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iPod Killers?

Mobile phones that rock, jam, thunder, and swing are on the way.
/ Source: Business Week

Jason Smikle couldn't get the song out of his head. A freshman at Temple University, the 19-year-old hummed the tune by hip-hop impresario Ludacris, in the shower, over breakfast, and as he walked to class. On a recent 80-degree day in Philadelphia, he started singing the lyrics while he and a buddy, who had just broken up with a girlfriend, relaxed on the campus quad. His friend whipped out his LG mobile phone, tapped a couple of keys, and presto, the melody wafted into the air. "So cool," Smikle recalls. He only wished he could download the song to his own phone on the spot. "It'd be very cool, when the moment called for it, if I could just get the song," he says.

Jason, your wish may soon be granted. Mobile phones that rock, jam, thunder, and swing are on the way. Wireless operators around the globe are working with music studios, phone makers, and artists such as Sean "P. Diddy" Combs in a sweeping effort to turn the mobile phone into a go-anywhere digital jukebox. Foreign carriers such as Vodafone and SK Telecom are leading the way, and U.S. wireless players are following fast. BusinessWeek has learned that Verizon Wireless, Sprint, and Cingular Wireless are expected to unveil services for downloading music directly to wireless phones later this year. "We have a tremendous opportunity to make a big impact in music," says Dennis F. Strigl, CEO of Verizon Wireless.

With innovative services and snazzier phones, the telecom players figure they can swipe a chunk of the digital music market that Apple Computer Inc. cracked open with its iconic iPod. That sets the stage for a battle between two industries. On one side are Apple and the other tech players concentrated in Silicon Valley that see the computer as central to the future of music. On the other are telecom companies, from Finland to South Korea to the U.S., that think the mobile phone can become the center of this emerging world. "The iPod is great," says Frank Nuovo, chief designer for Nokia, the world's largest handset maker. "But no one has a stranglehold. There's nothing that keeps the mobile phone from moving into that area."

The telecom approach has several strengths Apple can't match. For starters, a quarter of the world's population already has a mobile phone. That's 1.4 billion people, compared with 10 million iPods sold to date. Most of those cell-phone toters pay a monthly phone bill, making it a snap to add a music charge. Perhaps most important, wireless technology could provide access anytime, anywhere to millions of songs. "You don't have to be a genius to see that the phone will be your own portable stereo that's with you wherever you go," says Jordan Schur, co-president of Geffen Records, whose artists include Snoop Dogg and Garbage.

To Apple, this threat may look more than a little overblown. After all, the company's elegant iPod and easy-to-use iTunes have been such breakthroughs that they sparked a musical revolution. The carefully crafted combo gives consumers a no-hassle way to buy tunes on the Net and carry every single song they own with them. Already, Apple has faced a fierce onslaught from the likes of Dell, Sony, and Microsoft, and turned it back with little more than a twist and shout. On Apr. 13, Apple is expected to have announced more than 5 million iPod sales in the latest quarter, building on its market lead. "I absolutely love it," says Michelle Clapp, a 17-year-old student from Saratoga, Calif., who got an iPod for Christmas.

Plus, Apple has learned from the past. Some 20 years ago it lost its lead in the personal computer industry by insisting on complete control over its technology. But Apple has learned from its mistakes and is showing much more flexibility these days. It opened up its iTunes store to people using computers with Microsoft Corp.'s operating system and let partner Hewlett-Packard Co. distribute its own version of the iPod. (MSNBC is a Microsoft-NBC joint venture.)

Threatened or not, Apple is also trying to play a role in putting music on phones. It's developing an iPod phone with Motorola Inc. that the pair have started marketing to wireless operators. Motorola says it expects at least one carrier will begin selling the phone this summer. If that happens, the carrier would not build its own music store and instead send its customers to iTunes.

But Apple has had a rough start in working with wireless operators. Most major wireless companies, including Verizon Wireless and Sprint, have balked at carrying the iPod phone. That's a serious impediment because the operators essentially control distribution by subsidizing phones. Why the resistance? Operators want customers to download songs over the air, directly to handsets. But with the iPod phone, customers would download songs to a PC and then copy them to the phone. "It's hard for people in any industry to support something that cuts them out of potential future revenue streams," says Graeme Ferguson, director for global content development at Vodafone Group PLC, one of the world's largest wireless players. Apple declined to comment for this story.

