Text Box: Apple has sold over 2m units to date. Their success has been widely emulated and has led to several new vendors offering HDD-based MP3 players. While Flash memory was initially adopted widely in early digital music players and is still the most popular, HDD-based players will continue to gain traction, due to their much higher storage capacities, continuously improved reliability and shock resistance, and of course, their ever decreasing prices. Apple alone is forecasted by Merrill Lynch to ship 3.4M iPods this year, growing to 8.1M in 2006. After 20 years of talking about it convergence is finally happening Of course, digital music is just one segment. In fact, the long awaited convergence of bandwidth deployment, the emergence of on-line services to take advantage of that bandwidth, (such as Rhapsody and iTunes not to mention Comcast’s Video on Demand), the proliferation of smart phones, deployment of mobile access, and the deployment of home networks, all will lead to greater content demand. The coming gizmos will connect to the Web for e-mail, music, and video clips from anywhere, anytime. Undoubtedly, they will need storage. Consumer electronics applications for hard disk drives in general are forecasted to rise from approximately 27M units this year, to 109M units in 07. It will be a huge, but firecly competitive market. Thus for hard disk drive makers, Darwinian forces will continue to apply. Execution will be everything. ### Gary Davis is the Managing Director of Davis Consultants Asia, a business development consultancy based in Kuala Lumpur, Malaysia focused on high technology manufacturing and markets in Asia. Mr. Davis also serves as the Co- Executive Director of IDEMA, Asia Pacific, a non profit Disk Drive industry trade group. Text Box: Source: IDC, Merrill Lynch Text Box: | ABOUT US | CONSULTING SERVICES | DATA STORAGE NEWS SUMMARY | SUBSCRIBE | SEARCH | INDUSTRY LINKS | Text Box: Aug 26, 2004 The Digital Content Market Heats Up; And You Are Going To Love It… Maybe By Gary Davis Davis Consultants Asia THE BATTLE for the music download market, both from a player and a service standpoint, continues to heat up with big name companies chasing Apple’s hugely successful iTunes. It appears everyone wants a piece of this action and manufacturers of consumer electronics are jumping into the fray. This should come as no surprise - - sales of digital tunes in the United States alone will reach US$270 million in 2004, more than double the takings from the previous year, according to a report released by Jupiter Research on Monday. That revenue will rise to US$1.7 billion, or 12 percent of total consumer spending on music, by 2009, the research firm projected. However, The stakes reach way beyond who sells the most downloaded Linkin Park tunes. In June of this year Creative Technology introduced it’s newest “Nomad Zen Xtra® portable media player. As before, it took a cue from the iPod in appearance, and it featured the thumb controlled touch pad which offered users an easy way to scroll the menus. In addition, just like earlier models it featured a longer battery life, targeting what had been an early weakness in the iPod at the time. The Zen® was the first player to support upgrade to the next generation of Windows Media Digital Rights Management (DRM) technology, a platform with certain clout in the marketplace. Of course, our toys evolve right along with us and Apple’s “mini iPod” released earlier this year retained the thumb wheel but added a set of buttons that vastly enhanced the interface. Unfortunately, you still can’t play a WMA file let alone an OggVORBIS or FLAK file. (Starting to get confused?) Following Creative, Sony, whose entry with a player (Walkman) and a download store in early July was widely pilloried in the press and among users for low grade, high compression encoding (ATRAC3 compression) and the fact that their new Walkman player could only play tunes from their service and did not support other, more common formats such as MP3, WMA, and Wav files. Dell did not make the same mistake last Fall when they introduced their “DJ” (Dell Jukebox). Available in 15GB and 20GB versions, the company teamed with popular player software company MusicMatch to deliver a complete solution for playing MP3s and Windows Media files. Also recently iRiver launched their new Portable Media Player. The PMP-100® supports a ton of audio, photo, and video formats (though it lacks DivX support, a notable omission), full video playback, FM tuner, voice and line-in recorder, USB-host transfers for direct downloading from cameras, and more. It uses, however, a variant of Linux to operate. Not shy to play all angles, a Windows OS version will soon be released, called the PMC-100, and it will support MS PMC (Portable Media Center) though it will give up compatabilty with a broad range of data compression schemes in the doing. Archos, with their AV320 MediaBox, has gone one better, designing a portable media player that also plays MPEG4 video. Even more impressive is it’s ability to record video on the fly from a VCR or DVD. While portable movies is an application I am not completely infatuated with, (who doesn’t carry their laptop when on the road, with its built in DVD player and it’s bigger viewing screen? Are people really going to want to watch movies on buses and trains?) Still, portable video is touted as the “next big thing”, and RCA, Phillips, and even Apple, are believed to be joining the party. Since the Archos allows users to make good quality recordings of TV programs and DVDs, and more players are in the works, you will start to see more content surfacing on the Net as the mediabox niche grows. The Archos player records via analog methods (a cable to a DVD or VCR), so it is unaffected by any Digital Rights management protections added to DVDs. If you can