• Chart: How MSN Music Stacks Up

MSN Music, Microsoft's online music store, bolsters the company's digital media strategy by providing a high-profile distribution channel for content that uses the Windows Media Format and its accompanying digital rights management (DRM) technology. Microsoft has entered this unproven business primarily to meet a threat to its digital media platform from Apple, but faces a significant learning curve and risks alienating other online music distributors that currently use the Windows Media platform.

Risky Business

Most of Microsoft's efforts in digital media have gone into building its platform technologies, such as the Windows Media Format and DRM; creating software that supports these technologies, such as the Windows Media Player and Encoder; and evangelizing this platform to content owners, device manufacturers, and end users. Although the company promotes its platform by offering free Windows Media content through MSN and other sites, it has generally stayed away from the business of selling digital media content—audio or video—to consumers.

Even after Apple's iTunes Music Store (iTMS) launched for the Mac in Apr. 2003 and drew widespread praise, Microsoft said it would not build a music store of its own. Instead, it left this business to Windows Media partners such as BuyMusic.com, Loudeye (which creates stores for third parties and bought European distributor OD2 in Aug. 2004), MusicMatch, MusicNow, Napster, and Wal-Mart.

This approach made sense, given the risks, such as the following, that Microsoft faces in selling music online:

Unproven business. After more than three years of efforts by content owners and technology companies to build a viable online music store, legal downloads account for a very small portion of overall music consumption. As of Aug. 2004, consumers are legally downloading less than 2% of the music they buy, according to statistics compiled by Microsoft, with the vast majority still favoring CDs. In addition, consumers continue to download copyrighted music for free (without permission from content owners) from file-sharing networks such as Kazaa. Peer-to-peer researcher BigChampagne estimates that, in the United States alone, there are between 8 million and 9 million users logged into these networks at any given moment, many of whom are downloading multiple songs. In comparison, Apple claims to sell about 16 million songs per month.

Even if consumers can be weaned from CDs and illegal downloads, selling music online is not particularly profitable—gross margins on individual song downloads are about 10%, according to Napster, and Apple has admitted that iTMS barely breaks even.

Learning curve. Creating an online music store requires Microsoft to stretch well beyond its core competency of building and marketing software. Among other tasks, the company must negotiate with content owners and create or buy a billing and provisioning system capable of handling millions of small transactions per month—a historical weak spot for the company.

Competing with partners. Building an online music store places Microsoft into direct competition with existing Windows Media distributors, potentially scaring them into supporting other formats.

Why Jump Now?

In Nov. 2003, shortly after Apple launched the Windows version of its music store, Microsoft said that it had changed its mind and would in fact launch a music store on MSN. The main reason for this change of direction was to meet a growing platform threat from Apple.

As of summer 2004, iTMS and iPod (Apple's portable digital music player) dominate their respective markets. The success of each business has reinforced the other, as the iPod is the only portable device that can play songs from Apple's store, and Apple's store was the only online source for legal downloads that could be played on an iPod (until RealNetworks reverse-engineered Apple's DRM scheme in Aug. 2004).

If Apple's dominance continues, OEMs, content owners, and device manufacturers could rally around Apple's preferred technologies, Advanced Audio Coding (AAC, a nonproprietary format based on MPEG-4) and its FairPlay DRM system. This is an unacceptable outcome for Microsoft, which hopes to popularize its own digital media platform to spur consumer PC upgrades and earn licensing and other fees from consumer electronics companies and content owners. (For more background on Microsoft's digital media strategy and the threat posed by Apple, see "Media Player Update Moves Strategy Forward".)

MSN Music, which launched in preview form in Sept. 2004, is part of a broad effort to meet this threat. With MSN Music, Microsoft hopes to match features that made iTMS popular, such as its clear interface and consistent rights for all downloaded songs, but that many other stores operated by Windows Media partners still lack.

MSN Music could generate new Web visits to MSN, boosting MSN's advertising revenue in the short-term, and it gives Microsoft a stake in the game if online music distribution ever becomes a viable business. However, these revenue opportunities are secondary to the goal of slowing Apple.

How MSN Music Will Compete

MSN Music sees its biggest opportunity in consumers who are just becoming interested in computer-based digital music but have not yet bought any Apple products. At the same time, MSN Music must differentiate itself from the growing number of other stores that also sell songs in the Windows Media Format. (For an overview of MSN Music and its competitors, see the chart "How MSN Music Stacks Up".)

