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Let the MP3 Price Wars Begin

Amazon's assault on iTunes will change the online market.

Updated from Sept. 26

SAN FRANCISCO -- It's over. Restrictions on copying digital music are going to be history -- and all hell could break loose in the music retail business.

Amazon.com's

(AMZN) - Get Report

move to sell more than 2 million songs free of digital rights management software, or DRM, could well be seen several years from now as the point of no return for this controversial technology. The days of music companies telling consumers when and how they can listen to their songs are numbered.

It won't happen overnight. Amazon's move is -- to lean on that useful but overused buzz phrase -- a tipping point. DRM is a well-intentioned idea that served to drive many music consumers away.

You can debate all day long whether DRM is good or bad, but all the arguments are moot. The market has spoken. DRM hurts sales. And that's bad for business.

Amazon's DRM-free store is launching on the same day that

Virgin Digital

, Sir Richard Branson's stab at an iTunes clone, is

being shuttered

.

It wasn't long after some music labels started experimenting with selling DRM-free music that they started to see a substantial

increase in sales

.

One of the biggest beneficiaries of DRM has been

Apple

(AAPL) - Get Report

. As Daniel Del'Re

pointed out

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in his coverage of the Amazon announcement, when people buy songs on iTunes, "the only portable music device on which users can play back songs is the iPod."

In that way, DRM had served as a retaining wall forApple, keeping buyers of more than 3 billion songsthrough iTunes locked into the iPod player -- unlessthey jump through ridiculous hoops like burning their music to CDs and then ripping them back to MP3s. (Our house is home to three iPods, and we haveyet to buy a single song through iTunes for this veryreason.)

Apple delivered the first blow to DRM this spring byselling DRM-free songs at a 30% premium on its iTunesPlus service. But the number of popular songsavailable on iTunes Plus appears to be a

small fractionof what's available on Amazon.

Amazon's new store may cause that retaining wall to crumble, prompting many Apple customers to buy songs that offer them better options.

But what about iTunes Plus, the service Apple launched earlier this year that lets you buy DRM-free songs? Well, here's where things will really start to get interesting:

ITunes Plus sells those DRM-free songs for $1.29 each. Amazon sells the same songs for either 89 cents or 99 cents. That's a discount of between 23% and 31% from iTunes' DRM-free songs. Many of Amazon's best-selling songs -- including those in the Top 100 albums -- are retailing for the lower price.

There are two reasons this is interesting: First, it's setting up a new tech-titan smackdown between Apple CEO Steve Jobs, the master strategist, and Amazon CEO Jeff Bezos, the

Crazy Eddie of the Internet.

Bezos is doing here what he does best: Building market share and volume by slashing prices. Jobs won't take that sitting down, and he is probably plotting some cunning strategy to hold on to its iTunes customers.

Second, it's leading to a full-blown price war. In fact, the first shot has been fired by Amazon with its 31% discount of popular songs. Over time, more companies are going to be jumping into the DRM-free market, each one trying to build market share with bigger discounts.

In a few short years, Apple and iTunes could be locked into the kind of deep-discounting that Tower Records and CD Wherehouse were engaged in during the years before digital downloads swept both aside. That's going to help rejuvenate volume sales of songs and albums -- and bring their prices down to earth.

But over time, it's also going to ratchet down the margins of music stores like Amazon and Apple. In announcing its new music store, Amazon didn't say how the discounts would eat into its margins, but you can bet analysts will be grilling Bezos on this in next month's earnings call.

Aside from price cuts, one factor can help determine which company will emerge as the market leader -- I'd call it the filtering factor. It's not enough to simply throw all your songs onto a site and expect users to find them, you need to have reviews and recommendations to help them out. This is Amazon's Achilles' heel right now, and the company may go hunting for a

Last.fm

-like start-up to help it out. Apple may also be on the hunt.

One beneficiary of the new DRM-free era could be

eMusic

, a niche player that has shunned top 40 artists to focus on more obscure titles. eMusic has long sold DRM-free songs from smaller labels for as low as 25 cents each. It also has a robust community of users who help create a strong filtering service.

Apple and Amazon could snap up eMusic, learning from the company's years of knowledge in successfully retailing DRM-free music. They could also use the 25-cent price point as leverage to pressure the bigger labels into lowering their own prices. With DRM on its deathbed, I doubt any company understands better how to sell digital music right now than eMusic.

Amazon and Apple are part of Jim Cramer's Fantasy Football Stock Picks. Amazon is among Cramer's Running Back Stocks, and Apple is among his Cramer's Wide-Receiver Plays.