Online Music Alters Industry Sales Tempo

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 small 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 people to spend more on tunes than they do today. But some industry executives and analysts fear the opposite result, with music lovers buying a few 99-cent singles instead of $15 CDs.

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 hit 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 file-sharing networks such as Kazaa have already undermined the sale of albums by making individual songs from virtually every release available online for free. Services offering paid downloads and access to online jukeboxes, some observers say, give the labels a chance to adapt and even profit..

“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.�

The authorized services’ growth over the last six months didn’t seem to hurt album sales, which have rebounded about 8% from last year, after a lengthy slide blamed largely on illegal downloading.

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 start-ups 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 U.S. alone by mid-2003.

The first breakthrough for commercial services came a year ago today, when Apple launched the iTunes Music Store. Pressed by Apple Chief Executive Steve Jobs for better terms, the major labels enabled Apple to make a significantly simpler and more 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% 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 that 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 U.S. last year, according to the Recording Industry Assn. of America.

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% of the paid downloads weren’t in Billboard’s Top 200 and about 60% were “catalog,� or older, tracks. According to Nielsen SoundScan, more than 63% of the CDs sold in stores last week were new releases.

The differences are significant, Hirschhorn said, suggesting that online services lead people to buy music they otherwise wouldn’t. Sean Ryan, head of music services at RealNetworks, said customers at Real’s Rhapsody service spent about $150 a year on music, far above what the average American spent 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, whereas 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 about $5 per subscriber per month.

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.

And companies typically sign new acts to potentially lengthy contracts that let a label pick up options for five or six additional albums if an artist’s first album succeeds -- or drop the act if it doesn’t.

Music companies relied heavily on sales of singles in the 1950s and even earlier, when technology limited recording capacity. By the mid-1990s, however, the labels had shifted their view of singles, seeing the format merely as a marketing tool. Record companies began flooding stores with cheap singles in hopes of inflating a song up the pop charts and catching the eye of radio programmers. But the strategy turned into a money-loser, prompting many to write off the format’s future.

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

To Isaac Hanson, oldest of three brothers who form the pop band Hanson, that kind of contract presents artists with a tough choice. Putting out a single may be the only chance to get the large-scale exposure an artist needs to succeed, but if it doesn’t do as well as the label hoped, the artist may be dropped.

The brothers’ career took off when their first single, “MMMBop,� helped their debut album sell 4 million copies, according to Nielsen SoundScan. Subsequent releases on major label Island Def Jam dwindled and the band departed last year. Its new CD released through Hanson’s own label is expected to rank as one of the nation’s top-selling albums when weekly data are released today.

The rise of digital singles could create a more extreme example of today’s sink-or-swim situation for artists, in which record companies typically promote albums by selecting a first song, then expending their full energy on turning that one song into a hit on radio stations and music video outlets.

“You’ve got the brief attention span of only one single,� Hanson said. “Because of the [companies’] need to report quarterly earnings, it’s a lot harder to take the long-term risk.�

Dexter Holland, lead singer for the punk band the Offspring, said online singles might cut both ways for musicians but would definitely rock the industry’s economics.

“I’m not a doomsday person -- I don’t think it spells the end of the music industry. But I think it could shake things out of whack,� said Holland, whose band made an early bet on the power of online marketing years ago by giving away a copy of a popular single.

Holland said he was wary of a world where record companies pursued pop music that simply attracted customers to singles. “If you’re a guy in a rock band that might be a bad thing,� he said. “If you’re a third-grader, you might like it.