MSN Music will use the following methods to compete:

Build a large, diverse library. At the time of its Sept. 2004 preview launch, MSN Music had licensed 1 million songs—equal to the number available on iTMS, and more than any other store that uses the Windows Media Format. (Only 500,000 were available at launch, but the full number will be available by the end of 2004.) In addition, MSN Music claims to offer greater diversity than its competitors, with songs from more than 3,000 independent labels (compared with about 500 for iTMS) and more classical music selections.

Match popular iTMS features. MSN Music duplicates many popular iTMS features that are not universally available on stores from Windows Media partners.

Most important, all users will have consistent rights to all songs downloaded from MSN Music—they may transfer the songs among five PCs and to an unlimited number of portable devices and may burn any playlist containing an MSN Music song to CD seven times before having to change the order. In contrast, some stores operated by Windows Media partners, such as BuyMusic and MusicNow, allow content owners to dictate different sets of rights for their songs.

MSN Music also offers (or plans to offer) other popular iTMS features, such as recommendations based on other users' purchasing habits, playlists posted by celebrities, and streaming virtual radio stations.

Leverage other Microsoft products. Microsoft can create links between MSN Music and other popular products and services, which helps the store compete in two ways. First, Microsoft can leverage other products to give MSN Music features that other stores cannot easily match, such as the ability to use MSN Search to find lyrics or concert tickets from directly within the MSN Music interface. Second, Microsoft can guide the enormous user base from its other products and services to MSN Music, giving it an instant leg up. For instance, whenever users search for an artist on MSN Search (which boasts about 90 million visitors per month), links to MSN Music will show up in the results. In the future, MSN Messenger users (currently numbering 120 million) will be able to share their playlists with their contacts and perhaps allow contacts to listen to streaming versions of these playlists. If the contacts then want to buy a particular song, links within the Messenger client will guide them to the appropriate download on MSN Music.

What's Missing?

In addition to the long-term risks mentioned earlier—the unproven business model, steep learning curve, and risk of alienating Windows Media partners—MSN Music has some limitations at launch that could hamper its ability to compete.

No subscription offering. Subscription-based music services, which allow users to stream or download an unlimited amount of music to a PC for a monthly fee ("all-you-can eat"), have higher gross margins than stores that sell single song downloads. For example, Napster claims its subscription service, which offers a combination of downloads and streamable songs for US$9.95 per month, enjoys 40% margins, versus the 10% margins Napster earns on single song downloads.

Although not as popular as the pay-per-song model, there is some demand for subscription services—RealNetworks’ Rhapsody service boasts 550,000 subscribers, and subscription revenue (including video and gaming services) now comprises 80% of RealNetworks’ of revenue. But subscription-based music services could become more popular as devices emerge that support Windows Media 10 DRM. That's because today, content owners will not allow content from all-you-can-eat services to be transferred to portable devices—a major shortcoming compared with pay-as-you-go stores. Windows Media 10 DRM removes this barrier by allowing content to be disabled on a portable device if users stop paying their subscription. (For more information, see "DRM to Support Subscription, Rental Services" on page 26 of the June 2004 Update.)

Although MSN Music says it is "interested" in subscriptions, and although Windows Media 10 DRM is a Microsoft technology, MSN Music has announced no concrete plans to launch a subscription service or support the new DRM scheme. As of Sept. 2004, only Windows Media partner Napster has launched a trial service, Napster To Go, that allows users to transfer all-you-can-eat content to a portable device.

Platform limitations. Because Microsoft’s main goal with MSN Music is to promote the Windows Media Format and its DRM technology, it could have trouble competing against stores that support multiple technologies. In particular, downloadable songs from RealNetworks’ RealPlayer Music Store use its own Helix DRM scheme, but can also be translated to Windows Media 9 DRM and Apple’s FairPlay, meaning that these songs can be played on the widest range of portable devices. If RealNetworks continues to support new DRM schemes as they emerge—particularly Windows Media 10 DRM—while increasing its song selection to equal that of iTMS and MSN Music, it will remain a stubborn competitor.

More generally, certain aspects of MSN Music can improve only as quickly as Microsoft improves its overall digital media platform. For example, Apple’s iTunes software makes it considerably easier to share music (including songs from iTMS) across a home network than Microsoft’s Windows Media Player. Until Microsoft matches or surpasses Apple’s functionality in all aspects—from buying or ripping digital music all the way through transferring it to portable and networked devices—it may have a difficult time convincing new users to give MSN Music a try instead of buying an iPod and being drawn into Apple’s world.

Resources

MSN Music is at beta.music.msn.com; the URL will move to music.msn.com in Oct. 2004.