Digital Audio Entertainment
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By the mid-2000s, digital audio entertainment—including services that allow consumers to download individual songs or entire albums, as well as portable media players—had significantly impacted the larger music industry. Traditional music recording and distribution continued to struggle as illegal sharing of music files, CD copying, and heightened competition for consumers' entertainment dollars reduced compact disc sales. The music industry continued to lose more than $2 billion annually due to piracy alone. According to the January 8, 2005 issue of The Online Reporter, the industry as a whole saw revenues fall from $40 billion annually in the early 2000s to $32 billion in 2004.
Amidst these difficult times, the music industry witnessed a number of significant changes, including mergers and ownership changes. Developments included the combination of Sony's recorded music business with that of rival BMG, creating Sony BMG Music Entertainment, as well as the sale of Warner Music Group by Time Warner.
While analysts did not anticipate a turnaround until 2006 or later, the growth of legitimate digital music sales was a bright spot in the industry's future. Following a breakthrough year in 2003, sales of digital music downloads continued at an explosive pace throughout 2004 and into 2005. According to figures from Nielsen SoundScan, online music purchases increased from 19.2 million tracks in 2003 to 140.9 million in 2004.
Many industry observers noted that Apple Computer's introduction of the iPod digital music player in 2002, followed by the opening of its iTunes Music Store in April 2003, were two factors that catapulted digital music into the realm of mass acceptability. By June of 2004 Apple had sold three million iPods, and the device had become the market's most popular portable music player. In addition, its iTunes store was responsible for some 70 percent of all legal music downloads. Estimates from Prudential Equity Group LLC placed fiscal year 2005 iPod sales at 21.9 million units. This figure was projected to reach 33.9 million units in fiscal year 2006, with revenues from the music players accounting for 35 percent of Apple's total sales.
Moving forward, the main challenge for major record labels was to convert illegal file sharers into customers of legitimate digital music services. While the future was uncertain, some observers foresaw a radical transition in which the music industry would become purely service-oriented. As digitized files became the principal format for distributing music, they indicated that the production and distribution of CDs would cease, and physical retail space for new music would likewise disappear. In addition, these futurists posited that a more direct link would emerge between creative artists and music lovers.
According to NPD Group research, by late 2004, some 62 percent of Internet-connected homes in the United States had digital music files stored on their personal computers. This figure demonstrated the sheer size of the digital music market. In the December 18, 2004 issue of The Online Reporter, NPD Senior Account Manager Isaac Josephson elaborated on his firm's findings, explaining, "Among regular Internet users who have been online during the past 30 days, there's a potential audience of 43 million domestic households with at least some level of digital music savvy."
During the mid-2000s, a sizable portion of the digital music market consisted of younger consumers, ranging in age from 13 to 35. The Hitwise Online Music Report found that while traditional music shopping sites like BMG Music Service were frequented more heavily by those in the 25 to 44 age group, 51 percent of online music site users were males in the 18 to 34 age bracket with annual incomes of $30,000 to $60,000. Within the teenage market sector, Jupiter Research found that teenage girls were an especially strong user category, spending 15 percent more per month on online music than boys.
By 2004, traditional online music retailers still held more of the consumer market than digital music download sites, but they were quickly losing share. According to Hitwise, download sites saw their share of the market skyrocket 20.6 percent between January and July of 2004 alone, while traditional music retailers saw their market share fall 9.1 percent during the same time frame.
The digital music industry was in a state of flux during the mid-2000s. A great many consumers still opted to illegally trade digital music via popular file-sharing networks. However, legal pay services were making strong inroads while illegal file sharing began to decline. By early 2005 consumers were able to choose from a range of pay services, including Apple Computer's iTunes Music Store, RealNetworks's Rhapsody, as well as offerings from the likes of Napster, Musicmatch, Sony, Wal-Mart, Dell, and Microsoft.
Converting consumers from illegal file-sharing network users to customers of legitimate pay services was a major industry challenge. According to NPD Group research, only two percent of Internet-connected homes in the United States had tried a for-pay service by late 2004. Twenty percent of those who "trialed" a pay service ended up actually subscribing, compared to a 50 percent conversion rate for those who trialed a free peer-to-peer (P2P) service. NPD also found that many P2P users who tried pay services continued to use free P2P services.
Although they once had a firm grasp on music distribution, traditional music retailers were negatively impacted by the advent of digital music. As retail sales of recorded music fell, some retailers (including National Record Mart) closed their doors, while others—such as Tower Records and Wherehouse—filed for bankruptcy protection. Industry leader Musicland Group responded by scaling back its base of stores.
As major music distributors moved to form their own digital distribution platforms, such as Pressplay and MusicNet, retailers were concerned about being cut out of the loop. In response, Best Buy was involved in the establishment of a retail consortium called Echo in early 2003 that eventually included Virgin Entertainment, Trans World Entertainment, Tower Records, Hastings Entertainment, and Borders Group. According to the Hollywood Reporter, each retail member reportedly contributed $150,000 apiece to the consortium, with an ultimate goal of raising $10 million to $12 million to build a digital distribution infrastructure. By working together, the retailers hoped to leverage their collective clout with the music industry.
When Apple Computer unveiled its iTunes service in April 2003, the dynamics of the game changed. With the potential cost of building a rival service pegged at $30 million to $100 million, this effectively sounded the death knell for Echo. By mid-2004, Echo's members were either pursuing their own individual strategies for surviving in the digital music world, or, in the case of Borders, were taking time to evaluate their options. As of early 2005, retailers were aligning with established digital music providers. For example, Best Buy partnered with Rhapsody and Napster to provide customers with digital music via in-store kiosks.
Some industry analysts argued that simply installing in-store kiosks was not enough to cure the music retail sector's ills. In the March 2004 issue of Business 2.0, Forrester Research Principal Analyst Josh Bernoff remarked, "I think retailers understand the change that's taking place in their business. There's just not that much they can do. It's beginning to look very scary for them." On a positive note, following the closure of more than 1,000 stores the previous year, the retail sector experienced improvement in 2004. Industry analysts attributed this to improved sales of CDs, combined with a decrease in piracy. Nevertheless, the popularity of digital music appeared to be an irreversible trend.
As for-pay music services grew in popularity and the use of digital audio tracks extended to everything from cell phone ring tones and Internet radio to TV commercials, the issue of managing digital copyrights and tracking royalties on behalf of artists developed into a prime concern.
By the mid-2000s, a number of solutions for tracking digital copyrights began to emerge. One example was Royalty Services LP, a $30 million joint venture between San Francisco-based Exigen Group, Universal Music Group, and Warner Music Group that offered a technology platform for managing the royalty distribution process traditionally handled by record labels. The new offering, which tracked how royalties from a 99-cent song download got divided among multiple parties such as singers, composers, song writers, and record labels, was based on existing Exigen technology that had been used to track transactions for stock brokers and insurance companies. This was an important...
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