Record companies seeking to promote new music or generate new revenue streams today face a daunting diversity of digital outlets: online music services, videogames, ringtones, Internet radio and, in some cases, peer-to-peer applications.

While physical CD sales still represent the bulk of consumer spending on music, marketing executives at music companies face confusion over which new media will ultimately boost, or undermine, their bottom line.

"All these channels are becoming part of the digital distribution portfolio, and all major labels have built full-fledged digital distribution teams for promotion and marketing," says Shahid Khan, a managing director with consulting firm Bearing Point.

The crux of a new-media marketer's challenge is to generate "incremental revenue without creating a decline in conventional revenue," says Phil Leigh, an analyst with Inside Digital Media.

Music executives, Leigh says, also must have "the intuitive ability to adapt to change."

While the digital age has brought a wealth of new promotion and distribution methods, each has had a different impact on revenue.

Physical CD sales—at traditional retail and online—still represents 98% of consumer spending on music, according to Jupiter Research.

"When it comes to the current business, if money is made through brick-and-mortar retail channels, the major thrust has to be in that area," says David Ellner, CFO/senior VP of Universal Motown Records Group. "Our marketing priorities follow the money, but it doesn't mean you can't be incubating ideas and focusing on the future."

Khan says the music industry's current transition is similar to what Hollywood experienced through the years with the arrival of successive formats, most recently from VHS to DVD.

"In Hollywood, anytime a new channel came up, they created new models to successfully take advantage of it," Khan says. "It's not going to be all or nothing with the CD, but the structures will change. The recording companies can learn a lot of lessons from Hollywood."

The growth of Internet radio began in 1998, when the Digital Millennium Copyright Act established revenue and royalty structures that spurred labels to support the technology.

"Labels knew they were going to collect fees because of the DMCA royalty structures, so they clearly saw that as incremental revenue," Leigh says.

Khan, however, notes that Internet radio's audience growth rate isn't quite as high compared with its expectations. Today, Internet radio giants Yahoo Launch, AOL Music and MusicMatch each have 12.5 million, 14.5 million and 10.3 million unique visitors per month, respectively, according to September's Nielsen NetRatings.

Record labels now look to Yahoo Launch and AOL Music as important outlets for exposing new music or promoting artists, especially AOL's First Listen, Sessions and Breakers programs, as well as Yahoo's recently initiated Who's Next.

"First listens are a way to attract consumers and a great marketing tool to bring attention to new music," Ellner says. "Consumers are using Internet radio as a clear way to find out about new music."

VIDEOGAMES BOOM

While some analysts say the potential of Internet radio seems limited, the videogame business continues to grow at a staggering rate. With that comes the opportunity for music companies to license their repertoire to such game producers as Electronic Arts, Activision and Atari.

Shipments of videogame consoles and software in North America are an estimated $13.7 billion for the year to date, according to International Data Corp. The research firm also reports the average age of a videogamer is 24.8 years old and that 15% own a portable MP3 player, which is well above the current market penetration.

Steve Schnur, worldwide director of music and audio for EA, says that record companies are spending increasing amounts of time and energy to license new acts and new music in EA videogames like "Madden NFL," "SSX" and "NBA Live" for platforms including Microsoft's Xbox, Sony's PlayStation and Nintendo's GameCube.

"Major recording companies found that soundtracks for new games introduced new music to listeners almost more than any other medium," Khan says.

This year's "Madden NFL" soundtrack contains new releases from Green Day, the Hives, Franz Ferdinand and Hoobastank.

"Labels know games are the perfect place to launch band discovery," Schnur says. "The hard part is [for the consumer] to connect the dots to say, 'Yes, I love this song, so I purchased it.' But once a song becomes more popular it becomes more valuable for other licensing opportunities."

David Card, analyst with Jupiter Research, says that videogame sales do not specifically cannibalize music sales, "although spending on videogames does eat into people's entertainment dollars."

Khan believes the time has come for the music industry to make more money from the music in videogames. "All the lessons we've learned from the movie industry can be directly applicable to videogames," Khan says. "That includes selling music, promoting the artist and creating compilations."

RING! RING! KA-CHING!

Possibly the most lucrative opportunity facing the industry is the growing windfall from ringtones for mobile phones. For master ringtones, which use the actual recording of a song, labels can reap up to 40% of the usual $2.50 retail price of the sound clips.

