Rockin' along in the shadow of iTunes

Consumer-friendly eMusic is the second-largest online music store, and growing. It's also the only music download service, other than iTunes, that's compatible with iPods. Fortune's Devin Leonard reports.

By Devin Leonard, Fortune senior writer

(Fortune Magazine) -- The music industry is rife with infighting. But for years the biggest record companies agreed on one thing: They refused to sell songs in the popular MP3 format, arguing that it might hasten their demise. Why? MP3s aren't copy-protected and are thus easily pirated.

David Pakman, CEO of eMusic, has long argued that they were making a mistake. His company sells nothing but MP3s, and its business has been growing rapidly.

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Maestro CEO: David Pakman has eMusic growing fast.
Chart Toppers
Top five U.S. song download stores by market share, third quarter 2006
  • iTunes 72%
  • eMusic 10%
  • Napster 4%
  • MSN Music 3%
  • Yahoo Music 3%

In January, eMusic announced that it had 250,000 subscribers - 50,000 of whom had signed up in the previous four months. According to the NPD Group, eMusic is now the second-largest online music store after Apple's all-powerful iTunes. The major labels have apparently noticed eMusic's success. In recent weeks several have experimented with selling MP3s themselves.

They have every reason to. eMusic has sold more than 100 million downloads since its parent, private-equity firm Dimensional Associates, bought the company from Vivendi Universal in 2003. (Apple (Charts) has sold over two billion songs since the launch of iTunes four years ago.)

Unlike its rivals, eMusic doesn't have any songs from the Big Four music companies: Universal, Warner Music, EMI and SonyBMG. That means no Beyoncé or Carrie Underwood. However, eMusic has deals with over 11,000 independent labels, and its catalog includes icons such as Johnny Cash and Miles Davis, hip-hop stars like Lil' Jon, and indie rock artists like the White Stripes and the Decemberists.

But the real reason for eMusic's growth is this: It's the only online music store aside from iTunes that sells tracks that can be played on an iPod. Nearly every other service uses Microsoft's (Charts) copy-protection software. That may please record execs, but consumers don't like it because most of them have iPods - and iPods don't play these tracks. By contrast, MP3s can be played on nearly every digital music device.

eMusic also charges a lot less. iTunes customers pay 99 cents a song, the standard rate for major-label music online. eMusic subscribers get 30 songs a month for $9.99. That's only fair, says Pakman. "If you buy a song from iTunes for $1 or an album for $10, it's about the same price as a CD," he says. "But it has inferior sound quality. It only plays back on one manufacturer's device. It can only be burned onto a CD under certain conditions. That's an inferior product."

Pakman says the music industry will never replace its lost revenues from the decline of the CD with digital sales unless it follows his lead. That's no longer unthinkable. EMI recently let Yahoo Music sell Norah Jones's new single, "Thinking About You," in MP3. SonyBMG did the same with the Jessica Simpson single "A Public Affair" last year. Dave Goldberg, Yahoo Music vice president, says Yahoo hopes to have a lot more major-label music available in MP3 by the end of the year.

This must be satisfying for Pakman. Then again, maybe it isn't. Presumably Dimensional Associates wants to take eMusic public or sell the company in the not-so-distant future. That's what private-equity firms do, isn't it? (eMusic declines to discuss its finances or its future plans.)

But with a powerful online brand like Yahoo (Charts) entering its niche, eMusic may not be the second-largest online retailer much longer.

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