Will DRM-free music and new subscription services threaten iTunes?

It's a disruptive time for mobile media

Need proof that Apple Inc.'s iPod and iTunes Store has forever changed how people, particularly mobile people, acquire music? Here it is: The recording industry recently reported that nearly 13% fewer CDs were sold in 2006 than the previous year, while sales of downloaded digital songs increased by almost 60%.

The iPod/iTunes combination accounts for about 70% of all digital music sales and portable media devices, according to market studies. But some industry analysts believe that we're only at the beginning of the digital media age and that changes are coming that could cut into Apple's dominance.

For example, nobody is quite sure what the impact will be as digital rights management (DRM) for purchased music fades away. One major record company, EMI, has said it will allow online stores like the iTunes Store to sell DRM-free downloadable music. Other major labels are expected to follow suit.

Another trend that could change the digital media scene -- and Apple's dominance of it -- is new models for subscription music services. So far, subscription services such as Rhapsody and Napster, in which users pay a monthly rental fee for downloading as much music as they want, have not proved popular. However, some claim that subscription service business models are evolving and may yet attract lots of new users.

"Everything is changing," said Neil Strother, an analyst at JupiterResearch. "It's a really disruptive time."

The end of DRM

The rise of the Internet in the mid-90s gave rise to the illegal sharing of media, largely through use of peer-to-peer file-sharing software such as the first generations of Napster. The recording industry responded first by prosecuting some of those who participated in file sharing, then by requiring DRM on music that was sold via legitimate online outlets, such as iTunes.

But consumers don't like DRM.

"DRM leads to suboptimal satisfaction," said James McQuivey, a principal analyst at market research firm Forrester Research. "DRM muddies the experience, so you're never sure if it'll work for you."

For one thing, DRM limits where you can play music. If, for example, you buy a song from iTunes, the DRM -- plus the fact that Apple uses a proprietary music format -- means you can play only the music on an iPod. Such limitations have angered many users, particularly in Europe where the European Union is threatening Apple with legal action for limiting competition.

The situation gets even dicier with Microsoft's PlaysForSure DRM, which is used by the music subscription services. PlaysForSure is somewhat more open, since, for example, you can buy a PlaysForSure-compliant device from a vendor like SanDisk or Creative Labs that works with virtually all of iTunes' competitors. But, as we'll discuss later, nobody is certain of the future of PlaysForSure.

As a result, dropping DRM likely will make it even more attractive for users to download music because it eliminates some of the hassles. That explains why industry leaders like Apple's Steve Jobs advocate terminating it.

The music subscription flop

Nobody doubts that subscription services had the potential to be a major factor in the digital music game. After all, for about $15 a month, you can download virtually all the music you want from services such as Rhapsody, Napster and Yahoo Music Unlimited. That's less than the cost of buying two CDs from iTunes or a single CD from a brick-and-mortar record store.

Subscribers can then listen to their downloaded subscription music at their PC and with their media players, which can connect to home and car stereos. But everybody, even subscription proponents, agree that, so far, the services have been a flop. One reason is that subscription services are hard to explain.

"One of the problems with subscription music is that, until you try one, you'll never understand why you should do it," McQuivey said. "But when you try it, it's incredible. But I'm not bullish about the [subscription services] because, even though I find it a satisfying experience, I don't know how they could market it to get people over that first hump."

Subscription services face other problems as well. For one thing, while the services boast more than 2 million downloadable tracks, that still isn't as many tracks as iTunes offers for sale. As a result, subscribers may still need to purchase some music in addition to their monthly subscription fee.

Then, there's the issue of the balky PlaysForSure DRM software, which the subscription services use. Microsoft rolled out PlaysForSure to great fanfare more than two years ago but has not released a significant update since. Among the frequently heard complaints associated with PlaysForSure is that it can get tangled with the software provided by music services, meaning that sometimes legitimately downloaded music can't be played.

That balkiness, and the fact that Microsoft has not indicated when, or if, it will update PlaysForSure, has angered subscription vendors.

"Yes, we feel abandoned by Microsoft," an executive at one of the subscription providers, who asked that his name not be used, said at last January's Consumer Electronics Show. "We're pretty angry about it." That anger was heightened last November when Microsoft released its Zune media player and Zune Marketplace, an online store that offers a subscription service. That put Microsoft in direct competition with the subscription services to which it also was selling DRM.

What all this means is that subscription services must change dramatically before they will have a significant impact on the digital music industry and take business away from Apple, which has repeatedly said it is unlikely to offer a subscription service. Many believe the subscription services will, indeed, change, and Microsoft claims it is leading the charge.

New subscription models

Jason Reindorp, Microsoft's director of marketing for Zune, said he's confident that subscription services will succeed, although they will probably look different in the future. He also agreed with McQuivey that the biggest problem is that many people don't understand the services.

"What's needed is a strong educational push," Reindorp said. "I can understand why, at face value, people could think that if they pay for something, they'd want to own it."

One way to combat that problem, Reindorp said, is to provide variations of the subscription model that people can more easily understand. He said Microsoft is looking into such variations for its Zune Marketplace, which is structured much like other subscription services. One option would be to provide different levels of service.

"There could be a basic level where you access tracks, another where the service pushes out recommendations to you, and a third where there is all the access you want and where there are videos and other premium content," Reindorp said. "Or maybe the player is free or subsidized, or the device is replaced when a new device comes out. We're exploring all those things."

He predicted that once the subscription model is fine-tuned, it will compete strongly against iTunes. Apple did not return calls for this story.

JupiterResearch's Strother said another reason new subscription models are needed is that the current model doesn't make business sense.

"It's like the cable model where the only way you can make more money is to raise rates or attract more customers," Strother said. "From a business-model point of view, unless you move me up to a gold or platinum level, it's hard to know where you could grow the business."

Reindorp stressed that even without changes, he is seeing some movement toward acceptance of the subscription model.

"Subscribers [to Zune Marketplace] have been increasing about 65% a month," Reindorp said. "The numbers are still quite small, but that kind of growth is important."

More competition and coexistence

While subscription services, by definition, require DRM, Reindorp said that eliminating DRM for songs that are bought rather than rented would open up the digital media marketplace.

"Selling unprotected music means an iPod user could buy something from Zune Marketplace or a Zune user could get music from iTunes," he said. "That would make it a matter of the stores and services competing with each other more."

And given that the Zune trails far behind the iPod, more competition is what Microsoft is looking for. Reindorp also noted that subscription and pay-per-track services can coexist. That's particularly true because subscription services, with their virtually unlimited downloads, encourage users to explore new music, which they later may want to purchase.

"I can assure you that [these possibilities] are part of the active conversation we're having with our label partners," Reindorp said.

Forrester's McQuivey agreed that subscription services are different from services from which you purchase the music and that the record labels are interested in both models.

"I would argue that subscription services don't substitute for iPod and iTunes; they really substitute for radio," McQuivey said. "For a lot of people, radio is just a way to find good music. To the extent that subscription services succeed, it'll be because you can download a ton of music, see what you like and discard the rest."

But the experts also agreed that the biggest changes to the competitive landscape will eventually occur because, despite the visibility of the iPod, the iTunes store and the forthcoming iPhone, not many people have bought into digital music yet.

"Those of us who live in the digital industry think everybody has a digital music player," Reindorp said. "But if you look at the total market, there are a huge number of people who have yet to get into this space."

David Haskin is a contributing editor specializing in mobile and wireless issues.

Copyright © 2007 IDG Communications, Inc.

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