view it on your television, the Archos can record it. This doesn't make the media companies happy. More recently RealNetworks, whose investment in software media players and digital rights software, as well as on line content distribution, has been their mainstream business, stunned watchers when they announced a limited test version of their software Harmony, which translates digital rights management software used with songs sold by Real to make them compatible with the iPod's standard. Apple, outraged, said Real had "adopted the tactics and ethics of a hacker" and said it was "investigating the (legal) implications." As yet, the iPod-maker has not taken legal action against Real but has strongly hinted that the compatibility will be resolved in subsequent updates to their service’s software. In the meantime, RealNetworks launched a price initiative selling individual songs at 49 cents, simultaneously launching a thinly veiled “Freedom of Choice” campaign aimed to thwart Apple's arguments. CEO Rob Glaser said. "Thanks to RealPlayer with Harmony Technology, consumers can now buy digital songs and play them on virtually any device of their choice. We believe Freedom of Choice is both the right thing for consumers and a crucial step in bringing digital delivery of music into the mainstream." We heartily agree, freedom and simplicity of use is exactly what users want, even more so then price. If we haven’t learned that lesson from our recent history of the dot com bust and post Y2K I.T. spending backlash, we are subject to Santayana's poignant warning that we are doomed to repeat history. Apple may have to tread very carefully if they are to avoid a consumer backlash over closed standards and lack of choice, but then Apple aficionados have always had their minds a little bit jailed by infatuation. Early this year Apple and Hewlett Packard cut a deal to provide HP with an iPod like product. Apple will manufacture the player, which will not have the iPod name but will have the same design and features as Apple's third-generation iPod players. It is due for announcement within days at this writing. In a recent interview Carly Fiorina said "The next step is that in the home, entertainment is one of those processes that will become digital, mobile, virtual and personal. Personal in the sense that the individual consumer is in control. We see a huge opportunity to leverage the trust our brand has in the home, and expand that into what's going on in the home, which is entertainment and the digitalization of that entertainment." Not everything is rosy in digital music land however. Motorola’s deal to get Apple’s iTunes player onto its mobile phones may have hit a snag - data hungry carriers. Since songs would be placed on phones via USB or Bluetooth, mobile carriers won’t see any money. Forbes.com reports analysts believe the operators will put a stop to this deal and any others like it: “The deal implies that fixed broadband connections are a better way to deliver high quality music downloads than mobile networks,” said Ian Fogg, broadband and personal technology analyst at Jupiter Research Europe. “It suggests that operators hoping to profit from music downloads will be bypassed by PC transfer services like this.” It isn’t just the traditional technology companies leaping into the business. Starbucks, Wal-Mart, eBay and even Coca Cola have all launched digital music download catalogues. Without question, the consumer’s thirst for digital music already represents an exciting demand driver for hard disk drive consumption. Shipments of MP3 players in the United States will more than double this year to more than 5 million and will continue to rise at that rate for the next several years, Jupiter Research said. Hard drive-based, low-end devices will drive the growth, as 77 percent of buyers of portable music players surveyed by the research firm said they would want no more than 1,000 songs on a player at any given time. Microsoft is expected to announce its long-anticipated foray into the online music business this week, raising the competitive stakes for the current market leader, Apple. The company plans to quietly launch the MSN online music store with the release of the new version of its Windows Media 10 player. Of course, as a result of the rising focus on digital music, the music industry has undergone a seismic shift. With the iPod and its ilk popularizing digital music and the majority of Internet users in the United States adopting fast broadband service, new approaches are required if retail is to use the Internet to its advantage, according to consultants advising at least one large retailer. In its turn around of the Musicland Group , acquired from Best Buy, management is building a strategy that envisions stores that embrace the Internet's role in music sales and emulates the lounge-like atmosphere of chains like Barnes Noble and Starbucks. Apple says that its iTunes on-line store has sold more than 100 million individual songs. Traditional retail sales remain much larger, and have even been rising this year, but they have suffered over the long term, partly because of the online onslaught. Music fans bought 667.9 million albums and singles in stores last year, down from 683.2 million in 1993, according to Nielsen SoundScan, a VNU unit that tracks music sales. Due to an ever-growing array of digital rights management (DRM) strategies, incompatible file formats, and disparate portable music devices, the digital music scene has gotten complicated. Nevertheless, digital music continues to sell briskly online, and innovative new strategies for distributing music and sidestepping proprietary formats are appearing. Songs from RealPlayer can be played on over 70 portable digital music players as well as the iPod. By contrast, many other online music stores distribute music in