Sean Ryan, formerly an executive at Real/Rhapsody, recently started a blog.  One of his first posts is a really good one about about how digital music is a really tough business, and how he will be staying out of this sector.

I think digital music will eventually be extremely profitable for the
content providers, including publishers, but I struggle to find a
business model for the middle man in this business, at least for any model which requires broad label rights.  And when you
consider the joys of the mobile music sector, where you have both a
concentrated supply chain AND a concentrated customer base (4 -6
carriers), you begin to see why I find that sector to just be a
disaster in spite of the hype.

So we will most certainly not be in the digital music business here
at Donnerwood, primarily due to our collective experience in it over
the last 5-10 years, but I have no doubts that companies will continue
to pour resources into it.

As he says, it's more difficult to get reasonable rights from the labels than negotiating oil from OPEC (due to the substitutability of the latter's product), making for low margins.  This combined with the competitive marketplace with well-funded companies makes for a crummy businesss.

Well put, Sean.

Unless you already touch a lot of consumers and think you can acquire them cheaply, running your own online music store or subscription service will probably be a losing proposition.   But what about bricks & mortar retailers who have had to negotiate rights with labels for years and were still able to survive?  They were able to do so because of the real estate they controlled, which generated traffic into their stores via their 'environmental oligopoly'.  Big retailers also have lots of other products to draw people in.  Distribution will be key, which is why I think mobile carriers will profit from digital music (as long as they don't get greedy and continue to charge $3 for a song).  Radio stations are also well placed given their broad distribution via their real estate on the dial.  Branding will be important but won't be the silver bullet withouth organic distribution.  Look at Napster, which continues to hemmorhage cash despite having one of the best known music brands around. 

With all of that said, there are a few areas of opportunity (though I'm sure I've missed out on many):

-Niche aggregator/retail.  While Amazon, etc. have deep catalog, their scope is broad.  That leaves room for niche players focusing on a certain niche like CDBaby and others (thanks to Chris Anderson's timely post on this topic). 

-Filters.  As the quantity of easily available music grows, the role of filters grows.  There are a good number of players in this area already but no one dominates, with Amazon's closed recommendation system probably being the largest, followed by Apple's iMix.  Still lots of room for innovation as neither of these are a robust solution to the problem.  Musicmobs is trying to be the del.icio.us of playlists, which is an interesting approach.

-Search.  Again the offerings out now aren't very robust.  Blinkx & GoFish are two startsup in this category though there are probably others flying below the radar.

-Services.  I'm a big believer in Web-based services.  Besides music rental, podcasting-related services immediately come to mind, but there are others (one of which I can't yet write about). 

Of the above, it'll be hard to build sustainable businesses from #2 & 3, although an acquisition-based exit strategy is perfectly reasonable.  So yes, digital music is a tough business for aggregators and branded stores, but there will continue to be pockets of opportunity for innovators that can offer the consumer and her friends a better and easier way to enjoy music.  But I don't blame Sean for giving casual games a whirl!


[Cross-posted from www.ragsgupta.com]