“As things stand now, digital music has failed.”

From the New York Times:

By ERIC PFANNER
Published: January 23, 2011

PARIS — After another year of plunging music sales, record company executives are starting to contemplate the unthinkable: The digital music business, held out as the future of the industry, may already be as big as it is going to get.

The International Federation of the Phonographic Industry, a trade group based in London, said last week that sales of music in digital form had risen only 6 percent worldwide in 2010, even as the overall music market had shrunk 8 percent or 9 percent, extending a decade-long decline.

In each of the past two years, the rate of increase in digital revenue has approximately halved. If that trend continues, digital sales could top out at less than $5 billion this year, about a third of the overall music market but many billions of dollars short of the amount needed to replace long-gone sales of compact discs.

“Music’s first digital decade is behind us and what do we have?” said Mark Mulligan, an analyst at Forrester Research. “Not a lot of progress.”

“We are at one of the most worrying stages yet for the industry,” he continued. “As things stand now, digital music has failed.”

Music executives disagree, saying there is hope, as long as they can come to grips with piracy, which according to the industry federation accounts for the vast majority of music distributed online.

Stronger measures to crack down on unauthorized copying are taking effect in a number of countries, executives note, and even as the authorities wield a heavier stick, the complementary carrots are appearing, too, in the form of innovative digital services.

“The challenging environment continues, but we have some grounds for optimism,” said Frances Moore, chief executive of the music federation.

Ms. Moore said the recent introduction of tough anti-piracy laws in South Korea and France, which authorize cutting off the Internet connection of repeat offenders, showed that stricter enforcement could persuade listeners to seek out legal alternatives to unauthorized file-sharing services.

In South Korea, where the music business has long been blighted by piracy, digital music sales rose 14 percent in the first half of last year, after the new law went into effect in 2009, the federation said. The first account suspensions occurred in the autumn, and the group said the publicity surrounding the crackdown should help convert more consumers.

Max Hole, chief operating officer of Universal Music Group International, said his company, the biggest of the four major record companies, was so encouraged by the signs of a turnaround in South Korea that it had decided to start investing in the development of new music acts again, after suspending operations in South Korea several years ago.

France has also implemented a so-called graduated response system. In the French system, cutting Internet access is preceded by several warnings. While the authorities say they have sent out hundreds of thousands of e-mails to suspected copyright cheats, nobody’s connection has yet been cut.

Record company executives said they were also encouraged by recent legal action in the United States to cripple the file-sharing service LimeWire, as well as by the progress in the U.S. Senate of a bill to give law enforcement officials more power to shut down file-sharing services.

In Europe, the industry has notched legal victories against other sites accused of abetting piracy, including The Pirate Bay and Mininova.

Industry executives say they are encouraged by the development of new digital services, particularly those that embrace the principles of cloud computing. These services can provide unlimited amounts of music to listeners on demand, through a variety of devices, from mobile phones to televisions.

“The television is a great opportunity,” said Thomas Hesse, head of the digital business at Sony Music Entertainment. “We haven’t innovated in the living room for many years.”

Around the world, 10 million people have already signed up for subscription-based online services from Spotify, Rdio and Deezer, some of which have attracted additional millions of users with free, advertising-supported services. Many executives hope the growth of offerings like these can reduce the industry’s dependence on sales of individual tracks through digital stores like Apple iTunes, a model that has attracted little interest from young music fans, particularly outside the United States.

Yet some services that were hailed as potential iTunes challengers when they were introduced are fading from the scene. Nokia, the mobile phone manufacturer, said this month that it was sharply scaling back a service that gives buyers of certain phones free, unlimited music downloads. Sky, the British pay-television and broadband provider, recently canceled a subscription music service.

Music executives say Internet service providers hold the key to solving the piracy problems and helping the music companies recoup lost revenue. For the most part, providers have balked at taking stronger action against file-sharing, saying they do not want to snoop on their customers.

But one provider in Ireland, Eircom, recently started instituting its own version of a graduated response system. Customers who illegally download music face a “graduated response” similar to the one in France, but they can avoid the threat of disconnection by using a new music service from Eircom that offers free, unlimited streaming.

Mr. Mulligan said tougher enforcement would succeed only if music companies and other rights holders, including collecting agencies that represent artists and composers, embraced digital services that met the needs and interests of consumers, particularly teenagers and young adults.

Rights holders have grown more flexible as industry sales have collapsed, but they remain reluctant to license their music to some services. For example, Spotify, a popular streaming service in Europe, has yet to sign the record company deals it needs to open a U.S. site. Meanwhile, Internet companies like YouTube have sometimes struggled to reach agreements to show music videos in Europe.

The industry has also balked at the unlimited MP3 format, which comes with no copy restrictions, allowing people to share music with friends or provide soundtracks for their own videos, or post songs to social networking sites.

With growth in digital revenue slowing nearly to a standstill, analysts say, it is no surprise that talk of mergers and buyouts is again swirling around some of the Big Four music companies — Universal, Sony, Warner Music Group and EMI. Warner, for example, is said to have hired bankers to explore a sale of the company or a purchase of EMI.

“What has been keeping labels afloat has been the digital story,” said Mr. Mulligan, of Forrester Research. “If, all of a sudden, what they have been telling the market is the future turns out to be a failure, that radically changes the conversation.”