iTunes ushers in a year of change

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 recordingengineer 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, butit's crazy howmuch has actually happened (this year)," he said. "Mycareer at thispoint realistically is going to depend on howsuccessful this businessmodel is."

Gillilan isn't alone in looking at iTunes as anindustry bellwether.Launched a year ago Wednesday with ablaze of publicity, the service effectivelykick-started a languishingdigital music business.

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

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

For the two years leading up to Apple's launch,attention had beenfocused on Napster, Kazaa and other file-swappingservices that wereallowing billions of songs a month to be downloadedfor free. The majorrecord labels, stung by falling revenue, focused muchof their attention on filing lawsuits, drawing chargesthat their main interest was to smother development ofthe digital music business.

"iTunes has been incredibly valuable," said LarryKenswil, presidentof Universal Music's eLabs division. "It has changedthe debate, changedthe buzz, changed people talking about recordcompanies putting up awall" against digital music.

But as the so far unchallenged market leader, Applehas established several other market realitiesagainst which various rivalschafe. The company's iTunes service is so tightly integrated with itshardware businessthat songs bought through the store can only be easily playedon Apple's iPod,not other MP3 players. The close integration alsomeans Apple canafford what it openly concedes are miniscule profitmargins on the storeitself, seeing it as a way to drive iPod sales.

Although Apple has taken a largely proprietaryapproach to iTunes, it made one major concession bymaking its software compatible with Microsoft'sWindows operating system, effectively untying the iPodfrom the Mac in hopes of tapping into the much largermarket for Windows PC users. The company has alsostruck a deal under which Hewlett-Packard will sell PCs with iTunes preloaded and also sell HP-branded iPods.

Apple launches iTunes Music Store and new iPods

The most public overtures when it comes to opening the iPod have come fromRealNetworksChief Executive Officer Rob Glaser, who--not longafter comparing Apple's closed technology doors to a Soviet grocery store--found his own privateappeal to Apple CEOSteve Jobs rejected.

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

"To be honest, it's just not worth it," Jobs said atlast week'sApple shareholder meeting. "Itdoesn't make any business sense."

However, record company executives are quietlyadvocating industry cooperation, contending digitalbalkanization will be bad for business over the longhaul.

"Interoperability is critical," said EMI Music SeniorVice President Ted Cohen. "We need to get to thatpoint, and people need to work together to do it."

Just getting started
Despite Apple's success, the digital music business isonly beginning to get off the ground, and it's hard topredict what might happen next. The iTunes launch wasseen by many in the record industry as an experimentwith loosening previous restrictions on digital files.Now that the first stages of the experiment haveproven successful, labels may be amenable to furtherexperimentation.

Some of that variability will come in prices. Apple's99 cent price for single songs and $9.99 price tagfor albums has been widely copied. But already that'sbeginning to change, with some record executivessaying they're eager to test tieredprice models.

A little of this is already evident on iTunes. Singles have remained steady at 99 cents, but a few albumshave begun creeping upward. Aerosmith's newest waspriced 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 otherservices said theyhad already seen labels raise prices on someindividual songs as wellas albums. None has passed on those per-song priceincreases yet, citing acontinued need to present consumers with the simplestoffer possible,however.

Label and Web company executives said the price increasesreflect anexperimentation with tiered pricing that mimics theway retail albumprices fluctuate according to title, and over time. Underthis model,pre-release singles or very popular artists might cost$1.50 or moreper song, average tracks might stay at 99 cents, andback catalog and otherpromotional songs or albums could drop even lower, forexample.

"It is a good thing to have that experimentation, bothup and down,"said Sean Ryan, RealNetworks vice president for musicservices. "Justbecause everyone went out at 99 cents doesn't meanthat's always theright price."

Labels are sensitive to charges that they want tocharge more onlinethan for CD sales, however.

"We've built in a lot of flexibility," said EMI GroupspokeswomanJeanne Meyer. "There are tiered prices (for wholesaledigital tracks), butthey're all lower than in the physical world."

With that experimentation in pricing may come somefluctuation in usagerules. Currently iTunes customers can use theirpurchased music on upto three computers and burn the same songs in the sameorder up to 10times. However, those rules may be tweaked as therecord companiesrenegotiate their contracts with Apple.

