Digital Music: Web Watershed

What a difference a year makes to the maturation of the digital music market.

In the past 12 months, the major labels have opened the content floodgates, authorizing hundreds of thousands of tracks for Internet distribution; Apple Computer has sold more than 6 million downloads through its iTunes Music Store since its debut in April; and since launching in February, AOL claims that more than 75,000 subscribers are paying $10 per month to access on-demand music through MusicNet.

This growth spurt for sales of music in digital form comes at the end of five years of plodding development, frustration and false starts.

Online music executives hope that recent developments signal that the digital distribution concept finally is poised for mainstream acceptance.

"We think we are at the tipping point," says Richard Wolpert, chief strategist at Real Networks. "We can see a path to this all making sense as an offering for consumers and as a business for us and the labels."

That Apple and AOL, two of the biggest names in Internet and technology, have generated a total of $4 million in revenue may not seem like much in the context of the $32 billion global music business.

But it shows clearly, for the first time, that consumers will pay for digital music.

That will be the topic du jour among attendees July 28-29 at the Jupiter Plug.IN Conference in New York.

The challenge now facing Internet and music executives is how to take the digital music business to the mainstream market.

"The focus will be on crossing over from the enthusiast to the general public," listen.com CEO Sean Ryan says.

Much of the talk at the ninth annual Plug.IN confab will likely center on feeding demand for online music among PC users, who account for 98% of the U.S. computer market. In contrast, the iTunes Music Store works only on Apple computers, which account for 2% of the U.S. market.

A host of leading media and technology brands bet that well-marketed pay-per-download offerings are the way to go.

Apple is developing a Windows version of its iTunes service. Amazon.com, AOL, MTV/VH1, Yahoo and MusicMatch are in various stages of exploring download services of their own.

"There's no question: The race is on," says Peter Csathy, president/COO of San Diego-based MusicMatch, about the scramble to develop download services.

But the future of subscription-based services remains to be seen.

Companies specializing in subscriptions are now consolidating because of slow growth and rethinking their strategies on à la carte singles.

Sony Music Entertainment and Universal Music Group recently agreed to sell their subscription service, Pressplay, to Roxio, a maker of CD-burning software that owns the Napster brand name.

Meanwhile, Real Networks has entered a deal to acquire listen.com, operator of the Rhapsody subscription service. As part of that move, Real discontinued its distribution of MusicNet—a joint venture with Warner Music Group, BMG Entertainment and EMI Recorded Music—in favor of Rhapsody.

At the same time, ventures like MusicNet on AOL, Pressplay and listen.com's Rhapsody are exploring the possibility of expanding their businesses to also sell downloads à la carte without a monthly subscription, sources say.

In such a scenario, consumers would have to download the subscription service's software, but they could purchase tracks without an upfront fee.

That's not to say the subscription model is dead. It will likely co-exist with à la carte services.

"It's not an either/or proposition," MusicNet CEO Alan McGlade says. "It's a false debate."

Subscription advocates maintain that any competitive digital music scenario will ultimately offer a mix of radio programming, subscription content and à la carte downloads.

Subscription businesses are responding to the rise of such services as iTunes by tweaking the price of CD burning in their monthly access packages and stressing the cost-effectiveness of their offer.

Listen.com lowered the price it charges for burnable tracks through Rhapsody, whose subscribers pay 79 cents per track when burning songs to a CD. Previously, CD burns cost 99 cents. Rhapsody offers unlimited access to on-demand streaming music for $9.95 per month.

Listen.com executives describe the pricing strategy as an advantage of subscription services over à la carte for high-volume music consumers.

The company reports that Rhapsody users are consuming 250 to 300 unique songs per month through on-demand streaming, in addition to burning select tracks.

For such users, subscription advocates say, the Rhapsody model is much more compelling, because buying a large number of tracks online via an à la carte service is cost-prohibitive.

Pay-per-download services typically charge 99 cents per track. Subscription services, by contrast, can charge a lower price for CD burns because their revenue streams are diversified.

Some maintain, then, that the debate is not between the pay-per-track services and subscription business models. Rather, it is between services that sell digital music in the context of broader programming and those that sell it in a narrow browsing context.

The likes of AOL and MusicMatch offer so-called "contextualized commerce," using programming like radio and CD premieres to gain subscribers.

AOL Music VP/GM Evan Harrison says MusicNet signs up most new customers in connection with its First Listen CD debut programming.

The company plans to use similar strategies in driving pay-per-download sales.

"This is the year to connect the dots with sales," he says.

Meanwhile, those already in the à la carte download business on the PC side—Liquid Audio and Ecast—want to capitalize on the attention surrounding iTunes to spur greater support from record-company and retail partners for their services. The Web sites of retailers that sell downloads do not promote and market that service as strongly as iTunes has.

But replicating an iTunes-style experience in the PC market will be challenging, both in developing products and gaining label support, according to industry sources.

Apple, which specializes in proprietary products and services for its own operating system (OS), must now develop software for use with a foreign OS. And competing companies must match Apple's design and ease-of-use innovations.

Recording companies also have to become comfortable with an iTunes-for-Windows concept.

Some major-label executives, for example, say that iTunes is not secure enough for PC distribution.

Some executives want to see greater control over how many times a copy can be made or synched to another computer before making iTunes available for Windows.

Despite these concerns, digital music companies will likely launch new offerings before Christmas—and that will require big marketing budgets to reach a broad audience.

"Going mass-market means a huge marketing, advertising and promotion initiative so the business goes from something in the background to something that's front and center," MusicNet's McGlade says.

Apple already has launched a high-profile ad campaign to promote iTunes. Others are expected to follow. Roxio, for one, says it plans to spend a significant amount on marketing to roll out the new Pressplay-powered Napster. And Real Networks will likely increase marketing for Rhapsody.

Label executives and operators of other digital music services are hoping that such marketing evangelism and sales success will create a halo effect for the legal digital-music market as a whole.

But operators of digital services point out that for mass-market acceptance, greater artist support is needed as well.

The amount of music available for digital downloads from the majors has doubled in the past year. But some of the most popular artists still resist requests to sell individual tracks from their albums online, either as à la carte downloads or on-demand streams.

Top artists and their representatives express concern about the creative and financial implications of shifting to a singles-based economic model. In response, some acts require their music be sold exclusively in an album bundle.

Fred Goldring, a leading industry attorney whose firm represents clients including Will Smith and Alanis Morissette, says the concern of musicians makes sense: "The fear among artists is that the work of art they put together, the album, will become a thing of the past."