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Digital Music: In Search of Biz Model

June 11, 2007

Once the scourge of the music industry, digital downloads are now officially “the way forward” for the “Big Four” record labels, Business Week reports. EMI, SonyBMG, Universal and Warner Music, which together control over 70% of the world’s recorded music, have embraced digital downloads, now that they have numbers to justify it, anyway.

Two years ago, music labels were making virtually nothing from digital music. By the end of 2005, digital music generated $1.1 billion in revenues in 2005 – almost triple from 2004 – which accounted for 6% of revenues earned that year, according to the International Federation of Phonogram and Videogram Producers’ (IFPI) 2006 Digital Music Report.

What’s more interesting is that the music industry is well aware that digital music is increasingly becoming a mobile phone play, not least because ringtones – which count as digital music – accounted for 40% of digital music dollars last year.

In 2006 there has been a rash of new music services launched by cellcos worldwide. In Asia alone, all cellcos in China, Korea and Japan have music download services, as do most cellcos in Hong Kong, and in markets from Indonesia to Australia. SK Telecom went as far as launching a groundbreaking joint venture with Warner Music last month for a South Korean mobile download service. Others have partnered with third-party music services like Soundbuzz, which has cellco partners in Australia, Singapore, India and Hong Kong.

The catch is that while demand for digital music is skyrocketing, the business case is still rickety for mobile operators, as well as other service providers that want to offer music download services. Few doubt that there’s money to be made from mobile music services. What’s less certain is how big everyone’s slice of the pie will be, and how the music labels can balance consumer demand with copyright controls that may not always work in the consumers’ interests.

One chief issue for mobile music services is that mobile music is driven largely by ringtones, not full track downloads. This isn’t necessarily a bad thing in the sense that ringtones, ringback tones, music video clips and even music karaoke have been successful to varying degrees.

On the other hand, the full-track model is the one most players across the value chain are chasing.

This has been the case in Korea, Asia’s hottest digital music market, according to Philip Kim, managing director of investment and advisory firm IRG Ltd.

“Korean users aren’t paying for full song tracks. People spend money on devices, games, avatars, but not music,” Kim says, although he does add that music clips do bring in revenues.

Koreans aren’t the only ones not paying for full tracks. A March survey from research company Synovate covering key North Asian markets found that while two-thirds of users under 25 had downloaded music, only 27% paid for it. Across all demographics, that figure was 17%. In China, only 15% said they’d paid for digital music.

On the bright side, the same Synovate survey reports that 42% of respondents intend to buy digital music in the next year.

Meanwhile, a report released last month by Yankee Group forecasts that the fate of MP3 players will depend on replacement cycles as markets saturate. By 2008, only 10% of MP3 player purchases in the US will be first-time purchases.

Moreover, the other 90% of sales will be driven by devices that feature voice telephony and Internet connectivity, the report says.

ABI Research has reached a similar conclusion, as mobile phones designed for playing music start hitting the market with greater memory capabilities than ever. Many new handsets support removable flash memory cards with capacities that match or exceed the lower-end MP3 players on the street today. The Nokia N91 comes with 4 GB of memory. Samsung’s SGH-i310 has twice as much disk space.

“As the cellular handset becomes the one device that the world carries, the standalone MP3 player may well be left behind,” says Alan Varghese, ABI Research’s principal analyst of wireless semiconductor research.

Varghese adds that while high-end digital music players are packing as much as 60 GB of memory, there’s “a point of diminishing returns beyond which a user doesn’t care whether the device can store 2,000 songs or 7,500.”

Such data echoes the message put forth by handset makers that have been enabling a range of music features in new cellphones, from Sony Ericsson’s Walkman phones to Motorola’s new ROKR E2, due for launch later this year. Nokia is also promoting music apps not only via handsets such as the N series of multimedia phones, but also service applications like AirAlbum and Visual Radio, which have been commercially launched in seven markets each.

Handset makers say the numbers are in their favor. Apple is expected to sell 80 million iPods this year, while the handset industry will sell well over 900 million mobile phones – over two-thirds of which will have music player functions.

“The iPod started the wave, but we will be shipping 80 million handsets with music players in them this year, and 150 million with FM radios,” says Jawahar Kanjilal, director of multimedia experiences at Nokia Asia Pacific.

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