The two sides also have very different perspectives on how digital music stores should work. Verizon, Sprint, and Cingular are expected to charge about $2 for wireless downloads when they introduce their services, or twice the 99 cents per song on iTunes. They figure they can charge a premium for the convenience of getting songs anytime, even though customers most likely won't be able to listen to those songs anywhere but on their phones, at least initially. One knowledgeable source close to Apple says the operators are simply being unrealistic if they expect customers to pay $2 or $3 for a song, especially with restrictions. "If you can get something for a buck, why would you buy it for $3?" says the source. "Do they think people are that dumb?

A run for the money
What will come out of all this is not just a battle of sharp words and elbows but also a new round of innovation in digital music. Apple and other MP3 player makers could add wireless technology to their devices or help develop a crop of music phones. As hundreds of millions of mobile devices around the world go musical, there will be an explosion in the possibilities for marketing, distributing, and listening to music. On Apr. 12, Capitol Records Inc. said it would release a hugely anticipated new single by the rock band Coldplay as a ringtone to Cingular wireless customers first, rather than on the radio. Virgin Mobile USA says it's exploring ways to couple wireless music downloads with news clips, lyrics, or even videos from the artist. "A lot of people are paying attention to this new frontier and what its potential can be," says Virgin Mobile CEO Daniel H. Schulman.

International wireless operators provide a sense of what's possible at the edge of this frontier. Korea's SK Telecom Co. offers a $5 a month music subscription that allows customers to download any of 700,000 songs to a phone, PC, or music player. That makes the subscription much more convenient than similar services in the U.S. because Korean customers can get any song they want, wherever and whenever they want it. Since the November launch, 300,000 people have signed up. "We are not yet making money, but we see a big potential for profits from music," says Shin Won Soo, a senior manager in charge of SK Telecom's music business, which is expected to go into the black with 800,000 subscribers. That conjures up the possibility that with music phones, consumers around the world could opt to pay a monthly fee for all the new music they desire, rather than buying individual CDs when they debut.

U.S. wireless operators aren't going to cause an overnight sensation in music. Their first offerings are too expensive and clumsy to spark strong demand. Yet within a year or two, the operators have a real chance of giving the MP3 crowd a run for its money. The phone companies have a track record of refining their offerings until they attract the mass market. Verizon and its brethren have traditionally overpriced services such as broadband, long distance, and even cellular service and then lowered prices later. That's likely to be the pattern in music, too. "Anyone who doubts Verizon's capability, I would just say, 'Watch us,"' says Strigl.

The wireless companies are coming from far behind in setting up their music stores. Apple spent years refining its iTunes site and already has sold more than 300 million songs. Yet the wireless companies may have one advantage if they compete against iTunes on price. Because they already bill mobile customers each month, they wouldn't have to pay credit-card charges to Visa or MasterCard. That's not much of an edge over iTunes when customers buy a $9.99 album. But if they buy single songs for 99 cents at iTunes, the fees total a significant 17 cents to 20 cents. Bottom line: Verizon, Cingular, and Sprint could end up lowering their prices to $1 a song and still make more profit than Apple does. "Business models will absolutely change," says Richard S. Siber, CEO of wireless consultant SiberConsulting.

Add it up, and Apple is facing what looks like the most serious threat so far to its digital music dominance. Of its trio of devices, the iPod may be the least affected. Its hard drive of as much as 60 gigabytes, or 15,000 songs, makes it a music aficionado's dream, and no phone can match it. The iPod mini and Shuffle are more vulnerable, since their storage is well within reach of a phone's capabilities. Some experts are convinced mobile phones will become the primary devices for carrying around tunes. "It's not a matter of if, it's a matter of when," says Scott Horn, a senior director at Microsoft Corp., which sells software for phones and music players.

Why are telecom players looking to steal some of Apple's thunder now? Technological advances in storage, compression, battery life, and wireless networks are making it easier to receive and store high-quality music on phones. Korea's Samsung Electronics just introduced a phone with a 3-gigabyte hard drive, enough to store 1,000 songs. A 10-gig phone could hit the market within two years. And the future looks wide open. Research firm Strategy Analytics estimates that in 2008

Wireless operators have seen what a gold mine music can be. Ringtones, the snippets of songs you can put on your phone to customize your ring, have become a huge hit. Operators charge customers $1 to $3 per download for a few bars of a song and keep most of that for themselves. Ringtone revenues have hit $5.8 billion, and that's expected to reach $9.4 billion in 2008. "People are thirsty for music," says Combs. "It's a way to express themselves and their personality." The hip-hop mogul is currently exploring the launch of a wireless music services company targeted to youth.

