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Gloomy iTunes predictions premature

Report shows declining iTunes sales, but it was based on data from fewer than 200 U.S. households and warns of drawing conclusions.

The imminent demise of iTunes appears to have been somewhat exaggerated.

Reports that iTunes sales plummeted during the first half of 2006, based on a survey from Forrester Research, whipped up the familiar waves of righteous indignation or schadenfreude, depending on one's stance on Apple.

The music industry would certainly like to see better growth from digital music sales, but the Forrester report is based on a small sample size and indicates that it's too early in the digital music era to be drawing conclusions about the habits of online music buyers, said Josh Bernoff, the author of the report, on Wednesday.

The release of the survey last week got the frenzy going with data indicating that iPod owners, on average, don?t buy all that many digital music tracks through iTunes. A different study by Ipsos earlier this year reached a similar conclusion: most people are ripping songs into their music library from CDs, not downloading them from online music services.

Forrester's report also concluded that the number of monthly iTunes purchases per 1,000 households declined by 58 percent from January 2006 to June, Bernoff said. This was the number that was prominently featured in many reports suggesting that Apple's iTunes momentum was waning.

However, the next sentence reads, "With only two years of full data, it is too soon to tell if this decline was seasonal or if buyers were reaching their saturation level for digital music." A similar but smaller decline occurred last year from January to June, driven by new iPod owners who filled up their holiday gifts with music in January and bought fewer and fewer songs as the year wore on, Bernoff said. Seasonal declines are common in mature industries like the PC market, in which sales during the first and second quarter of the year are often much lower than sales during the third and fourth quarters of the previous year.

And the 58 percent decline is based on purchasing data from just 181 U.S. iTunes-buying households, Bernoff said. Only 3.2 percent of the 5,580 U.S. households in Forrester's panel bought music from iTunes between June 2005 and June 2006. The households in the panel volunteered to have their credit card purchases monitored. Therefore, the survey does not include iTunes songs bought with gift cards or through PayPal's online payment service.

To understand the numbers further, Bernoff notes that of the 181 households, one-third of those households accounts for 80 percent of all iTunes revenue. Most businesses naturally follow the famous "80/20" rule, in which 80 percent of a company's revenue comes from the top 20 percent of its customers. But in Apple's case, this means that there are relatively few heavy users of iTunes and lots of infrequent or occasional users, Bernoff said. Thirty-two percent of the 181 households only bought one song from iTunes last year, and just 31 percent bought six or more songs.

Apple was quick to deny that its iTunes sales were collapsing. "The conclusion that iTunes sales are slowing is simply incorrect...iTunes sales represent nearly 6 percent of all music sold in the U.S., making us the fourth-largest music retailer," the company said in a statement. But Apple did not elaborate on the specific numbers in the report or provide its own data on broader digital music buying trends, making the Forrester data one of the few sources of iTunes purchasing habits.

The main conclusion of the Forrester report was that with such low participation rates, digital music sales are not saving the music industry right now. Apple continues to see growth in both the number of iTunes songs sold per year and the revenue it takes in from those songs, but that growth is not enough to make up for the decline in CD sales, Bernoff said.

Piper Jaffray released a report Tuesday indicating that Apple sold 390 million songs from January through September 2005, or about 10.4 million songs per week. During the same period in 2006, Apple sold 695 million songs, or about 18.5 million a week. In the last few months, the ratio of iTunes songs sold per iPod has actually increased from a historical ratio of 20 songs for every iPod to 23 songs per every iPod, according to Forrester.

"That's pretty good," Bernoff said Tuesday in an interview. "On the other hand, the music industry can not be saved by (23) songs per iPod. Imagine if people only bought two CDs for every CD player."

So while the data in the Forrester report suggests that the overall market for digital music still has a long way to go, Apple's iTunes business is in decent shape, Bernoff said. The company isn't making much money selling digital music, he said, but there's no indication that Apple is concerned about its low iTunes margins given its record financial performance this year.

The growth of online digital music sales is slowing, however, which is a little troubling considering the extremely small number of overall consumers buying music online, Bernoff said. "If people don't continue to buy after they've had the iPod for a while, that's not particularly good news for the industry," he said.