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Digital Music's Double Trouble

It's no surprise that digital music sales continue to grow. In 2006, digital music sales doubled to about $2 billion, roughly 10% of all music sales. Nonetheless, that increase failed to offset the pain of falling CD sales -- and since digital music sales had tripled in 2005, the increase actually represented a slowdown in sales growth.

The International Federation of the Phonographic Industry (IFPI), a global music industry trade association, reported the data, which included such granular details as an 89% increase in single-track legal downloads -- to 795 million -- in 2006. (Last July, Fool Anders Bylund reported on similar six-month data.)

The IFPI expects digital sales to comprise one-fourth of the market by 2010. Mobile downloads to cell phones, PDAs, or wireless-equipped players are another bright spot for the industry.

The trade association echoed concerns shared by record labels from Sony (NYSE: SNE  ) , EMI, Warner Music Group (NYSE: WMG  ) , and Vivendi's (NYSE: V  ) Universal: the damage done to the overall market by piracy and file-sharing. CD sales continue to lose traction; the format is looking increasingly tired in the digital age, despite occasional attempts (including a recent plan by Universal) to make it more appealing to fans. According to the IFPI, overall music sales fell 3%.

Despite the industry's bellyaching, my Foolish colleagues have noted the industry's dirty secret: Legal digital downloads are extremely high-margin products for music companies, since they don't incur manufacturing or distribution costs. Despite piracy concerns, Apple's (Nasdaq: AAPL  ) iTunes and other download providers like RealNetworks (Nasdaq: RNWK  ) make it easy for consumers to pay for their music -- and for major labels to get their hefty cut of the revenues.

The industry still faces plenty of challeges. The digital age makes it easier than ever for artists to eliminate the middleman, selling music directly to fans. Consider News Corp.'s (NYSE: NWS  ) MySpace allowing artists to sell music using technology from Snocap, the start-up from Napster (Nasdaq: NAPS  ) founder Shawn Fanning. The major labels' resistance to innovation, penny-pinching ways, and frequent complaints about piracy and the flagging popularity of CDs leave them ripe for disruption. Digital distribution should be only too happy to oblige.

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Alyce Lomax does not own shares of any of the companies mentioned. The Fool's disclosure policy thinks no album cover will ever be as cool as London Calling.

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