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Facing the Digital Music at Record Shops

In the red glow of fluorescent lights, pop divas smile and rap artists flash V-for-victory signs from glossy wall posters. They watch over shelves full of tapes and CDs and over listening stations that offer samples of the hottest tunes. Pierced-nose punkers and corn-rowed hip-hoppers all come here, to their favorite music store, to get their fix. It's a vibrant setting -- and an endangered one.

The arrival of easy and widespread digital downloads paired with cheap CD burners and online CD sales could put significant pressure on brick-and-mortar music shops, just as downloads and online sales have started to kill software stores. (Remember Egghead Software? It went from 205 stores at its peak to a Web-only operation in 1998 -- and it continues to struggle.) Music fans are already flocking to the Web to find their music: In the first quarter of 2001, some 22 million people downloaded tunes, according to consumer research firm Cyber Dialogue.

As that habit grows, more music sales will occur online. According to consultancy Jupiter Media Metrix, online sales of CDs and downloads will account for 25%, or $5.4 billion, of all U.S. music sales by 2005, up from an already healthy 18% this year. Amazon (AMZN) has vaulted into the top ranks of CD sellers after only three years in the business. "It's a signal to CD music retailers to abandon their stores and go online," says Phil Leigh, an analyst at brokerage Raymond James, who gives most offline music stores 10 years of life at best.

SHRINKING SINGLES. That's a radical view not all analysts share. But most agree that only the fittest stores will survive the next few years, with weaker music retailers closing shop or broadening into other products. Even today's biggest brick-and-mortar music retailers, including Tower Records, Virgin, and HMV, will have to use a grab bag of tricks to fend off the Web and keep customers coming back.

To some extent, retailers have only themselves to blame for the spot they're in. According to Jay Samit, senior vice-president for new media at Big Five record label EMI Group, one out of five customers can't find the CD they're looking for when they go to a store. Moreover, sales of CD singles plummeted 38% last year, helping to cut the value of music sold in the U.S. from $14.6 billion in 1999 to $14.3 billion in 2000, according to the Recording Industry Association of America. Industry tracker SoundScan counted 175 million albums purchased in the first quarter of 2001 in the U.S., vs. 177 million in the same period the year before.

Worse than a stagnant market, in the view of retailers, is that offline brand loyalty doesn't necessarily transfer online, says Idil Cakim, director of media and entertainment strategies for New York-based Cyber Dialogue. "If you're selling CDs and is selling CDs and you don't offer any differentiation, then you are too late," she says.

A NEW MIX? That's why many analysts say retailers have to change their tune dramatically. Music stores should become broader entertainment venues that include video games and movies, as well as tickets to sold-out or yet-unavailable-for-sale concerts, says Cakim. That's precisely the strategy of multimedia retailer Hastings Entertainment (HAST), based in Amarillo, Tex.: When consumers come to Hastings' stores, they "can get a bag of popcorn, rent a movie, buy a CD, and say hello to a friend," says Storm Gloor, Hastings' director of music.

Other shops are shifting their merchandise mix to more value-added and profitable items, such as DVDs of concerts and movies. "Nonmusic [sales] as a percentage of our total [revenues] has increased 15% over last year, says Tom Thirkell, CEO of Atlanta-based Value Music Concepts, which operates 50 stores in 24 states and grossed $48 million last year.

Digital kiosks are another gimmick stores are using to better connect with customers. Barnes & Noble (BKS) has installed Internet-enabled kiosks in its stores through which customers can order books and music. DigKiosk, by San Diego-based DigMedia, allows consumers a chance to listen to samples of music in MP3 and CD formats. Online-music startup Liquid Audio has built kiosks in London that for a while offered HMV customers the ability to burn a personalized CD selected from 120,000 tracks of independent music. Liquid Audio has exited that business, banking its future on offering subscription-based music services online. Nonetheless, services such as these "could give any mom-and-pop music store access to the entire music catalog without needing the stocking space," says EMI's Samit.

MUSIC LOCKERS. Retailers will have to augment stronger in-store efforts with a sound Web strategy, experts believe. With digital music "raising the bar for the savviest competitors out there, "distributors and retailers are increasingly striking deals with companies that hawk innovative technology," says Jim Donio, executive vice-president of the National Association of Recording Merchandisers (NARM), which represents nearly 1,000 U.S. retailers, wholesalers, and distributors of recorded music.

Already, many retailers are experimenting with technologies that are designed to create a seamless combination of the online and offline music worlds. These include so-called music lockers -- secure online storage -- where consumers can put songs from CDs they purchase and create customized play lists.

Free samples are another way of cementing the online-offline connection. Barnes& offers free digital downloads of select music by bands such as the Goo Goo Dolls, Depeche Mode, and R.E.M. And some retailers are combining a physical purchase with a digital-music file on a desktop. Tower Records is planning to allow online CD buyers access to MP3 versions of their purchases before the hard copy arrives in the mail.

WALK-IN BUYERS. For all the digital noise, some retailers remain skeptical that there'll be a wholesale shift to downloads and online sales. A large portion of CD sales come from big stores such as Wal-Mart and BestBuy that will still attract walk-in customers. And some retailers say the tangibles remain essential. "People still like to touch their CDs," says Eisenman. Retailers have a knack for knowing what the consumers want, picking the best CDs, and delivering customer service, he says. "Brick-and-mortar is here, and it's not going anywhere," he adds.

Indeed, many big industry players think reports of the retail stores' demise are greatly exaggerated. "That's the 1948 conversation about radio and television, or a conversation about VCRs and movies," says EMI's Samit. "In fact, we took a $400 million film industry and turned it into a $20 billion-plus business."

Even so, the Internet "has got to be taking market share" from traditional retailers, says Bill Armstrong, an analyst with research and investment firm C.L. King & Associates. Music downloading "is beyond the tipping point, it's almost an epidemic," adds Cyber Dialogue's Cakim. So unless music retailers take action, get online, and shift their product mixes, the next melody some of them are likely to hear will be a requiem. By Olga Kharif in New York

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