Other companies, if not Apple itself, are likely tobegin experimentingmore with subscription services as well. Jobs hasdismissed these asvirtually irrelevant, saying that people want to "own,not rent" theirmusic.

For the most part, these have remained niche products,althoughRealNetworks has said it now has a total of more than495,000subscribers to either its unlimited Rhapsody productor a cheaperonline radio service. But for companies that do nothave an iPod-like hardwaredevice to depend on for profits, this monthly streamof revenue looksfar more appealing, and will likely drive moreexperimentation nextyear.

Microsoft is also hoping to make such services moreattractive through technology, code-named Janus, that wouldallow subscription music to be transferred to portabledevices--a key drawback to the current crop ofsubscription services.

Though Apple has been the undisputed leader in themarket--and has done better than some would havethought a year ago--online downloads stillrepresent a small part of how people get their music.File-swappingservices continue to be popular, and CD sales havestarted to show somesigns of life. Apple itself had predicted it woulddistribute 100million songs by the time the one-year anniversaryrolled around, a goalthe company seems likely to miss.

To date, rivalslike Napster and Musicmatch have fallen far short ofApple's sales.According to the NPD Group, Walmart.com's cut-ratepricing has comeclosest, drawing about half the number of customersseen by iTunes inMarch.

Analysts say that although many of the new entrants tothe market couldpose strong competition, Apple will continue tobenefit from the fact ithas sold so many iPods--devices that work only withApple's service.Last quarter Apple sold 800,000 of the portable musicplayers, withrivals such as Dell and Samsung selling only afraction of that total.

"Apple set the bar incredibly high," said MikeMcGuire, an analyst withGartnerG2, a division of the Gartner research group.

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

"Apple is probably still riding the wave of theirinitial launch," said Jason Reindorp, a group managerin Microsoft's Windows digital media unit. "They havespent an inordinate amount of money to generateawareness around their closed ecosystem. (But) aspeople get more sophisticated in this area they aregoing to be getting more frustrated with a closedecosystem. I think the market will kind ofself-correct as things get more mainstream."

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 recordingengineer 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, butit's crazy howmuch has actually happened (this year)," he said. "Mycareer at thispoint realistically is going to depend on howsuccessful this businessmodel is."

Gillilan isn't alone in looking at iTunes as anindustry bellwether.Launched a year ago Wednesday with ablaze of publicity, the service effectivelykick-started a languishingdigital music business.

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

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

For the two years leading up to Apple's launch,attention had beenfocused on Napster, Kazaa and other file-swappingservices that wereallowing billions of songs a month to be downloadedfor free. The majorrecord labels, stung by falling revenue, focused muchof their attention on filing lawsuits, drawing chargesthat their main interest was to smother development ofthe digital music business.

"iTunes has been incredibly valuable," said LarryKenswil, presidentof Universal Music's eLabs division. "It has changedthe debate, changedthe buzz, changed people talking about recordcompanies putting up awall" against digital music.

But as the so far unchallenged market leader, Applehas established several other market realitiesagainst which various rivalschafe. The company's iTunes service is so tightly integrated with itshardware businessthat songs bought through the store can only be easily playedon Apple's iPod,not other MP3 players. The close integration alsomeans Apple canafford what it openly concedes are miniscule profitmargins on the storeitself, seeing it as a way to drive iPod sales.

Although Apple has taken a largely proprietaryapproach to iTunes, it made one major concession bymaking its software compatible with Microsoft'sWindows operating system, effectively untying the iPodfrom the Mac in hopes of tapping into the much largermarket for Windows PC users. The company has alsostruck a deal under which Hewlett-Packard will sell PCs with iTunes preloaded and also sell HP-branded iPods.

Apple launches iTunes Music Store and new iPods

The most public overtures when it comes to opening the iPod have come fromRealNetworksChief Executive Officer Rob Glaser, who--not longafter comparing Apple's closed technology doors to a Soviet grocery store--found his own privateappeal to Apple CEOSteve Jobs rejected.

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

"To be honest, it's just not worth it," Jobs said atlast week'sApple shareholder meeting. "Itdoesn't make any business sense."

