Slouching Toward Digital

(page 2 of 2)

But Amazon may present an opportunity to break from the entrenched thinking by selling tunes for much less and making up for it on volume. If iTunes broke the longstanding model of selling packaged music by letting consumers pick songs à la carte rather than forcing them to buy entire albums, then Amazon might be able to change the model on digital pricing. "There's a leap that needs to happen for the labels to adopt a pricing model that's more like the [music] publishing industry," Ali Partovi, CEO of iLike, told BusinessWeek in an interview late last year. Partovi's company is an online service that provides music recommendations and social networking for music fans. "Last century, publishers transitioned from selling sheet music to taking a smaller piece of a bigger pie [that is, getting a fraction of a cent when songs were played on the radio]. Publishers make a lot of money that way. The recording industry has had a lot of trouble making that jump. The leap they have to make is to agree to get a smaller share of a much bigger pie."

Says one top executive at a major Internet company's music division: The labels "have tried to build scarcity on the Internet, which is an oxymoron. They should say, 'How do we leverage the scale of the Internet? How do we get people everywhere listening to music?'"

Second-hand Sales: Pro and Con

To see the awkward position music labels are in, look no further than Amazon's own CD listings. Amazon's customers are increasingly turning to used CDs. Third-party sales by merchants across all Amazon products, much of those for used goods, now account for 32% of all the site's transactions. That's up from 19% in 2003. Just one example: On the Amazon page for Mary J. Blige's album Growing Pains, released Dec. 18, a new version sells for $7.99, but directly below it is a used version going for $6.45.

That steams the record labels, which don't make any money on sales of used CDs. The music industry can ill afford to have anything else pinch its faltering CD business. Album sales dropped another 15% last year, according to the most recent sales figures released by Nielsen SoundScan. That follows years of CD sales declines, which forced big retailers like Tower Records into bankruptcy and prompted other large chain stores to reduce the shelf space devoted to CDs.

Record executives decline to comment publicly about Amazon's new- and used-CD sales practices for fear of alienating their new partner for online sales. They say in private that Amazon should be extending a good-faith effort to the record labels by altering their policy to sell used and new together. "Nobody is happy about this but it's a little touchy right now with the new download store," says one executive. "You will begin to see a lot of pressure exerted on Amazon going forward," says another executive.

So far, Amazon's Carr says he has yet to hear any complaints on this score. "In my dealings with record labels over the past 12 to 24 months, it hasn't been brought up once. By and large, the labels are thrilled with us," he insists. He says Amazon is the only big retailer that has posted increasing CD sales for the labels in recent years, for a number of reasons. Unlike physical retailers that are trimming the size of their CD sections, Amazon carries all of the labels' inventory, from hits to obscure B-sides. And unlike Apple, it offers the music in either digital or CD form, which is still the biggest part of the market.

Carr goes so far as to insist that Amazon's used-CD business is good for the labels. He won't share specifics, but he says Amazon's sales of new CDs increased after the used business began to take off a few years ago. That's because it made the site more of a one-stop shop for music fans, who were exposed to new stuff as they trolled for used bargains. "Customers obviously want that choice [to buy used CDs]," Carr says. "If the only choice was to go to sites that only sold used, that obviously would not be good for the record companies."

Viewed as part of a bigger picture, the surge in third-party transactions at Amazon is just another sign of the enormous pricing pressure all media is facing. Some newly released DVDs, for example, sell for as low as $7 today. One reason may be that unit sales of DVDs fell nearly 5% in 2007, the first big decline since the format was first introduced in 1997, according to DVD sales tracker Adams Media Research. On the music front, Rich Greenfield, an analyst at Pali Research, says wholesale prices are coming down for CDs, thanks to the leverage being exerted by such big retailers as Wal-Mart Stores (WMT). But, he warns, music executives need to do more. "Cut prices or lose even more floor space," says Greenfield.

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