Tech Boom Buoys Biz

NEW YORK--In a rebound year for the music business, emerging digital formats are providing a much-needed financial boost.

Music-related products for PCs and mobile phones are on pace to deliver as much as $500 million in combined revenue in the United States for 2004, according to Nielsen SoundScan figures and analysts' projections

That's three times better than 2003 and perhaps the strongest evidence yet of digital distribution's growing role in the fortunes of the music business.

Six years after Napster made peer-to-peer piracy a mainstream activity, file swappers were reined in during the last 12 months, and sales of ˆ la carte downloads, subscription services and ringtones bloomed.

CONSUMERS GO DIGITAL

"Digital music has come into its own as a legitimate piece of the total music business," says Robert Acker, VP of music services at Real Networks.

For the piracy-ravaged recording industry-whose success has been hitched to the health of the CD since cassette sales began their dramatic decline in 1997-the emergence of digital music as a viable second format is a welcome shot in the arm.

In what amounted to year two of the mainstream digital music business, big brands, big phone companies, big anti-piracy efforts and portable players with big storage capacities drove consumers' adoption of products and services, technology executives and analysts say.

Download sales took off in 2004. Individual song sales monitored by Nielsen SoundScan are on pace to top 130 million units for the year. In 2003, digital tracks scanned 19.2 million units, though that was in an abbreviated reporting period. 2004 marks the first full calendar year for Nielsen SoundScan's tracking of download sales.

Year-to-date download sales have exceeded 120 million tracks as of Dec. 5, with more than 3 million tracks being rung up on a weekly basis. Jupiter Research estimates that overall download business, including track and album sales, will exceed $158 million this year.

Support is also growing for subscription services. Subscription fees for on-demand music and gated Internet radio services like Real Networks, Napster, MusicNet@AOL and MusicMatch are on track to top $113 million in 2004. That's in line with earlier Jupiter Media estimates.

Based on public statements by the leading PC-based music services, at least 1.4 million subscribers pay for music programming online; the average customer pays $7 per month.

The U.S. ringtone sector enjoyed a breakout year, with most projections placing the market north of $200 million. Consect, a research firm that specializes in tracking mobile entertainment, estimates that 2004 U.S. ringtone sales will total $300 million-up from $110 million a year ago. BMI projects sales of $240 million, up from $68 million.

Reflecting the rising popularity of ringtones and related products like digital wallpaper and games, Billboard launched a ringtone chart this year in conjunction with Consect.

The top digital story of 2004 was commercial downloading, led by Apple Computer's one-two punch of the iPod player and the iTunes Music Store.

The company had a busy year. It introduced two significant iPod updates, the iPod Mini and the iPod Photo; inked a major distribution deal for iPod and iTunes with Hewlett-Packard; pioneered the international expansion of digital music by bowing iTunes in more than a dozen markets in Europe and Canada; forged an innovative giveaway campaign with Pepsi tied to the Super Bowl; and partnered with U2 to market the band's Interscope album "How to Dismantle an Atomic Bomb."

"Apple continues to have a chokehold on the market," Forrester Research analyst Josh Bernoff says.

Analysts say aggressive TV and print campaigns for iTunes and iPod played a major role in educating the mass market about the benefits of digital music.

Phil Leigh, president of research firm Inside Digital Media, says the iPod craze is the most significant development in digital music since the early days of Napster.

"The runaway success of the iPod is awakening consumers to a range of opportunities in digital music," he says.

However, analysts are not expecting digital music services-including any Apple initiative-to replace physical product for at least five years.

Yet in spite of Apple's dominance and the modest expectations for the market's growth, a number of iTunes competitors have sprung up.

Since the start of 2004, such leading consumer brands as Microsoft, Sony, Starbucks and AT&T have launched digital music storefronts to challenge Apple for the hearts and wallets of tech-savvy consumers.

Other companies bought their way into the market this year. Yahoo, for example, acquired the assets of San Diego-based MusicMatch for $160 million.

