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Virgin May Show Apple a Thing or Two

By Alex Salkever The honeymoon was nice while it lasted -- Apple's digital-music honeymoon, that is. On Mar. 8, Brit billionaire Richard Branson jumped into the game with an announcement that his Virgin constellation of airlines, cell-phone networks, and media stores would soon add a digital-music business to the portfolio.

I don't know the particulars of the reaction at Apple (AAPL) headquarters in Cupertino, Calif. But if I were Steve Jobs, I wouldn't take this threat lightly. Virgin is the first potential challenger with branding moxie that can match even Apple's. The group, which posted revenues of $7 billion in 2003, also has far better natural distribution channels for digital music than Apple. The upshot? Steve, get ready to face the A-team.

RULING THE ROOST. For the last 29 months, Apple has been the uncontested champion of this nascent and increasingly lucrative field. Its iPod digital-music player, introduced in late 2001, is the runaway leader, despite premium pricing. Industry analysts have pegged the iPod as reaping over 55% of all money spent on digital-music players since Jobs & Co. launched the device in 2001.

In the fourth quarter of 2003, Apple sold a whopping 733,000 of these little beauties, bagging $256 million in gross sales. The pace at which iPods sold is up 216% as of the last quarter. Apple has turned these diminutive devices into a juggernaut, churning out well over $1 billion in sales per year.

That's not including results from the new and smaller iPod mini. Unveiled in January, 2004, it has already sold out after scant weeks on the market. (Full disclosure: I panned the mini as too expensive when Apple announced its $250 price tag -- see BW Online, 1/7/04, "A maxiPrice for Apple's miniPod". I promised Steve Jobs a full apology if my predictions of slow sales proved false, and I may well have to eat my words.)

QUEST FOR COOL. The iPod's triumph has come, in part, thanks to the success of Apple's iTunes Music Store, an online music bazaar that works on both Windows and Mac machines. The iTMS has won kudos from consumers for its ease of use and from the recording industry for finally finding a way to get customers to pay for music online. The tight integration between the iPod and iTMS has helped Apple create a nearly seamless user experience. That's always been Apple's argument -- software and hardware should be tightly linked. And it has been proven correct thus far in the iPod story.

While many pretenders to Apple's music crown emerged, until recently the field looked pretty weak. Digital players from Dell (DELL), Samsung, and Creative just couldn't match the iPod's "cool" factor. Online music stores from Dell, Wal-Mart (WMT), and a reborn Napster looked and felt clunky -- or at least less smooth than iTMS.

The entry of Virgin's online subsidiary, Virgin Digital, might change all that. Branson, chairman of the British conglomerate, is a master marketer. He has brought hip and fun to stodgy fields such as airlines (preflight massage, anyone?) and mobile-phone service (who else offers personalized daily predictions from cartoon character Sponge Bob Squarepants?). True, he flopped with the introduction of a soft drink, Virgin Cola. But overall, Branson and his irreverent marketers have had a golden touch, particularly when it comes to reaching younger demographics.

TEEN TITANS. Virgin's cell-phone service has effectively targeted teens with its the pay-as-you-go model. As more and more cell phones double as music players, Virgin holds an enviable position. It can easily begin to offer downloadable tunes through rapidly improving technology that can beam relatively fast streams of data directly to cell phones.

Those same cell-phone teens buy a significant chunk of the CDs sold today. So they could likely be turned into online music buyers without too much trouble. Virgin's 23 music stores across the U.S. already serve millions more customers than all the online music stores combined. Add on Virgin's hundreds of stores in Europe, and you have a global music powerhouse. "You look at all the users of digital downloads, the numbers are still very small compared to traditional brick-and-mortar retail," says Zack Zalon, president of Virgin Digital.

All of these customers could be pitched with the new service, as well as Virgin's expanding line of personal electronics devices. Currently that line, called Virgin Pulse, includes no serious iPod competitors. That could change in the next year or so. Virgin plans to add to its lineup a new personal music player that will more closely compete with Apple.

WINNING COMBO. That would give Virgin a "clicks and bricks" play that neither Apple nor any other online-music seller currently can match. Wal-Mart is a huge CD seller in the U.S., but has been notoriously gun-shy on clicks-and-bricks. Hewlett-Packard (HPQ), which will distribute iTMS on its PCs and sell an HP-branded iPod, has the largest retail presence of any computer maker (see BW Online, 1/14/04, "Apple + HP = iPod Forever"). But HP has no history as a music vendor online or off, and it would need to start marketing almost from scratch.

Clicks-and-bricks have been a potent combo for delivering additional customer services, and for pairing online and offline offers to drive traffic, both physical and virtual. Then there is the captive-audience factor -- Virgin holds the undivided attention of tens of millions of passengers each year as they soar on Branson's airlines, which serve Europe, Australia, New Zealand, Asia, and the U.S.

Zalon has said Virgin Digital will use Microsoft's (MSFT ) WMA music standard and has no plans to build Apple-compatible software. In other words, Apple users are out of luck.

PICKING UP THE PACE. Zalon envisions a service where customers can hear their music on any number of players and can always take their music with them, either through mobile Internet access or through digital copies of the tunes. "The promise of music anytime, anywhere is about being able to retrieve your music wherever you are, whenever you want to, on any device. That's different from what Apple is offering, which is a closed system that only runs on an iPod," says Zalon.

Unlike most other digital-music plays, Virgin has opted to build its own music-player software rather than buy from a third party. That decision could mean trouble -- building easy-to-use software is a pretty tough job. Still, I would give Virgin the benefit of the doubt. The outfit's track record shows a particular skill at grasping what customers expect and like, and turning that understanding into superior branding, marketing, and customer service.

The Virgin Digital assault remains at least a few months off -- it's scheduled to launch in the U.S. in late summer, 2004, and kick off shortly thereafter in Britain. But it looks like Apple's free ride in digital music is almost over. "This is going to be huge," says Zalon. If Virgin's past performance is any indication, he's not just blowing smoke.

Jobs & Co. should take note and start looking for new distribution partners to prepare for battle with one of the few companies that can rival them on the hipness scale. It's time for Apple to start dancing a little faster if it wants to hang on to its crown as the king of digital music. Salkever is Technology editor for BusinessWeek Online. Follow his Byte of the Apple column, only on BW Online

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