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Music industry looks to new models to boost sales

The U.S. music industry is becoming more open-minded about working with online music stores from the tiniest start-up to Amazon.com, hoping to boost digital music sales and erode the dominance of Apple Inc’s iTunes. U.S. music companies, once paranoid about the wide-scale piracy enabled by Web-based companies like Napster and KaZaa, are now embracing new business models such as giving away free song downloads.

Their goal is: to increase digital revenue as CD sales drop more sharply than anticipated; and to create alternatives to iTunes to boost their negotiating power against Apple when licensing contracts are renewed.

“Any viable music discovery option is one we want to see out there,” said a major music company executive who asked not to be identified.

“If done the right way, this leads to new revenues as some of them have pretty good built-in mechanisms to lead to direct purchases,” he said, reflecting the view of other industry executives contacted by Reuters.

Many Web start-ups have proposed business models to take on iTunes, which has a 70 percent market share of digital music sales. Many have also failed as they get caught up in negotiations with the music companies.

One of the most difficult parts of getting a digital service started is obtaining the licenses to the music itself.

In most cases, top music labels will not provide licenses unless the start-ups pay a hefty advance fee.

Amazon is expected to launch its iTunes rival this week, after signing deals with Universal Music Group and EMI.

Two smaller start-ups, Qtrax and Spiralfrog, are promising to offer music downloads for free to consumers supported by advertising sales that will be shared with music companies.

Whether these ad-supported models succeed remains to be seen, but Qtrax Chief Executive Allan Klepfisz said it will be an important way to compete with the free music still illegally available at peer-to-peer networks like Limewire.

“The idea is to make a better version of free,” he said in an interview.

Klepfisz said Qtrax is due to launch in December after four years of building the business, during which it has managed to sign all the majors record companies except the biggest

Universal Music, owned by French media giant Vivendi.

Spiralfrog said on Monday it launched its service, 13 months after the company signed rights to Universal’s catalog.

According to an exploratory public offering filing by the company last month, Spiralfrog will pay $4.4 million in nonrefundable fees to Universal by November 15.

“We have controlled content in an advertiser-friendly environment,” said Spiralfrog founder and Chairman Joe Mohen, who appointed a new management team earlier this year after losing two senior executives, who are now consultants to Qtrax.

“People were discovering music in one place and then downloading it somewhere else. Spiralfrog will change that.”

Spiralfrog and Qtrax are not the first to support free and legal downloads with advertising. Ruckus Network Inc of Herndon, Virginia has been offering a similar service for three years and is now officially at 170 U.S. colleges and claims 700,000 members.

A big problem for these free download services is that they are incompatible with the most popular digital music player, Apple’s iPod.

This is where Palo Alto, California start-up Lala.com comes in. It has been pushing a business model that allows fans to buy digital songs and upload them directly on to their iPods.

Songs on an iPod can not be transferred elsewhere.

Yet, as a measure of how difficult it is to gain traction in this market, Lala only has one deal with a major label, Warner Music Group. Lala also offers to send fans free CDs of digital albums they buy from its site, and also plans to give them a chance to “return” downloads they do not like.

“There’s a significant amount of trust involved,” said Lala founder Bill Nguyen. “But it’s unsustainable if we don’t do it right,” he said.

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