Also getting in on the act were brick-and-mortar retailers like Virgin Megastores, FYE, Wal-Mart and Circuit City. Some of those companies struck out on their own following the collapse of Echo, a would-be digital venture from a consortium of CD retailers. Circuit City scooped up fledgling Chicago-based music service MusicNow.

But none of the year's new digital music efforts presented a meaningful challenge to Apple in terms of product development or marketing.

MusicNet executive VP/COO Ellie Hirschhorn cites big brands entering the digital music space as a significant trend for the year, though the effects won't be felt until 2005.

"All the marketing dollars and all the education that gets consumers both aware of and excited about subscriptions and stores will really come to bear next year," she says.

THE LEGAL FRONT

The growth of commercial digital music offerings corresponded with the recording industry's efforts to curb P2P piracy.

In the last year, the industry has filed thousands of lawsuits against consumers who distribute music on P2P services, pushed its copyright-infringement case against Grokster and StreamCast all the way to the U.S. Supreme Court, lobbied for the adoption of legitimate music-subscription services on college campuses and worked to develop copyright-friendly commercial P2P services through deals with the likes of Peer Impact and Shawn Fanning's Snocap.

"The success of the legitimate services will be in many ways dependent on reducing piracy," Bernoff notes.

Concerns persist, however, that attempts to shift consumers to commercial P2P offerings will falter because of the lack of interoperability among competing services.

Apple and other leading technology players like Microsoft and Sony power their services using proprietary digital rights management technology.

Apple in particular came under fire for its refusal to make iPod and iTunes compatible with products and services from other companies.

In an effort to make itself more consumer-friendly, Real Networks introduced a technology initiative called Harmony that allows consumers to use Real's software to manage devices supported by Apple or Microsoft.

Apple has since responded by introducing new iPod software that defeats the Harmony initiative.

However, Harmony does not address the core compatibility issue. The recording industry has been pushing technology companies to make their DRM standards compatible within the next year.

In one of the major developments of the year, Microsoft finally made its push into digital music.

The company launched the MSN Music Store late in the year in more than 13 markets, including the United States.

The MSN offering-which has yet to be aggressively marketed-is part of a larger Microsoft strategy to supplant Apple as the top dog in digital music.

Microsoft is looking to consumer choice for its competitive edge. It is making its Windows Media format available to a wide array of products and services and branding the platform with an initiative using the tag line "Plays for Sure."

Microsoft also aims to gain on Apple with a technology called Janus that allows users to transfer subscription content to portable devices.

The promise of portability helped renew industry enthusiasm for the subscription model-especially among music service providers that are not pushing proprietary hardware.

Janus has the potential to substantially impact music consumption, because it would allow consumers to move around with a massive catalog for the monthly price of a single CD.

The major labels are balking at the prospect of allowing subscription music to move off the computer at current prices.

The labels like the download business because it is a permanent-ownership proposition that approximates physical sales. Subscriptions, by contrast, are recurring income streams that provide a much lower immediate compensation per track.

As a result, service providers and labels are still trying to determine a working model for portable subscriptions.

WHAT'S AHEAD

One proponent of portable subscriptions is Napster CEO Chris Gorog, who predicts a big year ahead for the technology. "In the digital world of 2005, ownership will begin to seem irrelevant, and the idea of paying a fee for access to all music-anytime, anywhere-will reveal itself as the model of choice for both consumers and rights-holders," he says.

Other developments on the digital horizon are the rollout of legitimate P2P services, a Supreme Court ruling in the Grokster case, convergence between mobile and PC music platforms, a rise in master ringtone sales, growth in digital distribution of music video and, of course, the ongoing rivalry between Apple and Microsoft.

Bernoff notes, "If the Windows Media services start to gain market share because there is a device that's as cool as the iPod, that will signal a real shift in this business."

Additional reporting by Antony Bruno in Los Angeles.