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Apple whistles a happy iTunes

This week's earnings report is expected to shed light on the impact of iTunes for Windows, which launched one year ago. U2 tunes up for iTunes

It's been 12 months since "hell froze over" at Apple Computer.

A year ago this week, Apple CEO Steve Jobs announced the company's plans to sell tunes to Windows users. And while the company hasn't magically converted them all to the Mac view of the world, it has made a pretty nice business for itself.

In that time, Apple has sold tens of millions of songs and more than doubled the number of iPods it is selling. The Mac maker won't say how many of its songs or players are going to Windows users, but it's reasonable to think it's a pretty good chunk, given the relative prevalence of PCs (90-plus percent of the market, while Mac holds less than 5 percent).

Apple has clearly established the iTunes Music Store as the standard for legitimate music sales. According to new data from the NPD Group, iTunes retained a 70 percent market share for digital downloads between December 2003 and July 2004, the last month for which data is available.

"iTunes has set the standard in online music in terms of sales, usability, and in the quality of its library," said Yankee Group analyst Mike Goodman. "They're the ones who cracked the code, and everyone is following in their footsteps."


What's new:
Apple reports earnings for its most recent quarter today, expected to indicate the effects of bringing iTunes to Windows a year ago.

Bottom line:
Although its closed business model may eventually hurt Apple's juggernaut music line, right now iTunes and the iPod are dominating the digital music market like Microsoft rules the desktop.

More stories on Apple

But the best measure of Apple's success might be something separate from iTunes itself. The company has a very slender profit margin--just cents on the dollar--for sales at its online store, and it gives away the software. It looks at both as tools to attract customers to the iPod, which, despite its own flurry of competitors, continues to set the standard for cool.

Investment bank Piper Jaffray traveled to high schools across the country and found that 16 percent of students already had an iPod. Another quarter of them plan to buy an iPod, with only about 8 percent planning to buy some other type of digital music player.

Just how high does the iPod rank on the teenagers' minds? Well, only clothes, money and a car were named higher on the holiday wish lists of those surveyed by Piper Jaffray.

Apple's earnings report on Wednesday is expected to bring further confirmation of just how well things are going in Cupertino, Calif. But, even if things are stellar, the company faces the challenge that expectations are also running red hot.

Apple's stock is trading near $40 a share, double where it was late last year and up nearly a third since August. That could be a challenge for Apple as the company's recent success and expectations of more of the same are increasingly factored into the company's stock price.

Sitting pretty
There is little question that Apple has set the standard when it comes to digital downloads. Before it entered the game with the iTunes Music Store, there was little availability of most major labels' collections. Now, there are any number of stores selling hundreds of thousands of songs that can be downloaded, played on a computer and burned to a CD or transferred to a music player.

Apple's 70 percent market share--a number often touted by Jobs in his speeches--appears to have remained relatively consistent despite the entrance of other companies. According to the NPD Group, the closest rival over the 8-month period leading to July 2004 was Napster, with an 11 percent share. RealNetworks, MusicMatch and Wal-Mart each had a 6 percent share.

Even iTunes' growth may have leveled off, however. The number of people using any paid download service peaked at about 1.3 million individuals a month, and afterward fell to about 1 million a month by July, according to the NPD Group.

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Apple owns the market
for digital music players
according to a survey that measured
market dominance and the cool factor.

Indeed, Apple's biggest competition thus far has been not from rival services, but from unauthorized services. In that Piper Jaffray survey of teens, two-thirds of students said they downloaded music, but three-quarters of those use a service such as Kazaa or Limewire.

Some see more opportunity ahead for Apple to use its store as a platform for launching and promoting music. The store already has hosted a fair share of pre-release tracks and online exclusives, and its free song of the week shows some of the potential for the store to be a marketing vehicle for music labels and artists.

But some of the more profound possibilities are as yet untapped. It is not yet possible to get full streaming previews of entire albums or songs. And even if it does not want to get into the subscription business, Apple might benefit from adding technology that would allow songs to "expire" after a certain period of time. Doing so would allow it to offer new music free for a limited time and then require those who want to keep listening to buy the track.

Speaking at the recent Web 2.0 conference, iTunes executive Alex Luke talked about the potential of iTunes as an important vehicle for record companies to promote new music. Luke said he wouldn't be surprised if in the next two years an artist managed to get their big break "online."

Crystal-ball questions
Two big questions for Apple in the coming months are how much it can really expect its music business to grow and to what degree iTunes and iPod can help revive flat sales of the Macintosh.

Clearly the store is fueling iPod sales, which have continued to grow. As the second calendar quarter closed in June, Apple was selling iPods at nearly a $1 billion a year run rate, more than double the rate at which Apple was selling the devices before the launch of the Windows iTunes store.

Opinions are more divided on the question of the Macintosh business. Merrill Lynch analyst Steven Milunovich thinks that iPod's success is likely to translate into somewhat higher Mac sales. In a report earlier this month, Milunovich said the halo effect of the iPod, among other factors, will allow Apple to "gain small increments of PC share. Even half a point of market share is about $1 billon in sales, Milunovich noted.

The company also plans to expand its music store further into Europe sometime this month.

There is also worry of how well Apple's somewhat proprietary strategy will work over the long haul. Apple's music player is designed to support only one store--Apple's. In the same vein, Apple's iPod and iPod Mini are the only digital music players that work with Apple's music store. That strategy has worked well, with both the store and player proving to be vastly more popular than their rivals. But Microsoft and others counter that eventually the popularity of Apple's gear will wane and consumers will want the ability to move their music to a broad range of devices, such as music players, cell phones and home theater gear.

"I think that everybody would agree that Apple has done a fine job with a proprietary end-to-end integration and the two-sizes-fits-all model," said Will Poole, senior vice president of Microsoft's Windows Client business. But at the same time, he said, he sees a day not too long from now when consumers will demand more flexibility than Apple is offering.

There's worry of how well Apple's proprietary strategy will work over the long haul.

It appears that Apple is also making some moves to address those concerns. The company has already struck a deal with Motorola to put a mobile version of iTunes on some upcoming cell phones--an arrangement that could pave the way for other companies to include the ability to play music bought from Apple's stores.

But even as it has made some deals to broaden its reach, Apple has resisted calls to openly license its FairPlay protection scheme to allow either its songs to play on other companies' music players, or to allow rival music stores to securely transfer songs to an iPod.

RealNetworks' Rob Glaser has been the loudest critic, saying that Apple's approach is slowing the transition to downloadable music and will ultimately leave Apple with a tiny fraction of the market. After being rebuffed by Apple, Glaser has gone on his one to try to make RealNetwork's service compatible with the iPod, with an effort dubbed "harmony."

Ultimately, Glaser has said, it will be customers who will force Apple's hand. At the PC Forum in March, Glaser colorfully predicted this reaction from customers: "I bought an iPod and can only shop at one store. What is this? The Soviet Union?"

CNET's Jim Hu and John Borland contributed to this report.