Yahoo! Takes Center Stage With Music

Its strong content and record-label alliances will force quick action from online music rivals.
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Yahoo!

(YHOO)

has entered the business of selling music online -- and the businesses involved in selling music online are reeling from the news.

Yahoo! took the wraps off a beta version of a new service, called Music Unlimited, that lets subscribers play songs from a catalog that's a million songs deep, transfer tracks onto portable digital-music players and share music via Yahoo! Messenger. New subscribers will be charged $6.99 a month for the service, or at a rate of $4.99, if they sign up for a full year.

Yahoo!'s stock was little changed on the announcement, down less than a percent to $33.82. But the stocks of companies much more dependent on online-music sales suffered as Yahoo! elbowed its way into their core market.

RealNetworks

(RNWK) - Get Report

was down 21% to $5.79, and

Napster

(NAPS)

was down 32% to $4.32.

Apple

(AAPL) - Get Report

, which has been trying to parlay the success of its ubiquitous iPods into steady music sales, was down 6% to $34.40.

Of course, it's no surprise that Yahoo! would push into selling music, or that it would copy the model of blending subscription with a pay-per-download option with its own frills. What sets Yahoo!'s version apart -- and what's bad news for others already selling music online -- is the way Yahoo! has bolstered its offering with other pieces of its content empire.

Ramping its Music Unlimited service up into an immediate threat to Rhapsody, Napster and iTunes is a piece of cake for Yahoo! Not only has it built up strong relationships with the top music labels with the music videos it already offers, but it's past acquisitions of Internet-radio station LaunchCast and music player MusicMatch allow it to roll out a fully developed product.

"We are committed to being at the forefront of the rapidly growing online music segment," said Lloyd Braun, head of Yahoo! Media Group. Braun, a former ABC network executive and one of the few people to receive the honor of having a Seinfeld character named after him, said, "Yahoo! Music Unlimited draws on the best of Yahoo! to provide personalization and community features unlike anything else in the marketplace."

Yahoo!'s clearest advantage, at least for now, is its low price, which may become the first shot in a pricing war for online music. Yahoo!'s annual subscription rate of $59.88 is a third of the $179.88 rate charged by RealNetwork's Rhapsody, and the 79 cents it charges per downloaded track is a dime cheaper than Rhapsody's standard rate.

Critics of Rhapsody and Napster have often pointed out that, at 79 cents a song, downloaded tunes aren't much cheaper than CDs, which almost everyone but the music labels agree are overpriced. At that rate, an album with 20 songs is $15.80, or the cost of most CDs in stores. Smaller music sites, like eMusic, charge about a quarter per song.

"Yahoo!'s entry is not a surprise, but the pricing of its service is," says Sasa Zorovich, an analyst at Oppenheimer, who lowered his forecast Wednesday for RealNetworks' EPS this year to break-even from four cents a share. "RealNetworks and Napster are likely to lower their price offerings to match Yahoo! Otherwise, the difference is just too big for consumers for RealNetworks' and Napster's services to remain competitive."

With hundreds of millions of users already visiting its network of sites each month, Yahoo! could use economies of scale to push music prices down even further, if others match its lower prices. And it could offset some of the costs for music labels by giving them more attractive advertising rates on the rest of its site.

The major record labels have fought tooth and nail against all efforts to harness the Internet's power in bringing music prices down to earth. But Yahoo! is bringing to the table a very compelling bargaining chip in the form of social networking technology, which allows a community of users to find and share new music with each other.

Subscribers to Yahoo! Music Unlimited can use the personas they create in Yahoo! Messenger, or on personalized homepages that Yahoo! is starting to set up for them, to post playlists of favorite songs or lists of favorite artists. Yahoo! can use data-mining technology to suggest new artists they may like, based on music interests of other members who share similar tastes. The site can also introduce them to new people who share their tastes in music.

This sounds useful for music lovers, but how does it help the labels? First off, they can discover promising new acts by tracking which bands or artists are developing a cultlike buzz among music lovers. More important, they can target their own advertisements to music lovers based on highly tailored demographic data that Yahoo! collects when members enter data about themselves.