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Online music may finally play a tune of profit

SAN FRANCISCO -- This fall could finally mark the arrival of online music as a legitimate, profitable business, after two years of false starts, dead ends, and legal salvos in the recording industry's quest to stop the trade of pirated music over the Internet.

As the holiday shopping season nears, two vanguards of digital music, Apple Computer Inc. and Roxio Inc.'s Napster, are launching services that many analysts say may succeed where others have failed: selling pay-per-song services to the Internet masses.

"It's a threshold event," said Milton Olin, an entertainment lawyer with Manatt, Phelps & Phillips in Los Angeles who served as chief operating officer of the original Napster. "The launch of these two brands in the PC market is really going to demonstrate what the real demand is for paid digital distribution."

Apple, which ignited the moribund online music market last spring by persuading record labels to loosen their restrictions on how customers could copy purchased songs for personal use, is expected today to make its iTunes Music Store available to the hundreds of millions of people using Windows-based computers. Apple has sold more than 10 million songs since April, even though iTunes was available only to the 3 percent of US computer users with Apple systems.

Next up is Napster 2.0. Born in a Northeastern University dorm room, the original Napster software allowed people to download and share copyrighted music over the Internet for free. A federal court shuttered Napster in 2001. But Roxio is resurrecting the Napster name as a for-fee service on Oct. 29.

Napster and Apple's Windows version of iTunes join a crowded field of digital-music hopefuls. Musicmatch Inc., BuyMusic.com, RealNetworks Inc., and others have introduced pay services for downloading songs or subscribing to music streamed over the Internet, but, lacking brand recognition, they've found only moderate success. Microsoft Corp., Dell Inc., Amazon.com, Yahoo Inc., and America Online are also planning or considering similar services. All the music services, with the exception of iTunes, are Windows-only.

"This is the next major shift in music," said Gene Munster, a senior research analyst with US Bancorp Piper Jaffray, an investment bank. He expects Napster to lead the way with a 30 percent share of the online music market and Apple, with a combination of Macintosh and Windows users, in second, with 20 percent. He does not own stock in either company, but his firm has sought banking business with them.

Selling music via downloading is less expensive than manufacturing compact discs and selling them in stores. Customers can listen to 30-second clips of songs before buying them and purchase only one song instead of a whole album. Most services sell CD-quality songs for 99 cents and full albums for about $10.

But in the same way the entertainment industry fought the advent of radio and VCRs, record labels have sought to slow digital distribution because it threatens their current business of selling tapes and compact discs. "The music industry has fought technology at every turn," said Jerry Goolsby, a business professor at Loyola University New Orleans.

The record labels succeeded in shutting the free version of Napster, but a federal judge in Los Angeles last spring deemed two of its successors, Grokster and Morpheus, not liable for the illegal exchange of copyrighted materials by their users. So the five largest record labels began suing users themselves, filing 261 lawsuits last month.

The record labels also supported early for-fee music services, but the labels released a limited catalogue and imposed heavy restrictions on copying downloaded songs, keeping most potential users away.

People who purchase songs from services like iTunes or Napster 2.0 enter credit card information, then download songs onto their computer's hard drive. They can listen to the songs through speakers on their computers using digital jukebox software, burn the song onto a CD for listening on a home or car stereo, or copy the song onto a portable music player like the Apple iPod.

For Apple, the launch of iTunes last spring was a bold foray into a new market. Based in Cupertino, Calif., the computer maker has shown a flair for innovation over the years, such as its early push into wireless networking before WiFi caught on, but it has been unable to persuade many computer buyers to pay its higher prices. Only 3.3 percent of computers sold in the third quarter were made by Apple, according to a report released yesterday by International Data Corp., a market researcher in Framingham.

But last spring Apple introduced the iTunes Music Store, stocked with 200,000 songs not tethered by many of the copying restrictions of previous services. Apple said its music store, like its popular iPod digital music player, would soon be available to Windows users.

"It really cemented their reputation as the innovative product leader," said Stephen Baker, director of industry analysis for the NPD Group Inc., a Port Washington, N.Y., research firm.

But the move into products that work on all computers, not just those owned by the Macintosh faithful, marked a change for Apple. Instead of trying to persuade Windows users to switch to Apple computers, the company's new strategy was to offer digital music to paying Windows customers.

"Apple was finally breaking away from the Mac religion and saying, `Let's be a different kind of company,' " said Charles Wolf, a securities analyst with the investment bank Needham & Co. He owns Apple stock.

Apple CEO Steve Jobs plans to take the stage in San Francisco today to introduce the Windows version of the iTunes Music Store.

Profit margins are thin in selling music online. After the credit card company, song publisher, and record labels take their share of the 99 cents per song, only 8 to 10 cents are left for the digital storefront's operator, Wolf said. So Apple and others hope to make their money selling hardware for playing the songs. Roxio, Napster's owner, also sells CD burners and recently struck a deal with Samsung to sell music players under the Napster brand name. Dell said it plans to create a paid download service and begin selling portable music players before the holidays.

So far Apple has been succeeding, as its iPod sales have risen sharply since introducing the music store. Analysts say opening the service to Windows users can only help. Apple said yesterday that it sold 336,000 iPods last quarter, a 140 percent increase from the same period last year, making it the best-selling digital music player on the market.

The success of the iPod, as well as strong sales of notebook computers, have helped Apple remain one of the few companies besides Dell able to make money selling personal computers. Apple yesterday reported a net profit of $44 million, or 12 cents a share, for its fiscal fourth quarter, which ended Sept. 27. Its results improved sharply from the same period last year, when Apple lost $45 million, or 13 cents a share. Even though its computer sales rose only 7 percent, overall revenue increased by 19 percent, to $1.72 billion.

Chris Gaither can be reached at gaither@globe.com.

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