Ringtones: Music To Music Moguls' Ears

Earlier this year, as the rapper 50 Cent was putting the finishing touches on his second album, The Massacre, for Interscope Records, the Jamaica (N.Y.) sensation carved out time from his studio schedule for an important task: recording a voice tone and a voice ringback. Those snippets would eventually let cell-phone users paying a one-time fee of $2 to hear him when they received or placed a call. Then a musical ditty from the single, Candy Shop, was converted into a ringtone, making 50 Cent ubiquitous in wireless -- just as The Massacre topped the charts in March.

For music executives still stung by Internet piracy and slammed for not moving quickly enough to exploit the Net, the industry is going to great lengths not to blow it with new wireless technologies. They're seeing that cell phones are just as important as CD and MP3 players, radio, and music videos. And ensuring that breakout artists like 50 Cent have content tailored for mobile phones is now a must, not just for the sake of promotion but as a critical new source of revenue.

Increasingly, selling $13 CDs at retail stores is the old-fashioned way to make money on music. Now there's a host of fresh possibilities, from video game soundtracks to preloaded artist catalogs on hard drives in cars -- imagine an Elvis Cadillac or a Britney BMW. Meanwhile, lawyers are working overtime on new publishing, royalty, and licensing agreements for the nascent business models. Cell phones now represent enough promise for all the major music companies to be setting up mobile-business divisions. "With 180 million handsets in the U.S., how could we not be bullish on the mobile market, especially now that downloads to phones are possible?" says Thomas Hesse, president of global digital business at Sony BMG Music Entertainment.

But no matter how many new businesses emerge, music execs still face an uphill battle competing with free. After the first uptick in music sales in years in 2004, the figures dropped again -- by 6% -- in the first quarter of 2005, to 134.8 million albums, according to Nielsen SoundScan (VNUVY ). About 750 million songs are still being swapped unauthorized or free on the Internet every month, according to file-sharing tracker Big Champagne. To understand the magnitude of the threat, consider that the most successful legal download service, Apple Computer Inc.'s (AAPL ) iTunes Music Store, has sold less than half of the illegal monthly volume, 300 million songs, since its launch two years ago.

Spinning Faster

What's more, digital-music sales are still a tiny sliver of the overall pie. Digital music, mostly made up of downloads on the Internet and tones on cell phones, accounts for roughly 2% of the $30 billion global music business. But executives see a quick ramp-up. Alain Levy, CEO of EMI Music, for one, has said that digital sales could be 25% of his company's total in five years, with cell-phone downloads and subscriptions making up a big chunk. In the first six months of its fiscal year ending last November, EMI reported digital sales that doubled year-on-year, to $37.8 million, still just a fraction of its $1.6 billion in total revenues. Much of the digital gain was attributable to online sales in America, mobile revenues in Japan, and ringtone revenues at EMI Publishing.

Ringtones are driving most of the mobile-music business today. The replication of songs into a series of tones costs customers $1 to $3 apiece. As their sound quality improves, so will demand, say executives. If there was any doubt of their importance to the future of music, the industry's stalwart trade magazine, Billboard, now compiles a regular chart of the 20 Hot Ringtones. Thanks to teenagers who sometimes swap out ringtones as many as three to four times a week, they will become a nearly $9.4 billion business in 2008, estimates consultant Strategy Analytics Inc. "Ringtones are all about personalization. They are self-expression," says Rio Caraeff, vice-president of Universal Mobile Music. "You buy a ringtone for a different reason than you buy a download of a song." How about Joss Stone's You Had Me as the ring for an ex-husband, or Sinatra's New York, New York for a cousin in Manhattan? Assigning a tune to a caller is an expressive way to make a statement about a person or a relationship.

The fact that the industry is embracing all kinds of new formats for selling music might be the one good thing to come from the nightmare of the past several years, says Mark Harrington, a media analyst at Bear, Stearns & Co. (BSC ) in London. "The music industry is where the movie business was 20 years ago -- trying to figure new revenue streams. For Hollywood, it was establishing [staggered] releases to VHS, then DVD, to premium cable, to now [video on demand]." Up until then, film libraries had little value, he says, but now they are being thoroughly mined in a booming DVD market. The message for music and its catalogs is parallel: The new technologies are making it possible to wring even more profit from the industry's vast song libraries. Music execs should no longer care about where revenues come from, says Harrington, especially since operating margins for digital music sales are expected to be 18%, vs. about 12% for CDs. What has music moguls even more upbeat on cell phones is the relative security they offer compared with the Internet, they say. "Cell phones are a closed system," says Sony BMG's Hesse. "And a payment system through credit-card billing is built into the device."

Nobody understands the prospects for digital music better than the publishing side of the business, which collects money for the rights of songwriters from radio plays, live performances, TV commercials, and movies -- and now ringtones. Publishing has always been a high-margin part of the business, but it stands to make a killing in this new world because of all the new ways for music to reach fans. "We love additive products, believe me," says Martin Bandier, CEO of EMI Music Publishing, the world's largest music publisher, with a catalog of more than 1 million songs. "It's like we are in the bread-crumb business. Sooner or later, you get a loaf of bread." Bandier says his company collects about 10% of the retail price of ringtones. The songwriter gets paid a royalty from that.

Despite the payoffs, threats still loom. There's new software, Xingtones, costing $20, that converts MP3 files to ringtone formats, pushing once again into the realm of free. Even so, the trick for the music industry will be to learn from the past -- that new technologies mean new opportunities. Just ask 50 Cent.

By Tom Lowry in New York

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