Tuning In

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.

Circuit City Stores Inc. has taken the multi-channel approach a step further by acquiring its own digital music service, MusicNow LLC, which the retailer is promoting throughout CircuitCity.com as part of a recent site redesign as well as through its 600 stores. "There`s not a lot of profit margin in digital music right now if you`re using a middleman, so we wanted to own our own service," says Fiona Dias, senior vice president of Circuit City Stores and president of Circuit City Direct. "We`re the only retailer now that sells its own digital music and CDs."

Circuit City lets customers purchase music downloads in its stores as well as on its web site, and promotes in its stores package deals of digital media players and related equipment.

IRCE 2008 Conference Multi-Media CD-ROM

Questionable future

Apple Computer remains the market leader by far, however, with more than 100 million digital music songs sold since it launched its iTunes service in April 2003, accounting for about 70% of legal downloads. Experts attribute Apple`s lead to its first-to-market strategy and its popular iPod media player. "There`s no Windows Media iPod equivalent," says Jupiter analyst David Card, adding that no Windows media players have received the kind of marketing support that Apple has put behind the iPod.

Apple also has several digital music marketing partners, including Hewlett-Packard Computer Co., Volkswagen and the Walt Disney Co., and it recently introduced its fourth generation iPod. The newest iPod features a Click Wheel feature for one-handed navigation and extended battery life of up to 12 hours.

But while other digital music providers are pushing multi-channel strategies with wide exposure in stores and an open policy on using different varieties of Windows media players, Apple will continue to emphasize its depth of iTunes services as well as the iPod. Apple says it has sold more than 4 million iPods at $299 to $399 depending on the number of songs they can hold, accounting for 52% of all digital media players.

But Apple`s strength in the digital music market is also its potential weakness, because it restricts mobile downloads to iPods. Many observers draw an analogy between Apple`s iTunes strategy and its home computer strategy. Apple developed a superior operating system for home computers, but wouldn`t license it for any use except on Apple computers. Without a core of developers coming up with new uses for the Apple, the market shifted to PCs and the Microsoft operating systems. A promising technology is today a minor factor in the PC world. Similarly, the company risks isolation from the growing digital music market as Windows media players gain acceptance, giving its competition the chance to chip away at its market lead, experts say.

"The iPod is a nice industrial design, but we`ll soon begin to see better designs in other media players," says Brad Duea, president of Napster. "It`s hard to say that anyone will surpass the iPod design, but this fall we`ll start to see things happen, such as better choices of color screens."

Napster`s new player

Napster has processed more than 20 million song downloads since it emerged from its illegal file-sharing predecessor as a commercial service in October 2003, and it has a catalog of more than 1 million tracks, Duea says. It expects to continue growing at a rapid pace with a multi-channel strategy as well as a pricing structure designed to contrast with Apple`s, he adds.

A new Napster to Go service, which Napster will make available this fall in a link through the new Windows Media Player 10, is designed to hit Apple hard on pricing, Duea says. The service will debut with an introductory monthly subscription price of $14.85, which will allow users to download unlimited songs from Napster`s catalog to a PC as well as to a 20-gigabyte Napster to Go media player, which will retail for $299.

By comparison, Duea says, it would cost close to $5,000 to fill a comparable 20-gigabyte iPod (which also retails for $299) at Apple`s per-song price of 99 cents. Apple offers no monthly subscription fee. "At our monthly fee, it would take 27 years to add up to $5,000," Duea says.

Napster says it will not announce a permanent monthly fee for Napster to Go until later this year, but Duea insists it will still be a bargain compared to iTunes. Apple did not make any executives available to comment for this story.

Like Wal-Mart, Napster is also building a presence in stores, and it was the first to offer stored-value cards in retail outlets, including Safeway supermarkets and consumer electronics retailers Best Buy, RadioShack and CompUSA.

Partners and competitors

But in the quickly changing market, even some partners can also be competitors. While Napster has high expectations for its Napster to Go service as part of Microsoft`s new Windows Media Player 10, Microsoft itself has entered the market as a seller of digital music. In the same week in August that it launched the new media player, which lets users link directly to Napster, WalMart.com, Circuit City`s MusicNow and other services, Microsoft also launched its own digital songs download service at MSN.com.

The MSN Music service lets users download music through a web browser or directly from the Windows Media Player. MSN is offering a selection of more than 1 million tracks, at 99 cents per song, from more than 3,000 music labels.

"Our vision is to deliver a seamless, end-to-end experience for discovering, downloading, and playing music, videos, and more, anywhere," says Jonathan Usher, Microsoft`s director of Windows Digital Media marketing. "These releases are an important step forward in delivering on that vision." The new media player also provides direct links to CinemaNow.com and it offers a separate "browse all" link to connect with virtually all other digital music download services.

Even eBay is getting into the market, or at least testing it, with about 20 sellers in its new Digital Downloads section. The move represents a policy reversal for eBay, which up to now has avoided getting involved with any types of digital downloads, including e-books and software. "We`re going to gauge how well digital music downloads will sell in the eBay marketplace," a spokesman says. He adds that eBay will pre-approve all sellers to check for ownership rights. After receiving payment through Bay`s checkout process, sellers e-mail their customer a link to a web page for downloading music from the seller`s own media player software.

Josh Bernoff, an analyst who follows the digital music market for Forrester Research Inc., says eBay may be too late to the market and without a defined service plan to attract many customers. "You don`t tiptoe into digital music downloads," he says. "You`re either in or you`re not. If you`re going to sell downloads, you need to offer a full service around it."

A music renaissance

For the retailers who play their cards right, digital music may provide enough market rhythm to win back some of robust music sales that have been lacking in recent years. But offering a full range of content and services is crucial, experts say. "I hope we don`t turn what today is a $12 billion to $14 billion business into a $1.5 billion business because we`re selling one song at a time, instead of albums as in the past," says Zullo of Muze.

That scenario recalls the days before the Beatles, who ushered in the widespread use of albums instead of the old 45 rpm vinyl disc, which had one song on each side. Retailers of digital music say they`re confident that won`t happen, because the digital revolution offers too many options to customize one`s music collection.

"We`re experiencing a renaissance of music with the new functionality of digital music," Circuit City`s Dias says. "I`m very bullish on digital music`s future."

paul@verticalwebmedia.com