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Online music sales a mixed blessing

A year after Apple Computer Inc. launched its iTunes Music Service, the online music industry is selling songs by the millions – and that may not bode well for the major record labels.

Online services account for just a fraction of overall music sales, but they’re growing rapidly. And the new choices they give consumers threaten to remix the recording industry’s traditional revenue streams, pumping up the volume of singles and subscriptions and turning down album sales.

Customers at three of the leading online services – iTunes, Musicmatch Inc.’s Musicmatch Downloads and RealNetworks Inc.’s Rhapsody – buy about 10 times as many singles as they do albums. Offline, people buy 50 times more CDs than singles.

The shift to online shopping could be lucrative for the music industry if the flexibility and convenience lead more people to spend more on tunes than they do today.

But some industry executives and analysts fear the singles trend could accelerate, with music lovers passing up $15 CDs in favor of the one or two 99-cent songs they heard on the radio. And, some industry veterans worry, moving to a singles-oriented business could lead to fundamental problems for artists and labels.

“There’s no money to be made from singles,” said entertainment attorney Gary Stiffelman, whose clients include rapper Eminem. “Unless you can sell an album, you can’t really afford to launch the artists. The whole economics are driven by some sort of critical mass of product.”

But the new distribution system of the Internet is changing demand. As it is, individual songs from virtually every album are available for illegal downloading through unauthorized file-sharing networks. Now people can buy tracks and play unlimited songs from authorized online jukeboxes, too.

“Consumers have moved on,” said analyst Josh Bernoff of Forrester Research. “The idea that they have to consume music by the album is something that many music consumers have left behind.”

Still, the authorized services’ growth over the last six months hasn’t seemed to hurt offline CD sales, which have rebounded about 8 percent from last year, after a lengthy slide blamed largely on illegal downloading.

The birth of online music

The online music business dates to the mid-1990s, when a handful of technology companies developed ways to sell downloadable songs. The first few waves of startups crashed and burned, largely because of onerous restrictions and high prices imposed by the major record companies.

In the meantime, online music piracy exploded. Dozens of free networks emerged to let people copy songs from one another’s computers, drawing an estimated 63 million users in the United States alone by mid-2003.

The first breakthrough for commercial services came just over a year ago, when in late April, Apple launched the iTunes Music Store. Pressed by Apple chief executive Steve Jobs, the major labels enabled Apple to make a significantly simple and attractive offer to customers: 99 cents per song, with no real limits on CD burning or transfers to Apple’s iPod portable music players. Apple said the service sold its 50 millionth song March 15.

Since the debut of iTunes, a rival business model – selling subscriptions that let customers play unlimited songs or specialized radio stations on their computers – has carved out a foothold. RealNetworks reported 450,000 subscribers as of March 31, up 80 percent in six months. Add in MusicNet on AOL, MusicMatch’s premium radio services and other online subscriptions and the total approaches 1 million.

Some online music companies continue to struggle, but the sector is growing fast and steadily. Analysts estimate the services’ revenue will grow from about $65 million last year to $250 million in 2004, with $120 million or more from downloadable singles and the rest from subscriptions. CD sales totaled $11.2 billion in the United States last year, according to the Recording Industry Association of America.

Purchases aren’t typical

So far, at least, online customers are buying a much broader range of music than is being sold in stores.

General manager Ellie Hirschhorn of MusicNet, which operates a subscription music service for Time Warner Inc.’s America Online, said about 75 percent of the paid downloads aren’t in Billboard’s Top 200, and about 60 percent are “catalog,” or older, tracks. According to Nielsen SoundScan, more than 63 percent of the CDs sold in stores last week were new releases.

That’s significant, she said, suggesting that online services lead to people to buy music they otherwise wouldn’t. The music industry’s hope is that paid downloads and subscriptions will attract people who haven’t been buying CDs.

Sean Ryan, head of music services at RealNetworks, said customers at Real’s Rhapsody service spend about $150 a year on music, which is far above what the average American spends on CDs.

Even if Rhapsody prompts its customers to buy fewer CDs, Ryan said, the labels can still come out ahead because it costs virtually nothing for them to distribute music through Rhapsody.

“Essentially, they send us spreadsheets, we send them money,” he said.

The labels’ wholesale price for CDs is about $10, while they collect about 70 cents per downloadable single; there are generally 10 to 16 tracks on a CD. Payments from subscription services depend on how much music users play, but typical amounts are around $5 per subscriber per month.

Industry economics shift

For years, the financial structure of the music industry – from artist contracts to manufacturing operations – has rested on sales of albums that can contain 16 or more songs. Labels pay for a variety of expenses, including studio recording costs, music video production and other expenses based on the revenue they earn from album sales.

Some record-company executives say returning to a singles-driven business is an inescapable reality of the Internet era. The major labels have already started to adapt – they’ve laid off thousands of workers to slash costs. Some also are talking about recording singles, not albums, with new artists and paying them smaller advances.

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