Online Music May Not Be the Same Old Song - TheStreet

It's become a tired axiom that in technology, low-cost commodities trump innovation. That idea will be put to the test when


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squares off against


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and Napster 2.0, two heavyweights soon to debut in the online music business.

While the potential of the music business itself remains a question mark, hardware players are racing to get into the game in a bid to boost sales of pricey digital music players. Since opening its iTunes online store in April, Apple has already seen sales of its iPod music player nearly quadruple.

Dell, which will soon roll out its own branded digital music player, likewise wants to goose sales by unveiling an online music store. And if this were like most tech scripts, the Round Rock, Texas-based powerhouse would clomp in, undercut Apple on price and start stealing share straightaway.

But the online music business just may be different.

Gadget lovers rave about the quality of Apple's music offerings, both from the software and hardware side. Sometime this fall the company will unveil a Windows version of the music store, broadening its audience far beyond the roughly 3% of the computer users who can now access iTunes through their Macs.

Another soon-to-be-competitor in online music, Napster 2.0, owned by



, is expected to grab a broad audience on the strength of its name and extensive playlist, likely to number more than half a million titles (compared to Apple's 200,000). It's teamed up with


to develop its own digital music player, optimized to work with its online offerings.

It's difficult to judge how competitive Dell will be, since it hasn't yet said how much it would charge for songs or outlined how many songs it will offer. But for all its marketing muscle, Dell may find it tough to dislodge Apple and possibly Napster from leading positions in the business, given their respective advantages in consumer-friendly technology and buzz.

At U.S. Bancorp Piper Jaffray, Eugene Munster predicts iTunes will eventually own as much as 20% of the online music market, while Napster could account for between a quarter and one-half of the business.

Conceivably, the rewards down the road could be big. The online music market is expected to show brisk growth over the next few years, with sales climbing from an estimated $104 million next year to some $240 million by 2006, according to an estimate from U.S. Bancorp Piper Jaffray.

The bank expects an increasing portion of the nearly $13 billion U.S. music market to migrate online, prompted by a crackdown on online file-sharing, the proliferation of high-speed Internet and the continued growth of consumer CD and DVD burning.

Apple's Head Start

For now, success in the online music business will be reflected in hardware. And the stakes are higher for Apple than Dell, with Apple drawing an estimated 40% of its sales from the consumer business compared to less than 20% for Dell.

The early signs are encouraging, with iTunes scoring a big hit with both consumers and investors. In the two weeks after its April launch, Apple's market cap surged by $1.9 billion, notes U.S. Bancorp.

Apple went on to sell more than five million songs in the quarter ending in June. Granted, at 99 cents a song, that's hardly making Apple rich. Assuming sales of roughly $5 million, the music store accounted for only a few percent of the company's quarterly $1.55 billion revenue.

But then, that's not really the point. "I don't think

the online music store is hugely important from a revenue or profit standpoint, and it's uncertain whether it ever would be," says Robert Cihra, an analyst for Fulcrum Global Partners. "It's more important as a marketing platform for Apple, from a brand standpoint

to show the integration with its iPod products and, potentially, follow-on audio or other multimedia products."

By that reckoning the music store has been a blowout success. Since it opened, iPod sales rocketed to 304,000 units a quarter from 78,000 units. All the better, iPod's retail price is between $299 and $499 a pop -- a healthy selling price at a time desktop PCs can be had for less than five C-notes.

Apple itself has poured scorn on Dell's entry into the market, suggesting that Dell will merely slap its own label on hardware and services from other companies. "It appears that Dell is re-branding one of the second-tier music services that will be announced soon, just like they are re-branding Creative's MP3 player. There is little original here," said Apple in a statement released soon after Dell's announced entry into online music. Its own music store and music player, it added, offer "an unbeatable combination that our competitors haven't even come close to."

Apple is hardly the only one to talk up its own offerings, though; the company's technology has no shortage of fans on Wall Street. Cihra calls Apple's iTunes product and service "fantastic."

"To date, no Windows music download software program has come close to matching the ease of use and simplicity of iTunes," says Charlie Wolf, an analyst at Needham & Co., in a note.

He doubts whether Dell's music store could even approach the Apple experience. "Since the price of a song will vary only nominally between music stores, the component that will determine the success of Dell's music stores is the quality of the software that powers it," he points out. "If Dell licensed the software from an existing Windows music provider, its quality and ease of use will not match that of iTunes, the software that powers Apple's music store; no Windows program does." Dell would likely have even less success if it tried to develop media management software from scratch, adds Wolf, because it has no experience doing so.

Crowded Market

That's hardly to suggest that Apple and Napster will have the market to themselves. Dell could surprise everyone with an offering competitive with that of Apple or at least priced low enough to ensure a big following.

And there are many other competitors waiting in the wings, including


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has refused to say whether it would make a foray into the music space, though such a move would fit with the company's recent focus on digital entertainment for consumers.


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, one of the big five record labels, said in early September that it plans to open an online music service to complement its line of mobile devices. Some analysts expect other record labels to follow.

"Personally I don't think online music is likely to be an enormous opportunity for any one company," says Cihra. "The barriers to entry are pretty minimal and it doesn't seem as though many companies are able to come up with a competitive differentiator."

Despite the technological kudos for Apple, Cihra has tagged it with a neutral rating, based partly on its pricey valuation. His firm doesn't do banking.

Indeed, Apple shares have shot up 77% since their year-to-date low last spring, rising from $13.12 on April 17 to Tuesday's close of $23.22. In light of the rise and broader concerns about Apple's market share challenges, institutional investors have

been wary of the stock.

Of greater interest than the investment takeaway, though, is that online music could just possibly showcase a soft spot in Dell's business model. Famously tight with its R&D spending, Dell has morphed into a powerhouse by commoditizing the tech advances made by other companies. But that may not translate outside of computer boxes and into content like music.