iTunes ushers in a year of change

One year after its launch, Apple's song store has changed the way the music industry views online distribution--and the way Americans buy music.

John Borland Staff Writer, CNET News.com
John Borland
covers the intersection of digital entertainment and broadband.
John Borland
7 min read
John Gillilan has hundreds of Pepsi caps lined up in rows in his University of Southern California freshman dorm room, each one representing a song downloaded from Apple's iTunes Music Store.


What's new:
Apple Computer's iTunes Music store was launched one year ago, and Apple is now the leading distributor of online music by far.

Bottom line:
Apple's launch has spawned numerous imitators and changed the way the recording industry views electronic distribution. Rather than being distrustful, as they were during Napster's heyday, the record labels now consider legal downloads a way to fight piracy and to tap a large and rapidly growing market.

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A Macintosh user and avid music fan, he started buying music from the store when it launched a year ago. This year Gillilan realized he could apply much of his $2,500 college dorm food allowance to purchasing bottles of Pepsi and taking advantage of Pepsi's iTunes song-giveaway promotion, he said.

The 18-year-old Gillilan might be a little more single-minded than most iTunes fans, but as a music major and recording engineer he sees the success of online digital distribution--today best evidenced by iTunes' sales--as a harbinger of his own future.

"Obviously the record industry has been reluctant, but it's crazy how much has actually happened (this year)," he said. "My career at this point realistically is going to depend on how successful this business model is."

Gillilan isn't alone in looking at iTunes as an industry bellwether. Launched a year ago Wednesday with a blaze of publicity, the service effectively kick-started a languishing digital music business.

Over the next year, Sony, Microsoft and Virgin all are aiming at the market. Yahoo is expected to throw its hat into the ring, and AOL may open its own store, instead of pointing its subscribers to iTunes as it currently does.

Even the major record labels are excited--a dramatic reversal for an industry that had previously seen Internet downloads as a threat to their business, rather than an opportunity for growth.

For the two years leading up to Apple's launch, attention had been focused on Napster, Kazaa and other file-swapping services that were allowing billions of songs a month to be downloaded for free. The major record labels, stung by falling revenue, focused much of their attention on filing lawsuits, drawing charges that their main interest was to smother development of the digital music business.

"iTunes has been incredibly valuable," said Larry Kenswil, president of Universal Music's eLabs division. "It has changed the debate, changed the buzz, changed people talking about record companies putting up a wall" against digital music.

But as the so far unchallenged market leader, Apple has established several other market realities against which various rivals chafe. The company's iTunes service is so tightly integrated with its hardware business that songs bought through the store can only be easily played on Apple's iPod, not other MP3 players. The close integration also means Apple can afford what it openly concedes are miniscule profit margins on the store itself, seeing it as a way to drive iPod sales.

Although Apple has taken a largely proprietary approach to iTunes, it made one major concession by making its software compatible with Microsoft's Windows operating system, effectively untying the iPod from the Mac in hopes of tapping into the much larger market for Windows PC users. The company has also struck a deal under which Hewlett-Packard will sell PCs with iTunes preloaded and also sell HP-branded iPods.

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The most public overtures when it comes to opening the iPod have come from RealNetworks Chief Executive Officer Rob Glaser, who--not long after comparing Apple's closed technology doors to a Soviet grocery store--found his own private appeal to Apple CEO Steve Jobs rejected.

Jobs says he sees little reason to open up to rivals, given Apple's commanding lead.

"To be honest, it's just not worth it," Jobs said at last week's Apple shareholder meeting. "It doesn't make any business sense."

However, record company executives are quietly advocating industry cooperation, contending digital balkanization will be bad for business over the long haul.

"Interoperability is critical," said EMI Music Senior Vice President Ted Cohen. "We need to get to that point, and people need to work together to do it."

Just getting started
Despite Apple's success, the digital music business is only beginning to get off the ground, and it's hard to predict what might happen next. The iTunes launch was seen by many in the record industry as an experiment with loosening previous restrictions on digital files. Now that the first stages of the experiment have proven successful, labels may be amenable to further experimentation.

Some of that variability will come in prices. Apple's 99 cent price for single songs and $9.99 price tag for albums has been widely copied. But already that's beginning to change, with some record executives saying they're eager to test tiered price models.

A little of this is already evident on iTunes. Singles have remained steady at 99 cents, but a few albums have begun creeping upward. Aerosmith's newest was priced at $11.99 last week, while rock-guitar virtuoso Joe Satriani's new release was $14.99, for example.

Apple declined to comment for this story, but other services said they had already seen labels raise prices on some individual songs as well as albums. None has passed on those per-song price increases yet, citing a continued need to present consumers with the simplest offer possible, however.

Label and Web company executives said the price increases reflect an experimentation with tiered pricing that mimics the way retail album prices fluctuate according to title, and over time. Under this model, pre-release singles or very popular artists might cost $1.50 or more per song, average tracks might stay at 99 cents, and back catalog and other promotional songs or albums could drop even lower, for example.

"It is a good thing to have that experimentation, both up and down," said Sean Ryan, RealNetworks vice president for music services. "Just because everyone went out at 99 cents doesn't mean that's always the right price."

Labels are sensitive to charges that they want to charge more online than for CD sales, however.

"We've built in a lot of flexibility," said EMI Group spokeswoman Jeanne Meyer. "There are tiered prices (for wholesale digital tracks), but they're all lower than in the physical world."

With that experimentation in pricing may come some fluctuation in usage rules. Currently iTunes customers can use their purchased music on up to three computers and burn the same songs in the same order up to 10 times. However, those rules may be tweaked as the record companies renegotiate their contracts with Apple.

Other companies, if not Apple itself, are likely to begin experimenting more with subscription services as well. Jobs has dismissed these as virtually irrelevant, saying that people want to "own, not rent" their music.

For the most part, these have remained niche products, although RealNetworks has said it now has a total of more than 495,000 subscribers to either its unlimited Rhapsody product or a cheaper online radio service. But for companies that do not have an iPod-like hardware device to depend on for profits, this monthly stream of revenue looks far more appealing, and will likely drive more experimentation next year.

Microsoft is also hoping to make such services more attractive through technology, code-named Janus, that would allow subscription music to be transferred to portable devices--a key drawback to the current crop of subscription services.

Though Apple has been the undisputed leader in the market--and has done better than some would have thought a year ago--online downloads still represent a small part of how people get their music. File-swapping services continue to be popular, and CD sales have started to show some signs of life. Apple itself had predicted it would distribute 100 million songs by the time the one-year anniversary rolled around, a goal the company seems likely to miss.

To date, rivals like Napster and Musicmatch have fallen far short of Apple's sales. According to the NPD Group, Walmart.com's cut-rate pricing has come closest, drawing about half the number of customers seen by iTunes in March.

Analysts say that although many of the new entrants to the market could pose strong competition, Apple will continue to benefit from the fact it has sold so many iPods--devices that work only with Apple's service. Last quarter Apple sold 800,000 of the portable music players, with rivals such as Dell and Samsung selling only a fraction of that total.

"Apple set the bar incredibly high," said Mike McGuire, an analyst with GartnerG2, a division of the Gartner research group.

But some rivals said they expect Apple's dominance will be temporary.

"Apple is probably still riding the wave of their initial launch," said Jason Reindorp, a group manager in Microsoft's Windows digital media unit. "They have spent an inordinate amount of money to generate awareness around their closed ecosystem. (But) as people get more sophisticated in this area they are going to be getting more frustrated with a closed ecosystem. I think the market will kind of self-correct as things get more mainstream."