Music Retailers Sue Sony; Virgin Demands Bigger Margin

The inclusion of "hyperlinks" in music CDs that direct music lovers to Sony-affiliated online sales sites has angered the National Association of Recording Merchandisers, a trade organization representing more than 1000 music retailers. NARM has filed suit against Sony Music Entertainment and Sony Coporation of America, seeking an injunction against the use of hyperlinks and charging that the practice of including the links in CDs is a violation of the Sherman Antitrust Act. Asking retailers to sell discs with such embedded links is the "equivalent of asking Tower Records to put posters for rival Musicland in their stores," said NARM president Pamela Horovitz.

When played in Internet-connected computers, the links can be used to connect users to Sony-operated or affliated websites offering CDs for sale—taking potential sales away from NARM members. The links are transparent to users playing the discs on ordinary audio CD players, and don't appear on every Sony Music CD.

The suit was filed in early February by the Marlton, New Jersey-based trade group in US District Court in the District of Columbia, and coincided with an announcement by Teruaki Aoki, chief executive of Sony Corp. of Japan, that later this year his company would begin exploring Internet sales direct to consumers of Sony's vast inventory of electronics products. The NARM suit is one of the first legal protests on the behalf of traditional retailers against major music companies taking their products direct to consumers, despite the fact that retailers have been feeling growing pressure from their online competitors during the Internet's rapid expansion over the past three years. Everyone in the business of selling music has a website, including the majors, independent labels, large- and small-scale distributors, local stores, and even musicians themselves.

High-quality digital downloads are not far away, presaged by the explosion of the MP3 phenomenon. Such truly direct sales of music—no shipping costs, no returned goods—will further erode the moving earth on which traditional retailers now stand. Despite the fact that last year, only about 1% of all music sold went to consumers via the Internet, it is widely acknowledged inside and outside the industry that the Net's growing influence will alter retailing forever. Horovitz acknowledged that other lawsuits may follow the one against Sony, including targets such as, an online venture jointly operated by Universal Music and BMG Entertainment. The proposed merger of Sony/Time Warner's Columbia House with CDnow Inc., is being examined by federal antitrust regulators.

The retail revolt is also taking place in Britain, where last week Virgin Our Price, the nation's second-largest music retailer, announced that it was witholding payment to music companies in protest over shrinking profit margins. Over the past two years, profit margins on music have declined from 40% to below 30%, Virgin executives claim. The decline may force the company to abandon music sales totally; the temporary halt of payment is meant as a warning to record companies to give retailers more consideration.

Virgin Our Price will hold back payment until a better deal can be hammered out, according to a Virgin spokesman. "We will pay record companies eventually, but the issue is, 'Do they get paid and we withdraw from music retailing, or do we agree a better deal?'," he said. Virgin claims that music labels are giving online sellers better pricing than they give traditional retailers. The company's Virgin Megastores have already cut back on music sales, which now account for only 50% of total sales, as compared to 70% only two years ago. Higher-profit items like magazines, videos, and mobile phones are now being featured to boost profits.

Woolworth's, Britain's #1 music retailer, has yet to join the protest. Ken Lewis, the company's marketing director, said, "We continue to actively work with our suppliers in the music and video industry to deliver the best possible value to our customers."