All Things Digital

Nearly 8 percent of high school students own an iPhone. And 22 percent of those who don’t, hope to buy one in the next six months. This according to Piper Jaffray’s 16th bi-annual Teen MP3 Player and Online Music Survey (click on chart below), which found that Apple’s (AAPL) cachet among teen consumers is as solid as it ever was, economic collapse be damned. “Apple’s dominance in the consumer electronics and online music markets is going seemingly unchecked,” Piper Jaffray analyst Gene Munster said in a note explaining the survey. “We believe that the teen demographic is a critical component of long-term growth in the digital music and mobile markets.”

If the [iTunes music store] was forced to absorb any increase in the … royalty rate, the result would be to significantly increase the likelihood of the store operating at a financial loss–which is no alternative at all. Apple has repeatedly made it clear that it is in this business to make money, and most likely would not continue to operate [the iTunes music store] if it were no longer possible to do so profitably.”

– iTunes vice president Eddy Cue

Not that it would ever have happened anyway, but Apple (AAPL) will not be shutting down the iTunes Store in protest over increased royalty rates paid to songwriters and publishers for CDs and digital music downloads. The Copyright Royalty Board Thursday left the rate for royalties unchanged at nine cents a track, paying no mind to a proposal by the National Music Publishers’ Association that would have raised it to 15 cents–a 66 percent hike.

Seems Apple’s posturing paid off. Said Apple spokesman Tom Neumayr, “We’re pleased with the CRB’s decision to keep royalty rates stable.”

Overall CD sales are plummeting after eight years of unflagging erosion. Digital music sales now account for 15 percent of recording industry’s revenues worldwide and 30 percent in the United States, according to recent data from the International Federation of the Phonographic Industry. And those numbers are climbing faster than ever. Consider: This past June, Apple (AAPL) said it has sold some five billion songs on its iTunes Store. Clearly, physical media are giving way to the Internet as a means of music distribution. What better time, then, to reinvent the music industry’s business model for physical media as SanDisk (SNDK) hopes to do with its new microSD memory card album format?

This morning the company announced slotMusic, a compact memory card-based music format that can be played on cellphones, PCs and some MP3 players. It relies on MP3s without digital rights management schemes and is backed by Universal Music Group, Sony BMG Music Entertainment, Warner Music Group and EMI Group, all of which apparently believe that more physical media is the best way to reinvent their business model in the era of digital distribution. Though as SanDisk VP Daniel Schreiber notes, they do have their reasons. “There’s a billion phones out there and a lot of them can play music and a lot of them have a microSD slot,” he explained. “We think there’s still a need for a tangible, physical product. People will appreciate walking out of the store playing music on their phones.”

Perhaps. But will they appreciate carrying that music around on a 0.6″ x 0.4″ medium that’s about the size of a fingernail? Seems easy to lose, doesn’t it (maybe Case Logic is planning a slotMusic binder)? And wouldn’t they rather carry around hundreds of songs, instead of the dozen or so stored on each slotMusic card? And what if the memory card in their phone is already in use, filled up with contacts, applications and other data? What then? And beyond this, haven’t iTunes and Amazon MP3 made consumers more accustomed to purchasing music à la carte? Why purchase a full album at $15, when all you really want are the only two good songs on it?

With analysts predicting Activision Blizzard (ATVID) will generate $1.38 billion in profits during its first financial year, Bobby Kotick, CEO of the new company, can perhaps be forgiven his grandiose proclamations. After all, there’s little doubt that the pure-play online and console game publisher will be the world’s most profitable. That said, it’s hard to believe that Activision Blizzard can launch a “successful competitor” to Apple’s iTunes music service through its Guitar Hero franchise, as Kotick claims. “When you think about the potential for what we will be able to do together, there have not been many viable alternatives to iTunes,” Kotick said, adding that it would be relatively easy to leverage the company’s new relationship with Universal Music Group (V) to develop an online music store tethered to Guitar Hero. “If you’re downloading a song to play on your Guitar Hero, there’s no reason why you can’t download the performance also,” he explained. “When you look at Universal Music Group as having such a big slate of artists and a large catalog and such a well-balanced presence over all the major territories in the world, there are plenty of opportunities.”

Opportunities, yes. Like debuting Metallica’s next album, “Death Magnetic” as a “Guitar Hero III” download. But opportunities large enough to unseat an entrenched rival like iTunes? A rival that has sold more than 4 billion songs and accounts for approximately 70 percent of digital music sold worldwide? A rival that in the next five years, may well account for a staggering 28 percent of all music sold worldwide?

In a 2004 email to Steve Jobs, RealNetworks (RNWK) CEO Rob Glaser asked the Apple (AAPL) CEO to consider a “tactical alliance” with his company. License us your Fairplay digital-rights management system, allow our customers to play their digital music collections on the iPod, wrote Glaser, and we’ll make the iPod our primary device for the RealNetworks store and for RealPlayer software.

