This is the sound of the future

The record bosses have a nasty case of slipped disc as music lovers download songs for free and copy them on to blank CDs. But now the industry is fighting back with plans to launch millions of new tracks in electronic formats. Charles Arthur reports

'If you talk to a kid in eight years' time they will say: 'What, you used to have these things [CDs]? You used to physically carry music around? How bizarre?'"

'If you talk to a kid in eight years' time they will say: 'What, you used to have these things [CDs]? You used to physically carry music around? How bizarre?'"

That's the thinking not of some wild-eyed visionary of the computing industry, but of the singer Seal, speaking last week. And even if some in the music industry think that his position is extreme - although analysts warn them he's absolutely right - they also recognise that the age of the download is already upon them, and are rushing to meet it at top speed.

"Record companies are going hell for leather to digitise their current and back catalogues," one industry source said this week. Their plan: have all of their music, including their vast back catalogues, digitised and ready for downloading within two years. Millions of tracks are already in digital form for downloading - none too soon.

The music industry is in a deep depression: worldwide sales fell by almost 11 per cent in the first half of 2003, according to the industry's trade body, the IFPI. That comes on the heels of a drop in 2002 of 7 per cent in value, continuing a trend which began in 2001, when the industry saw its first fall in sales for 10 years. Sales in the US - the biggest market - are down by about a quarter compared to 2000.

The reasons given are twofold: commercial piracy by criminal gangs who use CD factories that can be put on to the back of a lorry and driven to a new country if the police come calling; and home users burning their own CDs, either of their own music or of what they've downloaded illegally from file-sharing networks such as KaZaA or Gnutella. Others suggest different, or at least contributory, reasons: the recession in the US, which started in 2001, and the homogenisation of music through US radio, almost all owned by the media giant Clear Channel, just when the internet has made people able to find niche artists who never get airplay. Add to that the fact that record labels, in the US especially, have issued fewer albums during those years - the number of releases being strongly correlated with sales.

What nobody doubts, though, is that there are a lot of music files downloaded through file-sharing networks, for which the artists and labels don't get a penny. And so they need their own online retail outlets if they're to have any chance.

The record companies' haste to find electronic formats follows an uncompromising report from the analysis company Forrester, which in September announced that "the end of physical media is nearing".

In its report, entitled "From Discs to Downloads", Josh Bernoff, Forrester's principal analyst, noted that 20 per cent of Americans download music, and half of those admit they buy fewer CDs than they used to. The same attitude can be found in the UK, where youngsters with broadband only have to do some simple maths. Even if they do have to pay for the broadband link, that's about £25 a month, which gives access to unlimited downloads. Or you could buy two chart CDs. It's not a hard choice.

"In five years, 33 per cent of music sales will come from downloads," predicts Mr Bernoff. "The implications of the shift from hard media will mean change throughout the entertainment industry - there will be clear winners and losers."

An early winner is certainly Apple Computer, which made a huge splash in the US with the launch in April of its iTunes music store, allowing users to download individual tracks for 99 cents, or the entire album for $9.99. The results were dramatic: it sold more than a million songs in its first week, two million in 16 days, five million in eight weeks, and the 10 millionth - Avril Lavigne's "Complicated" - after four months.

That sale in itself encapsulates the problems that record companies have with digital - and other - distribution: about 80 per cent of people want just 1 per cent of the tracks they offer. So having lots of songs on a download site seems promising but actually isn't quite what people want. And for the record labels, that's doubly galling, because small artists cost the labels money, and don't bring it in.

Last month, with rivals such as Napster gathering on Microsoft's Windows platform, Apple decide to join them, making the iTunes store available to Windows users too. They responded by buying a million songs in a week.

Yet there have been problems. Radiohead were at first featured on Apple's store; then, within a week, they were gone. The reason: the band wanted their songs only to be sold as entire albums, not piecemeal. Other artists, including Linkin Park, Madonna and Green Day, have also refused to let their albums be offered in pieces; an interesting point of view, since they haven't stopped putting out singles featuring album tracks. And Apple says that half of the music that was bought from the iTunes store was in the form of albums.

The US is well served for download services - and analysts think that Apple will be overhauled by rivals offering more songs, perhaps more cheaply. However, that's not the point for Apple, which uses the store to drive sales of its iPod MP3 player, on which it makes nearly as much profit as on a computer. Despite the price, it is the market leader both in sales volume and revenues.

