The Coming Download Downturn
Arik Hesseldahl, 12.05.03, 10:00 AM ET
How many online music download services can the market bear?
That's going to be a key question as the music download market warms up to a white-hot temperature in 2004. The rush is underway among several companies to build music download services and replicate the success of others already leading the way.
Apple Computer (nasdaq: AAPL - news - people ) and its successful iPod digital music player are the ones to beat, along with Roxio's (nasdaq: ROXI - news - people ) Napster service, and Rhapsody from Real Networks (nasdaq: RNWK - news - people ). Others include BuyMusic.com, MusicMatch and MusicNow.
In recent weeks you likely heard of others with plans to start selling downloadable music in the new year: Microsoft (nasdaq: MSFT - news - people ) will start its push next year, adding music to its MSN service. Online retailer Amazon (nasdaq: AMZN - news - people ) is said to have its eye on a music service as is retailer Wal-Mart (nyse: WMT - news - people ).
Dell Computer (nasdaq: DELL - news - people ) recently launched its own music player but used MusicMatch as the download service to support it. Hewlett-Packard (nyse: HPQ - news - people ) will likely follow a similar model by both launching an HP-branded player and outsourcing the download service to someone else. Richard Branson's Virgin Entertainment Group says it has plans to launch a service of its own next year.
The actual size of the market opportunity for music downloads is growing. That much is clear. Market research firm Ipsos-Insight said last month that as of June of this year one out of every six Americans over the age of 12 who had downloaded music had paid a fee to do so. That translates into about 10 million people, and represented a twofold increase in six months.
The increase coincided, it seems, with the Recording Industry Association of America's aggressive prosecution activities against illegal file downloads.
One interesting stat that Ipsos discovered was that less than a fifth of those "downloaders" owned a digital music player, which may indicate there's a substantial opportunity to sell players in connection with download services.
Using the service to sell players is about the only reason to get into the download business in the first place. No one is yet making money selling music online, though--by one reckoning, that of Gene Munster, analyst at U.S. Bancorp Piper Jaffray--Napster can break even by selling between 1.3 million and 1.5 million songs a week and can realistically expect operating margins north of 15%. And though Apple has never disclosed it, its iPod player is thought to carry a margin much higher than its iMac computer.
But here's the long-term problem with music downloads. While the going rate to charge for a song appears to be 99 cents each, it's album sales that present a tricky pricing problem. Another Ipsos-Insight study just out today suggests that consumers find that paying between $10 and $15 to buy a full-length CD is acceptable. But when it comes to downloading full-length albums online, they expect to pay less.
The range of acceptable prices for a digitally-downloaded album, Ipsos found, ranged from $5 to $10. Right now downloading an album on Apple's iTunes Music Store costs $9.90, suggesting there's some price pressure ahead that will bring the breakeven point for these services under attack.
That will turn the music download business into a struggle for market share, and the chief weapon will be what it has always been: special promotional prices, giveaways and profit-sapping deals, which can't help but extend the time it takes these services to achieve profitability. That means a shakeout is coming. And by this time next year, its results, and the victors, will be apparent.
