to remember is that the changes aren’t over yet,” Napster’s Allen says. “We are about 10 years into a 20-year industry transition.”
katie@verticalwebmedia.com
