(CNET) -- A torrent of bad economic news is pouring down on Web 2.0 music sites, just like everywhere else. What's surprising is that even amid the horror story that is our economy, some online record stores have impressed music-industry poobahs, say insiders.
Several lesser-known online music services are struggling to emerge as rivals to iTunes.
Lala, Google's YouTube, and Last.fm, owned by CBS (parent company of CNET News), are some of the companies that executives at some of the top labels say are generating "cautious optimism."
At the same time, some big-label managers are underwhelmed with the performance of several shops, such as ad-supported download site SpiralFrog, and social network Imeem.
To be sure, none of the start-ups is delivering iTunes-like numbers. Digital music services are still in their infancy and have the misfortune of being hit by a macro-economic wrecking ball early in their development. The label honchos know this and take this into account when evaluating partners.
That's why most continue to strike deals. The most recent came two weeks ago, when Warner Music signed an agreement with start-up peer-to-peer service, Qtrax.
What is just as true is the top recording companies are in belt-tightening mode, just like every other sector, and patience is running out for underperformers.
"What's happening is that everybody in new media is scrutinizing their relationships," said James McQuivey, principle analyst at Forrester Research. "This is happening in online video as well. (The big entertainment companies) are even looking at the successful services, the ones bringing in traffic and revenue.
"There was a honeymoon period in 2007 and 2008 when the labels would take some risks, but they may not want to continue placing a bet on something that isn't performing."
How are these sites performing? Here's a closer look at three of them:
A social-networking site built around the legal sharing of music and video, Imeem streams free music to users' PCs. Founded in 2004, the company was considered a high-flier among the Web 2.0 music services. The site sees 25 million monthly visitors.
But Imeem is up for sale, has burnt through loads of cash and has struggled to generate income, say sources close to the company. Things were serious enough to prompt Imeem managers last year to ask the major recording companies for price breaks, according to multiple sources familiar with the discussions.
Imeem spokesman Matt Graves declined to comment on the company's relationship with the recording companies. "We're pleased with the progress we've made in the past year in growing the Imeem community," Graves said. "We've got some exciting things planned in the coming months."
Imeem is nowhere near alone in asking for a reduction in licensing fees. And in Imeem's case at least, some of the labels agreed to the request, sources said. One source, however, said that in the future the labels will be reluctant to offer discounts unless a site first proves its business model.
How did Imeem fall out of favor with some in music? One of the biggest complaints about Imeem is that the site's users don't buy enough music. The major labels want streaming services like Imeem to develop into music-discovery tools that spur listeners to acquire music. Graves said Imeem sells millions of dollars of songs, via third-party sites such as iTunes each month.
There are other hazards for ad-supported streaming services, such as Imeem. Most pay the labels a fee on a per-stream basis. For this kind of business model to work, a company must receive big CPMs, the term used in advertising to mean cost per a thousand users. So far, advertisers have shown little interest in paying streaming-music sites these kinds of rates.
The perception is that as people listen to streaming music, they're also e-mailing, doing homework, or performing lots of other activities that often don't include staring at ads, said the music industry sources. To advertisers, that's just not inviting.
"For streaming to survive, the music labels are going to have to figure out a new way to price it," said one music source, "because if you price on penny rates, it's not going to work."
As for boosting music sales, Imeem two weeks ago rolled out a "download this playlist" button that enables people to purchase entire playlists via iTunes. A source close to the company said since then Imeem has tripled sales.
The New York-based company made splash headlines in 2006 when managers announced they would offer downloads free of charge to users and support the service with advertising. Since then, the company has struggled with management turnover, debt issues and convincing the top labels to partner. SpiralFrog has signed Universal Music Group and EMI but has yet to strike agreements with Warner and Sony.
Some of the music insiders I talked to say SpiralFrog has yet to generate impressive traffic or revenue and has also failed to spark song sales from customers.
One of the weights around the SpiralFrog's neck is that besides wrapping its music in digital rights management, at a time when DRM is disappearing, the company's downloads only play on Windows-compatible devices. The reason is labels won't provide iPod support until the service proves its revenues are big enough to offset any cannibalization of iTunes, according to SpiralFrog founder Joe Mohen.
"Spiralfrog right now is 2.6 million registered users," Mohen said. "Our numbers are consistently growing. We just did a major software upgrade. On any given day of the week we have eight or nine of the Billboard Top 10 songs. The reason for that is because Universal is a third of the market but two-thirds of the releases."
Mohen said SpiralFrog and other ad-supported services just need time to build their audiences.
On the positive side, no company has impressed more music execs than Lala.
Lala began as a CD-swapping service but now offers a hybrid business model. Lala enables users to upload their existing music libraries into Lala's digital jukebox. This gives customers the ability to listen to their songs for free from any Web-enabled device.
The company also gives visitors the chance to listen to all of the site's music free of charge--one time. Lala then charges 10 cents for unlimited replay of each song. The user can then apply the 10 cents to acquire a DRM-free copy, which costs 89 cents.
The beauty of this is that Lala gets its hands on people's credit card numbers and positions itself to generate impulse buys, ala iTunes. Paying 10 cents to listen to new music doesn't sound very harmful does it?
According to a LaLa co-founder Bill Nguyen, among the users who have provided a credit card, on average they buy 180 songs for every 1,000 they listen to on the site.
"These are the kinds of numbers we like to see," said one executive. "When you're talking about the customer value, you have to preserve the retail model to some extent. The online ad business is not going to drive the customer value in this environment. We're looking for a blend of monetized sampling and discovery and sales conversion."
That's what Lala appears to be delivering.
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