Once again, Apple's iPod is expected to be the hottest gift of the holiday season. That should be great news for the recording industry, right? After all, many of the 10 million or so new iPod owners surely will rush to Apple Computer Inc.'s (AAPL ) iTunes Music Store to load up on songs.
Not necessarily. As has been true since the start, iPod owners mostly fill up their players from their own CD collections or swipe tunes from file-sharing sites. Now legal downloads may be losing their luster. According to Nielsen SoundScan, average weekly download sales as of Nov. 27 fell 0.44% vs. the third quarter. Says independent media analyst Richard Greenfield: "We're not seeing the kind of dramatic growth we should given the surge in sales of iPods and other MP3 players."
Which brings us to a grand irony: Apple, which launched the digital music revolution, may now be holding it back. Critics say Apple's proprietary technology and its refusal to offer more ways to buy or to stray from its rigid 99 cents a song model is dampening legal sales of digital tunes. "The villain in the story is the iPod," says Chris Gorog, CEO of Napster Inc. (NAPS ), which sells both subscriptions and downloads. "You have this device consumers love, but they're being restricted from buying anything other than downloads from Apple. People are bored with that."
There's no need to fit Apple CEO Steven P. Jobs with a black hat just yet. A source close to the Cupertino (Calif.) company says sales of iTunes gift cards are "off the charts," so downloads should surge after Christmas. And even with the sales lull, iTunes is still the fastest-growing and most margin-rich source of sales for record labels. What's more, Jobs also may have surprises in store at the Macworld gathering in January. Some Apple watchers think he may launch an iTunes phone -- one more appealing than the Rokr phone developed with Motorola Inc. (MOT ) -- giving music download sales another jolt.
Still, Apple will continue to take flak. That's because an army of companies has rolled out new ways to provide music -- from legal peer-to-peer sites to established players such as Real Networks Inc. and Napster that offer all-you-can-play subscriptions for a monthly fee. The thing is, very few work with the iPod. "I have half a million subscribers who would love to use an iPod with my service," says Napster's Gorog.
Industry players drool over what Apple could do to popularize new services. Take music subscriptions. Jobs insists people don't want to rent music and is loath to complicate his elegant iTunes store. But digitally savvy music fans are gravitating to subscriptions, which introduce them to music they otherwise might not hear. Still, subscriptions are a tough sell to mainstream customers. "The concept of a jukebox in the sky is not something most consumers intuitively get," says Dan Sheeran, a senior vice-president at Real. If Apple came in, it could change the game.
Then there's pricing. Three music companies have publicly pressured Apple to loosen up its 99 cents approach. Jobs is convinced that having a simple, acceptable price is crucial to lure music fans away from free file-sharing sites. "It might make sense to raise prices in the future," says a source close to Apple. "But now is not that time."
Music labels say they'd sell and earn more by offering an old Uriah Heep tune for 39 cents and a new Usher track for $1.29. "I'd be the kind of guy looking for older music at a lower price," says David Rosenblum, an 18-year-old political philosophy major at Harvard University and a singer who performs as Dev Avidon.
So will Jobs change his tune? Not unless he has to. Apple can barely keep up with demand for iPods, which reap as much as 25% gross margins, vs. minimal profits for each iTunes track. So right now there's no reason for the company to alter the way it sells music or make its player compatible with other services. But if download sales don't bounce back, music companies could start looking beyond Cupertino for answers.
By Peter Burrows, with Tom Lowry in New York and Ronald Grover in Los Angeles