Napster's New Old Business Model: Free.

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Author: Bruno, Antony

DIGITAL MUSIC

In their continuing struggle to attract music fans from iTunes, subscription music services are resorting to what made digital music popular in the first placeâ€"a price tag marked "free."

This time, however, they have the support of the music industry, because these services are using online advertising to compensate labels, artists and publishers for the rights to their work.

The latest iteration of this strategy is the relaunch of the napster.com Web site. Previously, napster.com existed only as a place to download the company's softwareâ€"originally as a peer-to-peer application and more recently as a subscription service. It is now presented as a complete music portal. Visitors can access and play any song in Napster's 2 million-track library free for up to five times before they are required to either buy the track or subscribe to the service.

"We never intended to be a Web-based experience," Napster CEO Chris Gorog says. "But this was an effective piece of real estate we weren't using to any scale."

This closely follows a similar move by rival RealNetworks, which in December introduced a new version of the rhapsody.com site that allows anyone to stream up to 25 songs per month for free, without buying or subscribing.

Both services sell banner ads on their sites, as well as on their Web-based music players. Both also share the generated ad revenue with labels and publishers in return for music licensing rights.

The result is yet another new source of income for a music industry desperate to recoup its losses from the continuing decline of physical CD sales.

"It's a great model," Pali Research analyst Richard Greenfield says. "It just shows how there's more and more ways to make money off of music beyond the specific sale of it."

Subscription services pay labels and publishers a per-subscriber minimum each month, estimated to be about $6-$8 per month. Now Napster and Rhapsody will include a percentage of that monthly ad revenue as well.

The amount of advertising revenue each label and publisher receives will vary based on the number of times their artists' music is played each month, according to industry sources.

And each service pays a different amount. It is widely believed that Napster is paying the music industry a larger split of its advertising revenue than RealNetworks, primarily because napster.com only limits the number of times an individual song can be played while rhapsody.com limits usage to just 25 songs per month.

"The more control you have over what the user can do and the less that the user can do with it, the lower the split," says Chris Castle, a music industry lawyer specializing in digital music services.

These moves come at a time when Internet advertising is at an all-time high. According to the Interactive Advertising Bureau, online advertising in the United States grew by 30% last year to $12.5 billion. Forrester Research estimates this figure will grow to $26 billion and represent about 8% of all advertising spending by 2010.

But the determining factor for marketers as to where they will spend these dollars online is the same as that of any other mediumâ€"viewers. By that measuring stick, Napster and Rhapsody have some catching up to do.

According to Nielsen NetRatings, rhapsody.com had 2.3 million unique visitors in March, while napster.com had 1.9 million. By way of comparison, iTunes received 20 million unique visitors in March.

Piper Jaffray analyst Gene Munster estimates Napster's ad revenue will total about $50 million annually.

"It's not going to be Google revenue by any stretch in terms of advertising," Gartner G2 analyst Mike McGuire says. "But it's probably enough to help fund it and pay for the licensing of the music. Now it's up to them to drive traffic."

According to RealNetworks VP of music and mobile services Kevin Nakao, the free rhapsody.com service is responsible for the majority of its monthly subscriber growth since the free service launched. The company has more than 1.5 million paid music subscribers, although this figure accounts for all RealNetworks music services, not just Rhapsody.

"Right now it's one of our best-performing channels for acquiring new subscribers," he says. "They're certainly the highest conversion rates I've ever seen in a Web or a direct-marketing environment."

If sustainable, this would be good news to the music industry. Record labels roundly profess their preference for the reoccurring revenue gained via subscription services over the thin margins collected from Ă  la carte sales. But to date, consumers have not shared that enthusiasm.

The idea of music as a service that is "rented" over music that is owned and purchased has proved a tough sell. With an estimated customer acquisition cost of $100 per subscriber, Napster spent tens of millions on marketing alone just to convince music fans to download their subscription software for a free trial. It currently has about 600,000 subscribers from the effort.

This new model allows Napster and Rhapsody to offer an indefinite trial period while still collecting revenue and paying labels for the ability to do so.

"We find it an interesting approach," EMI executive VP of strategy and business development Adam Klein says. "There's a huge amount of evidence that shows consumers need to listen to streams a certain number of times before they commit to buy. Consumers who spend more time experimenting with music end up spending more money buying music. We have to be progressive in our experimentation, understand where consumers are going and adjust our product accordingly."

PHOTO (COLOR): GOROG

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By Antony Bruno