Downloads: The Next Generation

Music merchants are trying new ways to make an honest buck off the Internet

After years of struggling with digital piracy, the music biz made big strides in coping with the Net in 2003. The major labels began licensing music to a bevy of legal download services, starting with the iTunes site Apple Computer Inc. (AAPL ) rolled out in April. Wide online availability, along with the threat of legal action against pirates, convinced music fans to buy over 30 million downloads last year.

Yet innovation around music services is just getting started. From Microsoft Corp. (MSFT ) to a startup founded by Napster creator Shawn Fanning, companies are experimenting with ways of distributing and selling music that, over time, are headed for the mainstream. Some involve sophisticated technologies that could have a sweeping impact on how music is marketed and sold, while others are as simple as lower prices. Right now, the pricing at the nearly dozen major services, from Apple to Dell (DEL ), is identical at 99 cents a song and $9.99 an album. But Wal-Mart Stores Inc. (WMT ) is testing 88 cents downloads, which may pressure rivals to trim their prices, and upstart Shared Media Licensing Inc.'s Weed service is selling independent-label tunes for as low as 50 cents.

PLAY NOW, PAY LATER. Profound changes lie ahead. File sharing, the technology the old Napster used, is going legit. In December, Universal Music Group (V ) and Microsoft unveiled a joint effort, the Content Reference Forum, to develop technology to enable swapping of digital content. With CRF, people will trade music links, not files. When they click on a link, the system will determine what kind of PC or MP3 player the requester has, doing away with the hassle of incompatible copy-protection technologies. Then a fan could check out a song for free, say for a day or two, before deciding to buy it. "Innovative business models are going to be experimented with on the fly," says CRF Chairman Albhy Galuten, a former Universal executive. Fanning's startup, Snocap Inc., also is developing software that will let people swap music and pay for what they like.

A LONGER LISTEN. File sharing may also become a key way that Web users discover music. Universal and Microsoft are designing CRF to be used by other companies, and they may find strong demand. EMI Music is thinking about using file sharing in the next few years to promote its artists, including Lenny Kravitz and Radiohead. Ted Cohen, senior vice-president of digital distribution and development at EMI, says one option is to let fans who swap songs hear them a few times before making them pay up. "We aren't going to know what sticks unless we kick the tires on these models," he says.

The Net is opening up plenty of ways to reach a wider swath of audiences. By advertising that it gives musicians 50% of the purchase price of each album instead of the usual 6% to 12%, indie label Magnatune appeals to aficionados who think major labels rip off artists. And rather than dishing up the typical half-minute samples found at the more mainstream services, music e-tailer CD Baby and the acoustic specialist Signature Sounds Recordings give away long clips or even whole songs. While industry sales dropped last year, both upstarts are prospering.

Other startups are harnessing technology to help music lovers discover up-and-coming artists. Music e-tailer GarageBand.com uses listener ratings to pinpoint appealing bands from among the 200,000 independent musicians who post songs on its site. It's working with local radio stations and advertisers to market its musicians -- and 13 bands have signed with labels. "We're developing a new model that takes advantage of technology to do a better job of discovering and promoting music," says GarageBand.com CEO Ali Partovi.

Think today's services are hot? They soon may seem as tired as eight-tracks.

By Heather Green in New York

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