All plated out

Legal downloads are revolutionising the way we listen to music. But, asks Claire Neesham, will the companies at the forefront of this technology ever turn a profit?

Claire Neesham
The Independent, 21 January 2004

The legal-download business is no longer the preserve of a few industry-specific start-ups. Companies as diverse as Virgin Megastore, Microsoft, MTV, Sony and Wal-Mart have either launched online music stores or have expressed interest in doing so. Yet late last year Steve Jobs, Apple's chief executive officer, revealed that Apple's iTunes Music Store was barely breaking even, despite selling tens of millions of songs since its launch in April - the 10 millionth song downloaded was Avril Lavigne's "Complicated". Jobs says most of the income is eaten up by record companies, licensing authorities, credit-card companies and the cost of hosting the site. Michael Robertson, the founder of the free-music site, comments, "Apple is leading a race of lemmings into the zero-profit business of closed music downloads."

Peter Jamieson, the executive chairman of the British Phonographic Industry (BPI), disagrees. "This is the greatest opportunity for the music industry since the arrival of the CD," he says. Tomorrow the International Federation of the Phonographic Industry (IFPI) will give its opinion on the download business. It's sure to be positive: more legal downloads have to be better than more illegal ones.

Fran Nevrkla, the chairman of Phonographic Performance Ltd (PPL) which collects licence fees from broadcast and public performance on behalf of the record companies, thinks that "electronic distribution poses a fantastic opportunity". It not only allows a huge range of new music to be heard, but also enables archive material thatit would not be financially viable to sell on CD to remain available. But how can companies provide this service if music-download services cannot turn in a profit? Peter Kastner, an analyst with the Boston-based research company the Aberdeen Group, sees 2004 as the year when many companies in the sector will go bust. "This market would be a terrible venture-capital investment," he says. "I think the survivors will be household brand names. The question is, which will survive?"

Ed Averdieck, the marketing director of On Demand Distribution (OD2), a European provider of music-download technology, remains confident. OD2, which supplies the technology behind digital music-store services such as those offered by HMV, Freeserve and MSN, broke even in three out of 10 months in 2003. "If just 1 per cent of people who download illegal files in the UK switched to OD2's services, the business would become highly profitable."

But an industry insider says, "Around 98 per cent of music acquired on the internet is still via a peer-to-peer network - it's notbeing purchased for download." Figures from Forrester Research show that 6 per cent of the UK's online population admits to using peer-to-peer file sharing. Typical is Jasper, a 15-year-old Londoner. He downloads 10 to 20 tracks a week from the internet, which he transfers to his MP3 player. "Everybody does it," he says. "It doesn't feel right paying for music any more."

Elizabeth Brooks, who is the senior vice president of business development for, part of the US-based e-commerce business, is well aware of this attitude. "For legal digital services to compete, they need to provide a wide range of music in a format with which the younger generation feels some connection. Initiatives that try to stop them downloadingmusic can only fail. And the cost per tune must come down."

But estimates from the industry suggest that in the US the legal digital-music suppliers are lucky to keep 10 cents (6p) of the 99 cents (55p) charged per tune (in the UK the price per tune is nearer £1 due to VAT). Kastner warns that this kind of pricing "leaves little to cover the cost of the network bandwidth and infrastructure such as computers, operators and search engines needed to run a site." Kastner says Microsoft and Wal-Mart have threatened to undercut the current suppliersif they launch their services this year. But how can a supplier that can't sell digital music as a loss leader (as Kastner believes Wal-Mart will), or that doesn't have an established infrastructure (like Microsoft's MSN) expect to flourish?

Mike Bebel, the chief operating officer and president of Napster, claims, "We believe that we make sufficient margin across the offering to make a profit." The Napster 2.0 service offers both an a la carte download music service at 99 cents (55p) per tune and a subscription service that offers subscribers unlimited listening and tethered downloading of tunes to up to three computers for $9.95 (£5.50) per month. Both BuyMusic.Com's Brooks and OD2's Averdieck see legal online music as a volume market. "The margins are tight, but when the volumes come through the profits will be made," confirms Averdieck.

Brooks notes, "To give the digital services the right numbers for 'all you can eat' subscription downloads, the labels would need to make the bet on volume versus pricing. That is a bet they have not yet taken." But Jay Berman, the chief executive officer and the chairman of IFPI, believes that even with current licensing agreements for digital music, the record companies are demonstrating that they are prepared to experiment with different business models.

John Hutchinson, the chief executive of the UK's MCPS-PRS Alliance, which represents composers and music publishers, stresses, "We are very keen to see regulated online business develop." His organisation is currently offering a discounted licence fee equivalent to 8 per cent of a legal service's gross revenues compared to the 12 per cent of revenues that will eventually be charged - and this agreement can be arranged with just a single e-mail or telephone call.

Are such initiatives enough? Kastner is dubious. He believes that if the record companies bet on selling around 100 million songs a week and charge fees that let the online stores sell tunes at 25p or 50p each, then more people might be tempted to pay for music online. And Rebecca Jennings, a senior analyst at Forrester Research's UK Research Centre, thinks that there is room in the market for a number of players - "but current offerings aren't flexible enough for a significant mass of online consumers to pay for them".

Claire Neesham

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