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Love it or hate it, MP3 users are a huge new market, as yet untapped by the music industry. Portable digital compressed-audio players, whether employing Flash memory or compact hard drives à la Apple's iPod, are estimated to begin reaching critical-mass sales numbers around 2006, with an installed base of 24 million units by 2007. Most observers agree that this dramatic growth has been driven, in large part, by the vast quantity of no-fee music that is available in the format, as well as the players' ease of use and flexibility.

Until secure MP3 players dominate the portable market, however, Jupiter Media Metrix is suggesting that the combination of high rates of portable CD player ownership among online users and the "near ubiquity" of CD-burning drives bundled with new computers "defines an important market segment that music subscription services must address. This segment will comprise the majority of portable music users through 2007—over 34 million people."

Jupiter reports that digital music's second phase, following the first-phase success spawned by Napster, began with the December 2001 launch of MusicNet and Pressplay. The researchers also declare that this phase represents "the make-or-break period" for the music industry's answer to MP3: digital music subscription.

The researchers write that subscription services would benefit greatly from a technology landscape that supported secure portability, "but in the absence of such technology, companies must explore other models." The report predicts, "The third phase of digital music will begin once a critical mass of secure devices exists in 2006 or 2007. At this point, subscription services will have the opportunity to offer secure portability."

The big question, though, is will they be able to get from phase two to phase three intact? "They will either have found success with an interim model or have long since closed up shop," opines Jupiter. Additionally, the researchers say that the window of viability for secure portability is rather small, adding that once affordable wireless streaming is available, circa 2008, "this platform will be a far better method of distributing flexible, secure digital music without the messy apparatus of DRM and downloads."

Wild cards that could throw this schedule off include federal regulation and industry reaction. Examples include the recent Hollings Consumer Broadband and Digital Television Promotion Act (CBDTPA), which would mandate universally adopted secure technology. "While it is unlikely that the CBDTPA will pass in its current form," says Jupiter, "it is possible that the ongoing threat of regulation will force hardware manufacturers in the US to reconsider the rationale for adopting secure portability technology."

Is there a way out for record labels? Jupiter says that the only way for paid-service companies to compete in a market dominated by no-fee MP3 is to create services that beat MP3 on its own terms. "The answer lies in a two-tier service model that combines the flexibility of tethered rentals with the portability of owned, unprotected downloads and burns." Such a model, figures Jupiter, would appeal not only to the growing digital device market, but also to the far larger number of online music fans who own CD-writable drives and portable CD players.

According to Jupiter, "It is essential that such a service have, on the one hand, a very simple value proposition to eliminate consumers' confusion and, on the other hand, a broad range of features to allow for maximum flexibility and portability." In order to attract and retain paying customers, the rental tier must offer the features that consumers say they value most about digital music. These include broad catalog availability where a genre-oriented strategy focusing on depth, rather than breadth of titles, may make sense for subscriptions in the short term. Also recommended: infinite playlist accessibility. "Subscription services should adopt the same model that health clubs do—offer consumers theoretically infinite access to the service and assume that actual usage will pale in comparison." Also important according to Jupiter are easy access to music from any device connected to the Internet as well as invisible rights clearance. "As long as consumers keep paying on a monthly basis, they should never be aware that a meter is silently ticking away."

Finally, the research group recommends that more than simply offering an ownership or rental services, subscription services should position themselves as "integrators of consumers' permanent and temporary music libraries." As such, services should consider offering consumers no-fee or low-cost music "discovery and management" tools (for example, an online storage locker) for their permanent collections, even if they are not paying subscribers. "Such a strategy would deepen consumers' relationships with service providers, add value to purchased product relative to pirated product, and give subscription providers a treasure trove of potential paying customers."