However, record company executives are quietlyadvocating industry cooperation, contending digitalbalkanization will be bad for business over the longhaul.

"Interoperability is critical," said EMI Music SeniorVice President Ted Cohen. "We need to get to thatpoint, and people need to work together to do it."

Just getting started
Despite Apple's success, the digital music business isonly beginning to get off the ground, and it's hard topredict what might happen next. The iTunes launch wasseen by many in the record industry as an experimentwith loosening previous restrictions on digital files.Now that the first stages of the experiment haveproven successful, labels may be amenable to furtherexperimentation.

Some of that variability will come in prices. Apple's99 cent price for single songs and $9.99 price tagfor albums has been widely copied. But already that'sbeginning to change, with some record executivessaying they're eager to test tieredprice models.

A little of this is already evident on iTunes. Singles have remained steady at 99 cents, but a few albumshave begun creeping upward. Aerosmith's newest waspriced 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 otherservices said theyhad already seen labels raise prices on someindividual songs as wellas albums. None has passed on those per-song priceincreases yet, citing acontinued need to present consumers with the simplestoffer possible,however.

Label and Web company executives said the price increasesreflect anexperimentation with tiered pricing that mimics theway retail albumprices fluctuate according to title, and over time. Underthis model,pre-release singles or very popular artists might cost$1.50 or moreper song, average tracks might stay at 99 cents, andback catalog and otherpromotional songs or albums could drop even lower, forexample.

"It is a good thing to have that experimentation, bothup and down,"said Sean Ryan, RealNetworks vice president for musicservices. "Justbecause everyone went out at 99 cents doesn't meanthat's always theright price."

Labels are sensitive to charges that they want tocharge more onlinethan for CD sales, however.

"We've built in a lot of flexibility," said EMI GroupspokeswomanJeanne Meyer. "There are tiered prices (for wholesaledigital tracks), butthey're all lower than in the physical world."

With that experimentation in pricing may come somefluctuation in usagerules. Currently iTunes customers can use theirpurchased music on upto three computers and burn the same songs in the sameorder up to 10times. However, those rules may be tweaked as therecord companiesrenegotiate their contracts with Apple.

Other companies, if not Apple itself, are likely tobegin experimentingmore with subscription services as well. Jobs hasdismissed these asvirtually irrelevant, saying that people want to "own,not rent" theirmusic.

For the most part, these have remained niche products,althoughRealNetworks has said it now has a total of more than495,000subscribers to either its unlimited Rhapsody productor a cheaperonline radio service. But for companies that do nothave an iPod-like hardwaredevice to depend on for profits, this monthly streamof revenue looksfar more appealing, and will likely drive moreexperimentation nextyear.

Microsoft is also hoping to make such services moreattractive through technology, code-named Janus, that wouldallow subscription music to be transferred to portabledevices--a key drawback to the current crop ofsubscription services.

Though Apple has been the undisputed leader in themarket--and has done better than some would havethought a year ago--online downloads stillrepresent a small part of how people get their music.File-swappingservices continue to be popular, and CD sales havestarted to show somesigns of life. Apple itself had predicted it woulddistribute 100million songs by the time the one-year anniversaryrolled around, a goalthe company seems likely to miss.

To date, rivalslike Napster and Musicmatch have fallen far short ofApple's sales.According to the NPD Group, Walmart.com's cut-ratepricing has comeclosest, drawing about half the number of customersseen by iTunes inMarch.

Analysts say that although many of the new entrants tothe market couldpose strong competition, Apple will continue tobenefit from the fact ithas sold so many iPods--devices that work only withApple's service.Last quarter Apple sold 800,000 of the portable musicplayers, withrivals such as Dell and Samsung selling only afraction of that total.

"Apple set the bar incredibly high," said MikeMcGuire, an analyst withGartnerG2, a division of the Gartner research group.

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

"Apple is probably still riding the wave of theirinitial launch," said Jason Reindorp, a group managerin Microsoft's Windows digital media unit. "They havespent an inordinate amount of money to generateawareness around their closed ecosystem. (But) aspeople get more sophisticated in this area they aregoing to be getting more frustrated with a closedecosystem. I think the market will kind ofself-correct as things get more mainstream."