Slouching Toward Digital

Amazon may finally allow record labels to give iTunes a run for its money. But the e-commerce giant will also test the labels' tolerance for lower pricing

by Tom Lowry and Peter Burrows

Amazon.com's (AMZN) new music download service amounts to a grand experiment for record labels, many of which have agreed to sell their tunes for the first time without restrictions against copying and other digital rights management (DRM) protections. But Amazon's online store will also be a crucial test for just how flexible the beleaguered music companies are when it comes to pricing.

For the past several years, music executives have been desperately looking for a viable alternative to Apple's (AAPL) dominance in online music with its iTunes Music Store. Amazon, with its deep expertise in e-commerce, loyal following, and powerful brand, is exactly the kind of competitor that the music industry wanted. And unlike iTunes, where each and every song will continue to be priced the same, the new Amazon service is allowing the labels to have variable pricing. Most experts believe sales at the AmazonMP3 store, which opened Sept. 25, have been brisk and that Amazon is already the clear No. 2 in the market. Sony BMG's confirmation Jan. 7 that it will drop DRM for shoppers who buy music using gift cards for selected stores only increases the pressure for music companies to find new ways to sell downloads.

Record Labels Get Pricing Power

Being able to sell, say, a song off the new Alicia Keys album at a higher price than an old Bachman-Turner Overdrive tune is something the record companies have long wanted to be able to do on iTunes. But Apple Chief Executive Officer Steve Jobs has refused to budge, charging 99¢ per song (labels take home about 70¢ of that). While most songs now sell for 89¢ on Amazon, sources say, the record companies have the ability to vary what they charge the site—with two weeks' notice—in an arrangement similar to the wholesale rate card they offer bricks-and-mortar retailers. So the record companies can charge different rates for each song on an album, and Amazon sets the retail price. (Some record execs have said some wholesale prices are as high as 89¢ and that in order to stimulate sales, Amazon is choosing to forgo a profit on some songs).

Bill Carr, Amazon's vice-president for digital music, won't discuss terms of Amazon's contracts with the labels. But he says Amazon isn't running the business to be a loss leader: "Our business has to be profitable on Day One."

So far, the Amazon experiment seems to be yielding good news for labels. Besides the low prices, customers like the ability to get a wide variety of music that's free of antipiracy strictures that limit the type and number of devices they can play it on—especially after Warner Music Group (WMG) agreed to provide its catalog, sans DRM, in December. If Sony BMG follows suit as expected, Amazon will be the only site with music from all of the major labels that will play on an iPod, other than iTunes itself. Paul Verna, an analyst with eMarketer, says he thinks Amazon could easily grab a 20% share of the digital download market that's now dominated by Apple. Amazon hasn't released any numbers, but Carr says "we're really, really pleased with our early results."

Lower the Prices, Turn Up the Volume

The big question is, just how low are the record companies willing to go on prices? There has long been a school of thought in the industry that lowering prices substantially devalues music, and that's been anathema to music executives who see so much of their music downloaded and swapped for free.