Consumers apparently are willing to pay a premium for the clips to personalize their mobile phones, rather than using ringtones merely as entertainment. Sprint, for example, has sold 500,000 master ringtones of songs by 50 Cent.

The potential of the business is clear. According to Khan, only 5% of U.S. consumers have downloaded a ringtone, as opposed to 70% in Japan. Ringtones currently represent a $300 million business in the United States, but that figure is expected to reach $1 billion by 2008, according to market research firm Consect.

"We haven't begun to scratch the surface," Khan says. "When people buy ringtones as opposed to buying a track on iTunes, it comes from a very different part of our budgets—our lifestyle and image budgets as opposed to music-consumption budget."

Universal Motown's Ellner says the label is focusing its attention on ringtones, and boosting investment in promotions with partners, because of the potential payoff. "That is an area that we're seeing as a huge growth engine, so we're spending appropriately, commensurate with what we think the return is going to be in the next six to 12 months," he says.

For example, Universal's A&M label just rolled out a multiplatform campaign with the Black Eyed Peas to include exclusive promotions in conjunction with handset manufacturer Motorola and wireless carrier T-Mobile.

Michael Nash, senior VP of Internet strategy and business development for Warner Music Group, says his company aims to deliver ringtones to its distribution partners simultaneously with single and album releases to drive sales and other opportunities.

DOWNLOADS CONTINUE RISE

Amid the ringtone industry's growth, such digital music services as iTunes remain a major factor in music industry's long-term prospects.

Nielsen SoundScan reports almost 93.6 million total purchases of digital downloads between Jan. 1 and Oct. 10. That is nearly a five-fold increase from the 19.2 million downloads purchased from June 2003 through January 2004.

Record companies currently collect a margin of about 60% on paid downloads. Jupiter Research reports that this format should generate $158 million in 2004 but accelerate to $803 million by 2009.

"With digital music, it will take a longer time because the consumer has to change his consumption habits," Ellner says.

Digital download leader Apple Computer, which reports that its iTunes Music Store has sold 125 million tracks since launching in April 2003, has become a formidable platform for artist releases.

U2 plans to release its new album "How to Dismantle an Atom Bomb" Nov. 23 preloaded on custom iPods.

"Exclusives have become a key commodity online, in the same way a station visit or radio show appearances have value with traditional radio or an in-store appearance from an artist has value at traditional retail," says Alex Luke, director of programming and label relations at Apple.

"We've [also] taken existing Sessions@AOL and the EA game soundtracks and made them available to a wider audience. We've worked with artists to capture concerts or radio sessions, and we've been an outlet for unreleased material."

If the growth of digital music services continues apace, record companies face a seismic shift in their existing business model: one that sells 99 cent singles rather than a $15 album.

"Digital downloads have brought about the death of the album," Card says. "The industry has been based on the fact that album demand has been driven by one or two hit singles. There's an issue over chopping up an album into its parts. Even if you're making 60% of 99 cents, it's not a substitution and a net loss on gross revenue. This is one of the many reasons labels were slower to move on digital music services."

Eric Garland, CEO of market research firm BigChampagne, says that major labels profit mostly from the generation of "hit-driven" multiplatinum albums, those with upwards of 5 million in CD sales. Digital music services and peer-to-peer channels, however, undermine this model. This explains the notion that while CD sales may be on the increase, labels are still hurting when it comes to the bottom line, he says.

Meanwhile, such peer-to-peer channels as Kazaa and eDonkey provide a new means of promotion for smaller, independent labels.

"It's fair to say that major and independent label communities are sharply divided on issue of P2P distribution," Garland says. "The 'indie' sentiment is that anything that helps us get heard is an asset, because they are often shut out of the traditional retail channels. P2P represents a huge opportunity to one model and a threat to another."

NEW INVESTMENT

As challenging as the array of new channels may be, they are new investments and new ideas in the music industry.

"The good news is that there is a lot of private money coming into the industry," Khan says. "Companies have new management teams looking at best practices from other industries, such as retail and publishing. Things are moving in the right direction. What will and should happen is the labels will bring in direct-marketing experts from other industries to help them cut down on their costs and help them reach the right audience that will spend money on music."

Ellner adds: "The record industry is doing more with less, but it's an exciting time, kind of like when the CD boom started to kick in. I feel like we're on the verge of a giant wave. The opportunities are ahead of us."