The Player
Rivals won't find it easy competing with the iPod's closed system.
By Devin Leonard, FORTUNE

(FORTUNE Magazine) - Steve Jobs has had much to celebrate lately. But the Apple CEO was particularly happy in February when he announced that the iTunes Music Store had sold its billionth song, to a teenager in Michigan who had bought a copy of Coldplay's "Speed of Sound."

That milestone is all the more impressive when you remember that Apple (Research) has numerous competitors in the digital music world. Yahoo (Research) Music Unlimited and the legal incarnation of Napster are gunning for iTunes customers. Sony (Research) and Samsung are trying to create iPod slayers.

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The new iPod HiFi is Apple's entry into the audio market. (Full story)

And the field is only getting more crowded. By summer, Amazon (Research) may launch a digital music service with a branded MP3 player, possibly made by Samsung. It is already being referred to in the industry as the aPod. Amazon won't discuss its plans, but sources tell FORTUNE that Amazon is targeting people over 40 years old--it refers to them as "the NPR crowd" --who aren't as likely to own iPods as MySpace users.

Yet Apple's challengers all face the same problem: Jobs' company will no doubt dominate the digital music market for years to come. That's because Apple has learned its lesson about closed systems.

In the desktop market Apple shrank to a niche player because it designed proprietary hardware and software that were often incompatible with programs that proliferated in the PC universe. Microsoft replicated the basic features of the Macintosh operating system in Windows and licensed it to mass-market PC manufacturers like Dell. Apple ended up with 3.2% of the U.S. desktop market.

With the iPod, Jobs created a closed system with mass appeal. Fulcrum Global Partners estimates that iPods now account for 73% of the 30 million MP3 players currently in use in the U.S. That's partially because Apple released versions of the player and iTunes for Windows.

But it's also because Jobs cut a deal with the Big Five record companies in 2003 that locked up his device. The music companies wanted to sell songs on iTunes, but they were afraid of Internet piracy. So Jobs promised to wrap their songs in Apple's FairPlay--the only copy-protection software that is iPod-compatible.

Other digital music services such as Yahoo Music Unlimited and Napster reached similar deals with the big record labels. But Apple refused to license FairPlay to them. So those companies turned to Microsoft for copy protection.

That satisfied fearful music companies, but it means none of the songs sold by those services can be played on the wildly popular iPod. Instead, users of the services had to rely on inferior devices made by companies like Samsung and SanDisk that supported Microsoft's Windows Media format.

The situation has been a disaster for Apple's competitors. iTunes holds a commanding lead over its rivals, selling more than 75% of all digital songs, according to NPD. The second-place digital music store, eMusic, can't sell any major label hits because it refuses to copy protect them. Instead, it relies on independent labels for content.

But eMusic has a 9% share of the market, largely because you can play its unprotected MP3s on an iPod. Meanwhile, Rhapsody, Napster, Sony, Wal-Mart (Research), AOL, and Yahoo--nearly all of which have deals with the major labels but are stuck with Microsoft's technology--are fighting over the remaining 16% of the digital-music-store market.

Most of these music services argue that they have something to offer music lovers that Apple doesn't: digital music subscriptions providing customers the chance to listen to more than million songs for a monthly fee of roughly $10. You can't burn these songs onto CDs, and they become unplayable if you don't pay your bill. But Napster argues that it is cheaper to listen to music this way than to buy thousands of iTunes.

True enough. But the software that Microsoft developed to allow this heavily protected music to be moved to portable devices has been so buggy that a lot of subscribers have given up and just listen to songs on their computers.

Poor Microsoft. Nearly every music service and MP3 player maker other than Apple supports Windows Media and its copy-protection software. But not enough music lovers want to use them. It's a far cry from what happened in the desktop wars. It's no fun when you're outside of the closed system looking in.

DEVIN LEONARD, a senior writer at FORTUNE, can be reached at dleonard@fortunemail.com Top of page

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Market indexes are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer LIBOR Warning: Neither BBA Enterprises Limited, nor the BBA LIBOR Contributor Banks, nor Reuters, can be held liable for any irregularity or inaccuracy of BBA LIBOR. Disclaimer. Morningstar: © 2014 Morningstar, Inc. All Rights Reserved. Disclaimer The Dow Jones IndexesSM are proprietary to and distributed by Dow Jones & Company, Inc. and have been licensed for use. All content of the Dow Jones IndexesSM © 2014 is proprietary to Dow Jones & Company, Inc. Chicago Mercantile Association. The market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. FactSet Research Systems Inc. 2014. All rights reserved. Most stock quote data provided by BATS.