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Apps Trump Tunes at Apple


As iPod sales ease, the company is focusing more and more on software—to the dismay of the record labels

Right after unveiling new iPods and iTunes software at an event on Sept. 9, Apple (AAPL) Chief Executive Steve Jobs invited singer Norah Jones on stage to perform for the assembled tech and media pundits. "Like you, we love music," he told the crowd. "That's probably the primary reason we do this."

The music industry had better hope Jobs & Co. keeps that passion because, from a business point of view, music isn't nearly as important to Apple as it once was. While Apple built its comeback over the past decade on its music-playing iPods, sales of those devices are expected to be flat in the years ahead.

So Apple is shifting its focus to new kinds of content. The Sept. 9 event was billed as a music-oriented affair, but Jobs spent much of the time showing off the game-playing abilities of the iPod Touch and new camcorder features in the iPod nano. Analysts say the most critical driver of Apple sales in the future will be the thousands of software programs, or "apps," that owners of iPhones and iPod Touches can download from the company's online App Store. "It's no contest," says Needham analyst Charles Wolf. "Apple's strategic future is tied to the App Store. There is no strategic importance to music anymore."

That leaves the music industry in a precarious spot, since Apple plays a more important role in their business than ever before. It is the world's largest music distributor, having passed Wal-Mart Stores (WMT)in early 2008. Apple sells around 90% of song downloads and 75% of digital music players in the U.S. Since so few people are interested in listening to music on non-Apple products, digital music schemes that aren't blessed by Apple typically die young. The upshot: While the record labels need to crank up digital sales to counter falling CD sales, they're dependent on a company that's becoming less dependent on them.

Apple executives insist music is still central to the company's mission. IPhone owners want music along with those other apps, and digital downloads are growing fast. Apple says it has ratcheted up the number of employees on its music team over the past two years.

Apple is also providing more room for others to innovate as it broadens its focus. For example, the company long took a dim view of outfits that tried to develop iPhone apps that competed with Apple's services. But on Sept. 10 the company quickly approved an application by Real Networks' Rhapsody, which sells music subscriptions as well as songs for download. "We sailed right through," says Rhapsody Vice-President Neil Smith.

The question is whether other companies can come up with the record-selling innovations the major labels once looked to Apple to create. There are some successes. An application from startup Pandora for personalized radio stations is downloaded about 20,000 times each day from iTunes, says Tim Westergren, Pandora's chief strategy officer. The company's popularity helps the labels two ways: Pandora pays the labels for any music played on its service (unlike regular radio stations), and Pandora's internal surveys show that 45% of people who use Pandora buy more music, while only 1% buy less.

These are intriguing innovations, record label executives say. But none of the apps will be as important to music sales as iTunes itself, and some experts worry Apple isn't doing enough to improve the core service. Though the latest version of iTunes has new features, including a simpler approach to sharing songs, there's "nothing groundbreaking," says Ted Cohen, a former EMI executive and now managing director at consultant TAG Strategic.

Music executives are beginning to recognize that Apple's attentions are shifting. "Our biggest concern would be if they started resting on their laurels [in music]," says one senior executive at a major label. "We need them to continue innovating."

Burrows is a senior writer for BusinessWeek, based in Silicon Valley.

Hollywood Goes YouTube
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