Digital Music's Dirty Little Secret

The All-American Rejects went platinum two weeks ago. The alternative rockers celebrated the event in Las Vegas, but it wasn't the band's new CD that lapped the million-unit mark. The company's "Dirty Little Secret" single had just sold its millionth copy as a digital download.

Things like this should be making the music industry ecstatic. Digital music means fewer CDs to press, package, and ship out to retailers. And the smaller amount of inventory means that there is also no dread of costly returns once a hyped-up project pulls up lame.

This should be a Nirvana nirvana or a Green Day green day, but the blissful ka-ching melody is ringing hollow in the ears of the music labels. The industry execs are not satisfied. Donning the watchdog street clothes of the Recording Industry Association of America, the record labels have gone on to sue music fans and satellite radio providers while giving the industry's digital-download gorilla -- Apple Computer (Nasdaq: AAPL  ) -- an earful over pricing instead of a heaping bowl of warm gratitude.

It's embarrassing. It's troublesome. It's greed at the first sign of a lifeboat.

The day the music lied
Remember when the music companies were pointing to peer-to-peer piracy as the root of waning CD sales? Industry sales have fallen in four of the past five years, and they somehow think it isn't due to a disconnect with what the masses wanted.

Digital music, in both legal and illegal forms, had stimulated consumers' music-listening appetites. The labels just didn't get it at the time. By and large, they still don't.

This doesn't mean I condone the original incarnation of Napster (Nasdaq: NAPS  ) . It's just that everything from the iPod's success to the whitewashed reconstruction of the Napster model to the financial turnaround at Warner Music Group (NYSE: WMG  ) would have never happened if not for tens of millions of teens hitting up the peer-to-peer networks for pirated downloads.

Behind every disruptive technology, there is always an established industry crying foul. Digital downloads are no different, only this is a unique situation because the whining has come from the same camp that stands to benefit the most from the disruption.

Music-file sharing may have hurt the music makers in the near term, but it was also the perfect set of training wheels to teach the masses how to embrace portable music-listening solutions. Does anyone really think that Apple's iTunes store would have lapped the billion-download mark if consumers hadn't already gotten a taste from Napster?

Piracy is bad, but in this case, it proved to be no different from the chicken joint at the mall's food court that hands out free samples on toothpicks, all to bring in the bigger sale down the road. OK, so maybe the original Napster situation was more like mall patrons swiping the samples when the chicken joint is looking the other way, but the end result is the same. Consumers are hungry for digital music, and the labels remain the top choices on the menu.

Model citizens
There is money to be made in distribution by piggybacking on others' content. No one does this as well as Google (Nasdaq: GOOG  ) . It is the leading search engine because it is able to sift through the content of others better than its rival sifters do.

That doesn't make the content creators any less important. In digital music, most of the attention has gone to the digital-music streamers and peddlers, such as Apple, Napster, and RealNetworks (Nasdaq: RNWK  ) . The credit is well earned, but the music industry itself will be the ultimate beneficiary. You already see it in the stunning digital-music growth at Warner, offsetting moribund growth elsewhere.

The record labels were left for dead a couple of years ago. The five major labels were in a daze, scrambling for either new ownership or sector consolidation. There is money to be made there, especially after the companies become the lean, mean, high-margin machines that they are capable of in this glorious digital age.

There are other opportunities, of course. Motley Fool Rule Breakers subscribers have already been exposed to a few of them in XM Satellite Radio (Nasdaq: XMSR  ) and Akamai (Nasdaq: AKAM  ) . XM is benefiting from ears being awakened to music that matters again. Akamai is there to speed up digital distribution of online stores like Apple's. Both companies are clear plays on the renewed interest in recorded music, but they are also lifelines to the music industry itself. XM is able to provide deeper playlists in narrower niches than conventional radio can, and it's going to drive music sales higher. Akamai makes the downloading process more efficient, and that, too, will sway music fans to go digital.

So let's hope that the major labels will can it on the whining. It lacks vision, even for an industry that is more concerned with eardrums than eyeballs.

Relish the disruption. The dirty little secret is that the joke isn't on you.

Akamai and XM have both made the cut as activeMotley Fool Rule Breakersrecommendations.

Longtime Fool contributorRick Munarrizsubscribes to both satellite radio services and has no problem paying up for digital downloads over the physical product. He does not own shares in any of the companies mentioned in this story. He is also a member of theRule Breakersnewsletter team. The Motley Fool has adisclosure policy.


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