April 01, 2004

Wal-Mart and Music

Why Walmart.com's digital-music efforts won't bring about the great digital-music shakeout.

SAN FRANCISCO (CNN/Money) - Last week was a big week for Wal-Mart. First, the retailing titan topped the latest Fortune 500 list, and second, the company launched a digital-music download service.

Apple (AAPL: Research, Estimates), the leader in digital music, didn't seem fazed by the new arrival.

"It's hard to imagine any other company catching up with iTunes," says an Apple spokesperson. But insiders raised concerns for some of the smaller players, because Wal-Mart (WMT: Research, Estimates) announced it would sell its songs for 88 cents per track -- 11 cents below the going rate.

"Great, just what we need," one industry observer wrote to a digital-music mailing list.
Caution ahead

For Wal-Mart investors, however, the company's digital-music download effort just doesn't make much sense.

Don't get me wrong -- I firmly believe that there are already too many players in online music and a shakeout is imminent. I just don't think Wal-Mart will be the reason the herd begins to thin.

Apparently I'm not the only one. Wal-Mart's entrance into digital-music downloads "is kind of comical," says Gene Munster, a senior research analyst at Piper Jaffray. "The typical Wal-Mart user isn't tech-savvy."

Cynthia Lin, a Wal-Mart spokeswoman, counters that two-thirds of Wal-Mart's users are online and two-thirds of those people connect via broadband.

"It's a viable and profitable business model, one with huge growth potential. That's why we're moving forward with it," she says.

That's a nice thought, but unfortunately for Wal-Mart, the company's modus operandi won't work in the digital-music world -- at least not yet.

Typically, Wal-Mart can charge less because it pays less. Its suppliers sacrifice margin because they can make up for losses with high sales volume.

With digital-music downloads, however (aside from those made on Apple's site), the volume needed to support Wal-Mart's pricing strategy simply isn't there. What's more, according to a study conducted last year by Piper Jaffray, consumers won't respond to price differentiation among music download services until the price point gets to 50 cents.

"For the people who are going to purchase music online, the 79-, 88-, 99-cent price point doesn't make much difference," Munster says.

The "me-too" syndrome

Finally, Walmart.com's most recent me-too forays into the digital arena haven't proven successful.

Much fuss was made (including in this column) when Walmart.com entered the Netflix market, undercutting Netflix by more than $3 per month. Now, a year and a half later, Netflix still commands more than 95 percent of the market (by its own count).

"I frankly can't figure it out," says Josh Bernoff, an analyst with Forrester Research, of Walmart.com's decision to enter the digital-music space.

"Even if somehow the company captured 10 percent of the market this year -- which would be an enormous feat -- it would still only be a $30 million business. The company will sell over $1 billion in CDs this year in its stores. Why is it doing this? It doesn't make sense."

So the entrance of the country's biggest company into digital music isn't the most pressing problem facing investors in companies such as Roxio (Napster) and RealNetworks (Rhapsody).

Instead, they need to figure out where their portfolio companies will stand when the great digital-music shakeout occurs. When will that happen? I think it will start in the second half of this year, when Microsoft unveils its digital-music system. More on that in a future column.

Tech Biz: Wal-Mart takes on iTunes -- but who's listening? - Mar. 30, 2004

Posted by Craig at April 1, 2004 05:48 PM