It was an astonishing offer at the time, especially coming from Glaser, who had been a vocal critic of Apple and its decision to make digital music sold through its iTunes store playable only on iPod (”I bought an iPod and can only shop at one store,” Glaser once said. “What is this? The Soviet Union?”)

But it was an offer that Jobs found unappealing. The Apple CEO rebuffed Glaser, declining even to meet with him over lunch to discuss it.

Glaser, of course, took it poorly and spent the next few years slagging Apple and Jobs for declining the partnership. “We think Apple Computer, and Steve personally, are making a mistake by making the software proprietary,” Glaser said at the Digital Living Conference in 2005. “There’s no reason we should penalize Apple customers for Steve’s pigheadeness.”

Course, in the end Real didn’t penalize Apple’s customers. Apple’s customers penalized Real. And today Apple’s iTunes is the largest music retailer in the states. And Real? Well, Real’s “embracing” the iPod.

Funny how that worked out.

This morning the company announced a new MP3 store whose unprotected music files can be played anywhere–even on an iPod. Like Apple’s iTunes, the Rhapsody MP3 Store offers music from all four major music labels at 99 cents per track, or $9.99 for an album. Over five million songs will be made available, at 256k-bit rates. Visitors can preview them in their entirety instead of the 30-second samples offered by iTunes and the like. And, if they’re Verizon (VZ) subscribers, they can download music directly to their phones with the company’s V CAST Music with Rhapsody service.

“We’re no longer competing with the iPod,” said Rhapsody Vice President Neil Smith. “We’re embracing it.”

Pigheadeness, be damned.

If the recording industry thinks Steve Jobs has been a bear to negotiate with in the past, wait until it gets a load of him now.

Apple’s (AAPL) iTunes Store has become the No. 2 music retailer in the states, according to a new study by the NPD Group. It’s second only to Wal-Mart and, if things keep going the way they are, Apple will soon surpass it. “Digital sales were up close to 50% and CD sales were down 20% last year,” said Russ Crupnick, the NPD Group’s president of music. “Even at half that growth rate in digital sales, Apple will in all likelihood catch Wal-Mart this year.”

One last point worth noting here: While 1 million consumers dropped out of the CD-buyer market in 2007, 29 million acquired digital music legally. That’s an increase of 5 million over the previous year. Growth here was largely driven by the 36-to-50 age group. “The continued growth in legal download sites is encouraging, yet the industry struggles to improve the value of each digital customer,” said Crupnick. “With so many baby boomers and Gen Xers entering the market, there are certainly opportunities to sell more digital albums, promote older catalog titles, or create bundles that will raise revenues. In the near term that’s going to be the best means available to narrow the gap on dwindling CD revenues.”

Universal Music Group CEO Doug Morris’s attempt to wrest control of the digital music market from Apple has–shock!–run afoul of U.S. regulators. The Justice Department has begun investigating Universal for proposing to its three main competitors that they collaborate on “Total Music,” a service that would bake the cost of an “all-you-can-eat” music subscription into the hardware that supports it.

It’s not clear which aspect of Total Music has piqued the Justice Department’s interest, though it’s likely concerned that participating labels might collude to set wholesale music prices. And for good reason–the major labels were found guilty of wholesale CD price fixing back in 2000.

Digital music sales are soaring, but that hasn’t stopped the recording industry from continuing to spin its long-running woe-is-me tale of piracy and declining revenues.

According to the International Federation of the Phonographic Industry’s 2008 Digital Music Report (PDF), global digital music sales rose to $2.9 billion in 2007, up from $2.1 billion in 2006.

Now that 40% increase isn’t nearly the doubling of digital sales we saw in 2006, but it’s not insubstantial, either. Especially when one considers that digital sales grew to account for 15% of the world’s music market, up from 10% in 2006. That means that almost a sixth of music sales already come through digital channels. This despite five or so years of the recording industry’s Keystone Kops approach to the digital music revolution.

All things considered, things aren’t going too poorly–even if the growth of digital music sales hasn’t yet offset declines in physical music. That being the case, it’s difficult not to look askance at the IFPI’s calls for governments and Internet service providers to take a hard line against file-sharing.

“Copyright theft has been allowed to run rampant on [ISP] networks under the guise of technological advancement,” IFPI Chairman and CEO John Kennedy wrote in the report. “Some estimates say no less than 80% of all Internet traffic comprises copyright-infringing files on peer-to-peer networks.”–80%? Does the IFPI suffer from the same math disability as the MPAA?–”ISPs have largely stood by, allowing a massive devaluation of copyrighted music. This in turn–and despite all the positives about our digital growth–has prompted a crisis in recorded music that has wide implications for the whole digital marketplace and all those businesses to whom music is an important ingredient. … Today, however, a sea-change is happening. The whole music sector, governments and even some ISPs themselves, are beginning to accept that the carriers of digital content must play a responsible role in curbing the systemic piracy that is threatening the future of all digital commerce. After years of discussing and debating, I am convinced it is no longer a question of whether the ISPs act–the question is when and how.”

And the answer? Five bucks and a copy of the latest Britney Spears album says it’s network-level filtering.