Digital Music Unplugged: The Play Stations

Consumer giants and start-ups alike are rushing to cash in on the need for devices to play downloaded music.
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For any new technology to succeed, it needs a gadget capable of unifying the medium. Remember what the Walkman did to the portable audio market?

That's why everyone from

Diamond Multimedia

(DIMD)

to

Hewlett-Packard

(HWP)

is swiftly moving new hardware products into the digital music space, seeking ways to bring MP3-compressed tunes to the masses.

So far, digital-music companies haven't been able to replicate the universal success that consumer-electronics companies had with audio CDs or Walkmans. Internet telephony, or technology that lets friends or colleagues talk via the Web, hasn't taken off because the technology isn't universal: Only those sharing the same software can converse. That's why the new portable players out this fall will support both MP3 and SDMI-compliant content.

The MP3 hardware space is really divided into two camps, the giants and the upstarts. The newbies are Diamond and its Rio portable, Singapore's

Creative Technology

(CREAF)

and its portable product called Nomad, and

Iomega

(IOM)

, with its new CD-recordable device for its own Zip and Jaz drives called ZipCD.

The consumer-electronics heavyweights are H-P,

Sony

(SNE) - Get Report

,

Philips

(PHG) - Get Report

and

Samsung

, which has released a portable device called the Yepp. While Diamond's Rio has a significant first-to-market advantage, it may have trouble competing with the marketing muscle of H-P and Sony, which will launch a consumer portable by year-end.

For now, the two leaders in this MP3 downloading dash are H-P, which has around 60% of the CD-recordable market according to

Jupiter Communications

, and Diamond Multimedia, which leads in the embryonic and Walkman-esque portable arena.

H-P plans to sell 3 million to 4 million CD-recordables and CD-rewritables this year, according to Mike Matson, vice president of H-P's information storage group. CD-Rs, compatible with all CD-ROM drives, are sought by businesses downloading large amounts of data. CD-RW drives, compatible only with multiread drives, are being used by techies who download songs to "burn" their own CDs.

"The importance that consumers place on being able to burn CDs of downloaded tunes makes CD-R owners a primary addressable market for digitally delivered music," wrote Lucas Graves, an analyst with Jupiter Communications, in a report on digital music.

CD-Recordables Get a Head Start on Portables
A Jupiter study says CD-Rs will penetrate
the mass market quicker than products like the Rio.

Source: Jupiter Communications

At anywhere from $250 to $400 a unit, that's approximately $1.1 billion in revenue in 1999. That's no small potatoes, even for H-P, which expects to make $50 billion this calendar year. "We believe once we establish prices under $300 across the board, this market explodes," says H-P's Matson, who declined to break out current CD-R and CD-RW sales.

H-P isn't alone. Philips and

Yamaha

have CD-R and CD-RW products and Iomega, the struggling disk-drive maker, has its sights set on digital music much as a drowning man has his eyes on a life preserver.

Iomega's new product, however, is only compatible with its Zip and Jaz drives: CD-ROM drives are much more ubiquitous than Iomega drives. Some 94.3 million CD-ROM drives were sold last year alone, while Iomega has sold a little more than 25 million units in its history, according to

International Data

.

Portable Could Be King

It's the portable market, however, that may have the best chance of breaking out. Resembling the Walkman, portable players appeal to the right demographic of teens and college students. Right now, prices are too high to lure consumers en masse. The new Rio 500 costs $269, about $100 more than the first Rio that began selling in October 1998, according to David Watkins, president of Diamond's RioPort. Although Watkins was mum on the number of Rios that Diamond has sold, International Data estimates the company has sold around 250,000 units overall.

Diamond's new owner, Santa Clara, Calif.-based

S3

(SIII)

, is considering RioPort -- which will remain an autonomous company inside S3 -- as an IPO candidate. "It's true our business model is so different that we need to operate as a separate company," says Watkins, "but a RioPort IPO is a 2000-or-beyond type of story."

Beyond selling hardware, RioPort is entering the content aggregation business. The company is betting on content partnerships to build its little-known brand name and drive player sales. Tuesday, it said it would deliver downloadable music on its Web site and its portable players from

Viacom

(VIA) - Get Report

subsidiary

MTV Networks Online

in an exclusive, multiyear agreement.

The content, which will be compliant with the Secure Digital Music Initiative, will be available by the fourth quarter of 1999. MTV Networks Online will take an unspecified stake in RioPort and receive a slice of all digital music downloads, says a RioPort spokeswoman. RioPort also said Tuesday it signed a deal with

Universal Music

, a unit of

Seagram

(VO) - Get Report

, to integrate and promote Universal's music content with its Web site and portable players.

CD-Recordables vs. Portables

The advantage of CD-recordable devices is that they can store much more digital music. The portable Rio 500 can store and play back up to 64 megabytes, or about two hours of digital music, while CD-Rs such as the H-P 8100 can store 650 megabytes.

Moreover, Jupiter's Graves suggests that although portable playback devices look to be the "consumer-friendly alternative, using the Rio or a similar device is less convenient" because users are limited by what downloadable music they can play. As it stands, users can't put new tapes or CDs into the unit. "In general, we think that CD-recordables will be a larger tech driver than handheld portable devices," says Graves.

Another Sony Invasion?

Walkman pioneer Sony shouldn't be underestimated, because it has its own music to sell and the Walkman mystique, not to mention a worldwide network of consumer-electronics teams in place to sell its upcoming portable device.

It may pay for Rio to partner up with a larger player in the future to ward off Sony's marketing muscle, says Seymour Merrin, a high-tech consultant who watches new tech trends at

Merrin Information Services

. "S3 may not be able to fare much better than Diamond when it comes to taking on the consumer-electronics kings from the Far East."

While this shakeout won't occur for some time, it's already on the minds of those who can benefit. "It's coming, and I see a lot of consolidation in this space down the line," says a West Coast banker, who spoke on the condition of anonymity. "If the money is there, the M&A people will come."