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Big music stores squelch download plan

Mounting costs and smaller-than-hoped-for sales, even for iTunes, lead retailers to pull funding.

A group of big music stores has mothballed a plan to join forces on the Internet to fight online services such as Apple Computer's iTunes, a move that highlights painful choices brought on by a digital shakeout.

Echo, a joint effort launched with a splash of publicity in early 2003, was supposed to give the big brick-and-mortar retailers such as Best Buy and Virgin Megastores an online foothold that would help them beat back file-swapping services and digital stores.

But mounting development costs, a glut of rivals offering bargain-rate services, and smaller-than-hoped-for sales across the online-music spectrum, even at Apple's successful store, have led the big retailers to pull funding for the project, its founders say.

"The reality is that compared to all the retailers' bottom lines, even Apple's music sales are insignificant," said Alex Bernstein, a co-founder and investor in the Echo project. "Our board repeatedly told us that."


What's new:
Echo, a joint venture designed to give big brick-and-mortar music retailers an online foothold, has been mothballed.

Bottom line:
The move spotlights the deeply mixed feelings that many of the big offline retailers have toward digital music.

More stories on this topic

The decision to halt Echo's work, at least for now, spotlights the deeply mixed feelings that many of the big offline music sellers continue to show toward digital music. Once so fearful of being replaced by Internet upstarts that an immediate joint effort seemed necessary, they are now taking a more measured approach in which their natural competitive instincts are returning to the fore.

Analysts say that the digital market--while likely to grow over time, perhaps even to rival sales at physical stores--is still very immature, giving the retailers time to experiment and react more slowly.

"Right now, we're not forecasting the death of the CD anytime soon," said Michael Gartenberg, an analyst at Jupiter Research. "I don't see (the retailers) as being overly concerned at this point that they're missing out."

According to the Recording Industry Association of America, or RIAA, $11.2 billion worth of CDs were shipped to retailers in 2003. By contrast, estimates for sales of music downloads optimistically top out at $245 million for this year, or just 2 percent of CD sales and only a little more than double 2003's sales figures for cassette tapes.

Put another way, a little more than seven average days of CD buying would equal the revenue of one year of digital downloads at today's peak rates. While those figures will certainly change over time, they are sobering to giant corporations.

A fading Echo
Echo was conceived in 2001, largely by Bernstein, then an independent consultant, and Dan Hart, who was chief executive officer of , a struggling boom-era Internet radio service. Together, the pair drew up plans for turning the old Echo into a vehicle for offline retailers' technological future.

Drawing on the pull of Bernstein's father--who had once headed the Musicland group of stores, as well as the National Association of Music Retailers trade group--the pair wangled an early-2002 meeting with executives from nine of the biggest offline retailers to pitch their idea. It took much of the rest of the year, but the seeds planted at that meeting ultimately took root.

"We're not forecasting the death of the CD anytime soon."
--Michael Gartenberg, analyst, Jupiter Research
In January 2003, six of those companies--Best Buy, Hastings Entertainment, Tower Records, Trans World Entertainment, Virgin Entertainment and Wherehouse Music--announced their plans with considerable press fanfare, promising to use Echo-built technology to create a suite of digital music services backed by the giant retailers' brand names. A seventh member, Borders Group, joined shortly afterward.

It was Apple and its iTunes music store that genuinely shook up the market a few months later, however. From that point, Echo's future slowly clouded.

A host of Apple competitors quickly sprang up, ranging from Musicmatch and MusicNow to giants including Sony and Microsoft. Hart confidently told journalists that the Echo offering, when completed, would be more attractive, since the retail stores digital services could tie in closely to their real-world activities.

Indeed, by late 2003, Echo's team of mostly contract programmers said that the ambitious service was starting to take shape. Created in Macromedia's Flash, along with an assortment of open-source and proprietary technologies, it could offer an iTunes-like store or a monthly unlimited-listening streaming service like RealNetworks' Rhapsody.

But the service would also be able to tap into the retailers' back-end databases, offering potential additional features such as the digital version of an album, or making exclusive bonus tracks immediately available online to anybody who bought a CD in the stores.

The big retailers were having second thoughts, however. Small competitors, desperate to make money in a low-margin business, were offering the big music stores their services at bargain-basement prices.

Moreover, the industry's online-sales figures weren't looking good, Bernstein and Hart said. The first few weeks of Apple's store, in which millions of songs were sold to the relatively tiny audience of Macintosh computer users, had created a heady optimism among the retailers. When Apple moved into the Windows market, sales increased, but not nearly to the extent that the retailers had hoped.

The lesson they drew was that the market was growing, but it was small and would show little profit potential, at least for the near future. As the early months of 2004 came, they pulled back on funds, and the project was put slowly on hold.

Bernstein says the technology has gotten to the point where it is 100 days away from being able to launch, were the project to be refunded, and the contractors rehired.

"The numbers didn't justify a large investment at this stage in the market."
--Alex Bernstein, co-founder, Echo
Hart, who still serves as Echo's CEO, said that the company's board of directors--largely representatives of the retailers--will reconvene in three weeks and that "big news" could come out of the meeting. But for now, the project is stopped in place, he said. Others say a resurrection is highly unlikely, at least today.

"It ultimately boiled down to the idea that the numbers didn't justify a large investment at this stage in the market," said Bernstein, a former executive at the company. "It didn't make sense for retailers to stick together when playing with something that was so small. So they started to revert back to retailers' competitive sense, where the important thing was, 'How do you get something a little better than somebody up the street?'"

Retail mix and match
Their joint venture on hold, the big offline retailers' digital future is less clear. A few are charging ahead, while others, like Borders, aren't yet sold on the need for immediate action. What's emerging is a diversity of plans, rather than the need for a common platform.

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With the debut of iTunes,
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Virgin in particular sees a vibrant online presence as an important part of its future strategy, although it has outsourced the guts of its online service to MusicNet, the same company that powers America Online's subscription service. As in the Echo vision, Virgin plans to have close connections between the online and offline stores, and Virgin-branded digital music software that will compete with Apple's iPod.

"Virgin digital exists to bring together a lot of digital media assets that no one has," Zack Zalon, president of Virgin Digital, said in an interview after the company unveiled its plans in March. "We want to give you a seamless experience between what's on the Web and what's in your pocket."

Best Buy is less concerned about branding, serving instead as a distribution point for RealNetworks Rhapsody, Napster and the MusicNow services.

"We want to work with the leading services that serve our customers' needs," Best Buy Vice President Scott Young said. "It didn't make sense to us in the near term to focus on (one thing) and say that's the answer."

Waiting in the wings is at least one other retailer that hasn't yet tipped its hand: As the largest online goods retailer, the company has long worried brick-and-mortar competitors--although Borders has teamed up with the Net giant for online sales.

"We're in watch-and-see mode," said Anne Roman, a spokeswoman for Borders. "We're going to see what develops, and make decisions about if and when to get into digital downloading in stores when we see fit."