Europe has plenty of download services too, but you probably haven't noticed. In fact there are 40 online services in Europe, including four in the UK alone, such as dotmusic, MSN Europe, Tiscali and Freeserve. All rely for their output on Bath-based On Demand Distribution (OD2), set up by Charles Grimsdale (who pioneered virtual reality in Britain) and the singer Peter Gabriel. But so far, takeup is modest; Paul Smith, OD2's UK marketing manager, says that for the whole of September across Europe there were 350,000 downloads. "But it's doubling every six months," he notes.

One of the problems that OD2's associates faces is the way in which they sell their music. All the tracks are encoded using Microsoft's Windows Media system, which "ties" the playback of that track to a particular computer. Nor can you create a CD that will play in a normal CD player. Savvy computer users - the first generation of broadband adopters - will know enough to get file-sharing software instead.

By contrast, Apple's system has proved popular in the US because the songs (which are encoded in a Dolby-created format) can be "burnt" to CDs that will play normally, although the original files can only be shared with a couple of computers.

What OD2 needs to prosper is people who won't care about that - the second generation of broadband users, who are happy to go with what's legal and available. They're coming online all the time, though, boosting the numbers able to download music in real time.

OD2 is preparing for that with plans to create its own branded online shopfront, to capitalise on its experience and expertise. Mr Smith won't put a timescale on it, but there's an obvious deadline with the launch, expected in May next year, of Apple's iTunes store in Europe. That has been held up by the need to negotiate the distribution rights for each country with the labels and artists - a rat's nest of contracts.

"It would have been nice if when Napster started up we could have gone to them and said, 'This is a nice technology, let's fix it so that we'll get paid every time two users swap a file,'" says an insider at one of the big five record labels. "But the reality is that with a lot of the artists we've got, we couldn't have done that because we've never negotiated digital rights. The contracts, the entire industry, it's all predicated on the sale of physical CDs."

Indeed, the industry hasn't given up on CDs; it will keep selling those, probably for years, alongside its online offerings. "The lesson of the past is that having more formats in which to sell music always expands the market," says Jonathan Morrish, formerly PR manager for Sony Records in the UK, now at the Outside Organisation, whose client roster includes David Bowie, Shakira and Westlife. "Look at ringtones, look at music being used in advertising - it's even broken some artists to the wider public."

The trouble is that the industry hasn't liked the MP3 format - which could be swapped endlessly without restriction. Partly that's because it wasn't its own invention (it came out of efforts to encode music for films on DVD). But some view it differently. Having seen the business rise and slide, another music industry insider (names are dangerous things when one's employers are being criticised) puts it this way: "For 30 years the industry got fat. Fat doesn't necessarily mean lazy. But it does mean that when change comes, you tend to resist it, rather than try to see how you can take advantage of it."

And beating the file sharers is nowadays done more with the carrot than the stick, according to Adam Liversage at Universal Records. Some companies, including BMG, use "copy protection" on CDs, to make it harder to "rip" them to MP3s. (Dido's latest album is copy-protected.) "The trouble is that you tend to get a PR backlash when you do this," notes Mr Liversage. "We think it's better to offer something extra to people who do buy - like special access to websites, or early chances at concert tickets, or even prizes." The most outrageous example of the latter is the Willy Wonka-style "golden tickets" in four copies of the latest single by the rapper Obie Trice: the winners will get a $12,500 piece of jewellery (which they'd probably prefer over a tour around a chocolate factory).

Mr Liversage makes one other point, in response to another Seal suggestion - that online distribution will cut out record companies. "That's not going to happen. It's easy for him to say, but he's an established artist. How did he get established? People spent money on him, promoting him. Record companies these days really do provide the capital and expertise to pay for the record and videos. It's a marketing exercise."

But what about the losers? Though record companies are still going to be running what Joni Mitchell called the "star-making machinery", it's clear that traditional retailers will be hurt by any move to online distribution. While Apple and OD2 are not yet undercutting them (they're actually more expensive, since you have to provide your own blank CD if you want to have the music in physical form), the arrival of new competitors such as Napster, reborn as an industry-blessed downloading-only service, and Dell, the biggest seller of personal computers in the world, is sure to push down prices for online tracks.

"The catalog we have, 220,000 tracks, is about what you'd find at a big HMV store," said Mr Smith at OD2. "But in a year's time we'll have a million tracks. It's just a question of logistics and operations."

Quite how the big retailers will react is unclear. Virgin has been the most proactive here, with a downloads service (hosted, again, by OD2). But if the predictions of Seal and Forrester come good, then it's hard to see how they will continue to benefit from selling CDs. If it's cheaper online, then as more people get connected (and in 10 years' time, you could expect half of Britain to have broadband) there will be little point going to the shop.