Digital download providers forced to live on a song

It took only a day for a price war to erupt here among legal music download providers, provoking the question: Just how profitable a business is it?

Coca-Cola last week entered the fray with its CokeTunes service. With almost 600,000 tracks from more than 12,000 artists, it's easily the country's largest legal source of digital music. Digirama was the previous king, with more than 73,000 tracks.

But Coke took the offensive with more than just a sheer volume of offerings - it offered tracks at $1.75 and albums starting at $18, undercutting Digirama's respective prices of $1.99 and $19.99.

Digirama's co-founder Shaun Davis initially scoffed at Coke's prices, saying there was no way the company could be profitable. But, faced with big competition, Digirama lowered its prices the next day to $1.69 a song and $17.99 an album.

Davis says that since the two providers are offering the exact same service, he had no choice.

"We've got to stay in sync. If you cost more, who's going to get it from you?"

In order to get their goods, providers such as iTunes, Coke and Digirama must sign wholesale agreements with the record labels that own the music. The labels, facing ever-decreasing CD sales, are under pressure to replace lost profits with returns from downloads. And the digital music market is becoming somewhat crowded - in the United States alone, iTunes competes with nearly identical services from Real Networks, Napster and others.

Everyone is under pressure from the large and ever-present illegal download community.

The Financial Times recently reported that labels had initially set wholesale prices low - 65USc - to stimulate demand.

But now that demand has exploded - legal music downloads worldwide tripled to 180 million in the first half of 2005, according to the International Federation of the Phonographic Industry - the labels are looking to raise prices 52 per cent to 99USc.

Apple's current retail price on iTunes in the United States is 99USc a song, which means a profit of 34USc a song. If the labels impose an increase to the wholesale price, providers such as Apple will have to cut into their margins to avoid losing customers.

It's the same situation here as it is in the United States, Davis says. Digirama pays a wholesale price of between $1.30 to $1.45 a song, which doesn't leave a whole lot of profit margin.

"They're already pretty damn slim," he said. "We've got to be competitive, but we can't do anything about the wholesale prices, so we're squashed in at both ends."
CokeTunes isn't necessarily in the New Zealand market to make money, however.

"We do make a small margin on each track that's sold at the store," said Nick Lowe, director of new media for Satellite Interactive, which helped set up the site. "But because it's Coke, there isn't a requirement for the store to be generating a profit for the store to operate."

Lowe said the profits that are made are channelled back into the CokeTunes Music Fund, which will give quarterly grants to emerging New Zealand bands.

He referred questions about wholesale song prices to OD2, the UK-based company that runs Coke-Tunes. The company could not be reached for comment yesterday.

Davis says that while big players such as iTunes enjoy lower wholesale prices because of their size and clout, record labels can pretty well dictate costs to smaller providers such as Digirama.

"For us, we didn't have a whole lot of leverage really because we were just trying to break into it. We pretty much had to take what was put on the table."

For their part, the labels are starting to see returns from digital sales. Warner Music Group, which licenses songs to CokeTunes and Digirama, last week posted a narrower-than-expected loss over the previous year, citing improving sales of online music.

Analysts had expressed concern that digital sales would not be able to keep up with declines in physical sales. But Warner says the increase is outpacing the decline in traditional CD sales.

The label pressure on providers' margins is perhaps the reason iTunes has yet to set up in Australia or New Zealand. Several industry observers say that one or more of the record labels are unhappy with Apple's existing wholesale price and want it raised. The Financial Times article, meanwhile, reports that Apple chairman Steve Jobs is furious about the issue.

It's an impasse that could take a long time to resolve. The labels need iTunes and its ilk to overcome declining profits, and the digital providers need the labels for content.

Apple's service is getting closer to New Zealand, however. The company announced last week a new iTunes store in Japan. The site will offer more than 1 million songs from 15 Japanese record companies, with about 90 per cent of songs costing 150 yen ($1.93) each, and the remainder priced at 200 .

That undercuts Mora, a Sony-backed store, which sells tracks for between 150 and 370.

Downloads from iTunes stores worldwide topped 500 million in July. Apple started iTunes in April 2003 and offers the service in 20 countries.

The company has been enjoying a music-driven bonanza of late, recently reporting a fivefold increase in third-quarter profit to US$320 million as sales of iPods unexpectedly surged to a record and Macintosh computer shipments reached a five-year high.

The company's entry to the New Zealand digital download market - if it ever does happen - is sure to increase the pressure on all players.

- additional reporting: agencies