The ringtone boom has made the record labels enthusiastic supporters of the wireless companies. "Carriers are a new kind of retailer with massive reach," says Eric Nicoli, chairman of EMI Group PLC, one of the four major music companies. "Plus, they have a competitive advantage over online services because their consumers can truly make impulse purchases on their phones."

The success of ringtones has given operators the confidence to push digital music even further. U.S. players are moving into downloads of complete songs, radio-like services with stations for hip-hop and indie rock, and much more. A startup called Single Touch Interactive Inc., based in Encinitas, Calif., is even peddling a Hilary Duff phone packed with the teen pop sensation's music clips and plastered with her image. "Downloading music to phones is the Next Big Thing," says Duff. "I think it's so cool."

Work is under way to make it even cooler. One major focus is a simpler way to move songs from one device to another. The initial downloading services have locked tunes onto the phone partly because, unlike Internet music services, early technology didn't provide a way to prevent multiple copies from being released to file-sharing networks. Now, Microsoft, digital media specialist Loudeye, and mobile music startup Melodeo are developing systems that provide better copy protection so tracks can be moved around easily and safely.

The first iterations are crude. Nokia, in partnership with Microsoft and Loudeye Corp., provides operators with technology to send customers two copies of a track. One goes to the phone and can't be moved, and the other, a copy-protected version, goes to the PC. By yearend, Nokia will do away with this clunky workaround so a customer can buy copy-protected downloads over the air and move them freely. Operator O2 Germany, a unit of Britain's O2 PLC, will use the Nokia solution in its wireless music offering, launching this summer, and Vodafone may adopt it. "Consumers are in charge here," says Vodafone's Ferguson. "They want the freedom to do what they want with songs."

Telecom operators also are working on new ways to market digital tunes. Inside Sprint, which looks like the most music-savvy operator so far, execs talk about the mobile phone as if it were a modern-day jukebox. The company is offering wireless customers Music Choice, the same 24/7 service offered by satellite and cable-TV operators. Sprint's service lets a subscriber tune in to six different channels of music -- rock, hip-hop, '70s, '80s, current hits, and country -- for $5.95 a month. Customers can't pick individual songs yet. But Sprint is working on imitating SK Telecom by providing users with hundreds of thousands of songs. It's even considering development of a mobile-phone cradle, attached to top-notch speakers, for home use.

Creative thinking inside cellular and music companies is leading to ways to tap into the social appeal of music, too. Right now, a kid sprawled on a college lawn can use his or her phone to let friends hear the latest Green Day song. With the next generation of wireless music technology, called superdistribution, that song could be zipped off to the phone of a friend, who could listen to it one or two times or buy it directly from a wireless carrier's service on the spot. "There are lots of exciting things you can do that bring in the social dimension," says Hal R. Varian, a professor at the Haas School of Business at the University of California at Berkeley. "Labels need a platform where they can experiment more, and they can do that with wireless."

Phone makers, meantime, are focusing on making their products more music-friendly. Mobile music skeptics argue that only tech geeks will be patient enough to navigate a music playlist on the cumbersome keypads and tiny screens of most phones. "As long as the primary point of a cellphone is to be a good phone, any entertainment component will be somewhat lacking," says Jonathan Sasse, president of iRiver, a leading maker of MP3 players. But manufacturers from Motorola to Hong Kong contract manufacturer HTC are hustling to make phones easy to use. HTC's SDA has little buttons built in to the phone that let the user play, pause, fast-forward, and rewind songs. Sony Ericsson Mobile Communications' new Walkman phone and Motorola's new E680i sport built-in FM radio receivers and cables that make it a snap to transfer music from a PC to a phone.

Who would have thought the cell phone would evolve from a brick-sized talking device to a pocket-sized jukebox? In early April, 1973, to much fanfare, a Motorola researcher made the first reported call using a handheld wireless phone. Now, Jason Smikle and his buddies not only can talk on one, they can dance to stereo-quality tunes booming from the little gadgets. Music on phones is coming of age. Watch out, Apple.

By Roger O. Crockett, with Heather Green and Tom Lowry in New York, Moon Ihlwan in Seoul, Andy Reinhardt in Paris, and Peter Burrows in San Mateo, Calif.