• by Gavin O'Malley  @mp_gavin, January 15, 2007

In the midst of a rapidly changing music subscription market, AOL is ditching its own service and replacing it with Napster, the companies announced Friday. Financial terms of the deal were not disclosed.

In November 2005, AOL released its AOL Music Now service--which blended AOL's existing subscription service, MusicNet, with MusicNow, a Chicago-based company that AOL had just acquired from Circuit City Stores for an undisclosed sum.

AOL's new deal with Napster clearly acknowledges the fact that MusicNow failed to deliver, according to Forrester Research analyst Josh Bernoff.

"You can definitely say that if AOL's music strategy were working they wouldn't have had to go outside the company," said Bernoff.

AOL will now migrate its roughly 350,000 paying subscribers to Napster's service. AOL also plans to promote Napster with links to its service throughout its free music site, AOL Music. Napster also will retain Music Now's current pricing tiers for migrating subscribers, and transfer any pre-paid track credits they have in their accounts.

Since the explosion of digital music services--whether Internet radio, subscription, or piecemeal-payment based--consumers are spending considerably more on music, according to a report released by the Digital Media Association earlier this month. The survey of 1,008 participants conducted online by InsightExpress found that about half of digital consumers now spend over $200 per year on music, while nearly 30% spend over $300--significantly more than the average $100 yearly spend before the broad adoption of digital services.

Still, a service's success is hardly guaranteed, what with consumers' fickle tastes and surplus of alternatives.

In the realm of Internet radio, MSN last November quietly scrapped its existing service, MSN Radio, for that of music recommendation engine Pandora. (Pandora was not acquired by MSN.) Since its debut last November, Pandora's free recommendation system--dubbed the Music Genome project--has attracted loads of media coverage and over 1 million monthly visitors, according to comScore. By contrast, MSN Radio's monthly visitors dropped 9% to 2.5 million from October 2005 to October 2006.

Subscription services, in particular, have it rough because of consumers' distaste for copy and playback restrictions caused by digital rights management issues, said Bernoff.

Just last week, Virgin Group's digital music service, Virgin Digital, shut down amid sluggish growth. (Virgin is directing its existing customers to Napster, per a deal reached between the two companies.)

"The most popular subscription service is eMusic because they use the MP3 format so people can play the music on any device," he said. "Being a music service these days is pretty hard unless your first name happens to be Apple," Bernoff added, referring to the fact that Apple's iTunes accounts for over 80% of legal downloads.

Napster, however, seems to have its head above water. The company--known as Roxio before picking up the illegal file-sharing service's name for $2.4 million in 2002--reports that its subscribers downloaded 500 million songs and over 700 million music streams last year. Come earnings time, it now expects to report over $28 million in fourth-quarter revenues and the addition of 566,000 subscribers worldwide, according to a Napster spokeswoman.

Napster's recent deals with Virgin and now AOL make it ever more appealing as a potential acquisition target--an option that the company expressed interest in last October, according to Bernoff.

"I think Napster is consolidating its position here in competition with Apple," he said. "It needs whatever partners it can get to appear more attractive."