Technology

The Music Industry's New Internet Problem


Streaming music sites with freely accessible content are being used by a growing number of listeners as a substitute for buying music

Five years ago, San Francisco-based graphic designer Gitamba Saila-Ngita spent around $100 a month buying CDs and digital downloads to fill his iPod. Now, he spends less than $10 each month on tunes. The reason? He gets almost all of his music from services like Imeem and Last.fm (CBS) where he can listen to pretty much anything over the Web for free or at minimal cost. "And I absolutely listen to more music than I used to," says the 23-year-old. "I pretty much have music playing all the time. It's because I can access so much of it, however I want."

The music industry has a new Internet problem. A decade ago, the major record labels began to worry about online piracy, in which people illegally swapped music over peer-to-peer networks like Napster (BBY) and later LimeWire. Partly in response to the piracy threat and partly due to sliding CD sales, music companies began to experiment with licensing their records to new online services.

The idea was that services like Imeem, Last.fm, and Pandora would let people listen to music on PCs, mobile devices, and home stereos, while collecting small fees and advertising revenue that the services would share with labels and artists. Music fans would be discouraged from stealing tunes, and the major labels—Warner Music Group (WMG), Sony Music, Universal Music, and EMI—might even get a sales boost as listeners discovered new kinds of music.

Substitute, Not Catalyst

But it hasn't worked out that way. Researchers and industry consultants say online music sites are being used by a growing number of listeners as a substitute for purchasing music, rather than serving as a catalyst for more purchases. Saila-Ngita's experience shows that the sites allow music fans to spend much less money than in the past. "Most of this is substitutional. People go to [the Web] instead of buying records," says Jay Rosenthal, senior vice-president and general counsel for the National Music Publishers' Assn., a Washington (D.C.)-based trade group that represents publishers of songwriters and composers.

Overall music sales have continued their years-long slide. Total industry sales were about $10 billion last year, down from $14 billion in 2000, according to the Recording Industry Association of America. Revenues from digital download services like Apple iTunes (AAPL) and Amazon MP3 (AMZN) are still growing strong, but they're not generating enough revenue to make up for the sharp decline in CD sales. Overall spending on music is forecast to shrink 4% through 2013, according to a recent report by Forrester Research (FORR).

The new world of music looks very different from the old. With the new Web, services' listeners don't put CDs into a stereo or download tunes to their iPod. Instead, their music sits on a server somewhere else, waiting to be played from a computer or any other Net-connected device.

The Lala Business Model

Palo Alto-based Lala, a startup launched in 2007, shows how the music industry is struggling to profit from this new approach to music. Lala gives people the option of either paying 99¢ to download one song or paying just 10¢ for a Web-hosted song that they can access from any Web-connected PC. Lala users can also stream any song in the catalog once for free, and keep up to 50 songs in their online collection.

So far, little money is changing hands. For every 1,000 songs streamed at Lala, users pay the 99¢ download fee for only 72 of them. They pay 10¢ for only 108 out of 1,000. The remaining 820 songs are played for free.

When 26-year-old Greg Schnese's hard drive crashed in December, he lost his collection of thousands of songs. Now he's listening to free music on sites as varied as music blog aggregator The Hype Machine, Google (GOOG)-owned video portal YouTube, and Lala. His reluctance to purchase songs on Lala underscores one of the problems with the model: "If I dump $2,000 into Lala and they go down next month, that's it."

Tracking Listener Data

Lala CEO Geoff Ralston, who in the 1990s helped create RocketMail, the predecessor to Yahoo! (YHOO) Mail, says his service is similar to Web-based e-mail. The faith customers placed in pioneering Web-based services like RocketMail early on let those services grow into a reliable platform for hundreds of millions of users.

Some record labels are looking at other ways they can squeeze value from the growth in streaming music. Thanks to these online services, "you have a lot of real-time data about what's happening with a piece of music in the market," says Greg Scholl, president of The Orchard (ORCD), one of the larger independent music labels. He says some of his artists use interactive dashboards to monitor where on the Web their music is being played, and even the demographic group and geographic location of the people playing it. They can use that to answer questions like "Are we missing a market where there's interest we weren't aware of?"

Passion Pit, an indie rock act on the Orchard-owned Frenchkiss label, recently released two songs from an upcoming album on Web sites like YouTube, MySpace Music (NWS), and Artistdirect. The song that was streamed most on these sites, Sleepyhead, was picked to be the lead single of the album.

Imeem Not Profitable

Most industry experts agree there's no simple way to make money from online music. "The way we monetize music and other goods on the Internet is to take the excitement and experience around them, and monetize them through several different business models," says Dalton Caldwell, CEO of Imeem. "For instance, Imeem is primarily advertising, but we also make a great deal of money from driving digital purchases of downloads, ringtones, ticket sales as well as merchandising sales." With more than 100 million unique users, Imeem is drawing a crowd, but it isn't yet turning a profit.

If there's hope for the industry's ability to cash in on streaming music, it's the charity that even the most freeloading fans feel toward music that they're passionate about. After listening to free tracks from Swedish band Fashion on MySpace Music, Saila-Ngita recently decided to cough up $10 for their album on iTunes. "I know that these guys make a living off this and they need to be paid," he said.


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