proprietary formats. Apple's iTunes store delivers music to be played on the iPod, and Napster uses Microsoft technology that won't work with the iPod. It has to be noted that all of the success Apple, RealNetworks, and others are having selling downloaded music, their numbers pale by comparison to the darker side of consumption i.e. illegal downloads across peer-to-peer networks. File sharing is the most significant application explosion since the internet was first conceived, falling behind only email in terms of specific, non browsing usage. In a recent meeting with the Justice Department an industry group stated that illegal downloads of copyrighted songs have escalated from 1 million files five years ago to 25 billion songs last year, perhaps a self serving stretch but likely not far from the truth. And so, of course, the battle rages. A recent court ruling this week could lead to a significant increase in lawsuits against people who download copyrighted music from free Internet sites. The ruling by a San Francisco appeals court held that such services can't be sued for aiding copyright infringement. File-sharing operations Grokster and StreamCast Networks, which offers the Morpheus service, aren't liable because they don't have the ability to monitor or control how users of their software exchange files, the court said. The decision effectively grants legal immunity to other peer-to-peer file-sharing services that link together the PCs of individuals for sharing music and movies over the Internet. Representatives of the recording industry did not say whether they would appeal to the U.S. Supreme Court. The paradox created by the court decision is that the industry can still sue consumers for using the file-sharing services, even if the providers themselves are now off-limits, and it is likely they will. While HDD makers may have once been quietly thrilled at the idea of consumers filling up their hard drives with digital content, it is apparent to all, that digital rights management must be equitably be dealt with. It is not an easy problem. Consumers, once used to having the freedom to do whatever they wanted with a purchased CD or tape, are now faced with new definitions of usage rights imposed by the content providers. Inevitably these involve much greater restriction on usage. Still, it's looking like the biggest battles in digital music will continue to surround proprietary strategies and partnerships. This is likely good for consumers in the near term -- battles like these always yield price benefits and consumers normally could care less what acronym accurately labels the compression technique on their music -- as long as the sound is good and the restrictions are not too onerous. Sony’s unfortunate choice of highly restricted content and a low grade compression algorithm will surely doom them to another BetaMax experience. For sure, the checkered flag has not fallen on a clear winner for that elusive de-facto standard. The confusion between now and then could lead to consumer apathy as they bide their time to see which format will be the more widely adopted though sales numbers are impressive so far. All of this is good news for hard disk drive makers, at least those with the right products, but the road isn’t without certain navigational issues. As all of these companies target more and more consumer applications the competitive driven demand for price and execution will ratchet up even more. There will be a large number of programs for our industry’s major OEMs to sell into. Toshiba was an early entrant, winning design-in at Apple for the first iPod which used their 1.8 inch HDD. HGST won the design-in for the iPod mini with their 1 inch product. Fujitsu joins these firms with a long time commitment to small form factor drives and together they control nearly 90% of shipments of 2.5 inch or smaller hard disk drives. However this three way hegemony is likely not to last. Recent product announcements by Samsung and Seagate, as well as entrants of new firms such as Cornice and GS Magic, will challenge the dominating suppliers. Last month Seagate and Creative Technology jointly announced the selection of Seagate’s ST1 one inch HDD for Creative’s ZenTouch® portable music player. The ST1 Series is the industry's first 1-inch hard drive to offer 2.5GB and 5GB capacities. In addition both Western Digital and Maxtor are widely believed to be working on new small form factor products. Small is getting big. Product design, market timing, lean manufacturing, and partner selection has likely never taken on as much importance for the hard disk drive industry as it has now. Inevitably, as each company’s success waxes or wanes, there will be the temptation to use pricing initiatives to gain market share. The pressure will be enormous. Eighty-three brands of MP3 players, each spouting different features, different compression schemes, and various “lock ins” such as proprietary cabling, or support for in-house formats, will likely not be tolerated by the market. (in spite of Sony’s hubris). Competition will be extraordinarily fierce among the OEM buyers of our products. In recent press remarks, Taiwanese makers of proprietary brands point out the expected competition among HDD based devices stipulating that it will be much as it was with earlier solid state memory based devices. Barring that concern, we expect portable media players to be among the more popular consumer electronic devices. We also expect that the makers, at the urging of the consumers, will broadly adopt HDD storage technology. According to IDC, worldwide shipments of compressed audio players alone could surpass 55m units by 2007. Hard disk drives are forecasted to penetrate 45% of that market. (see table below).

Compressed Audio Forecast

(units = M)

2003

2004E

2005E

2006E

2007E

Compressed audio players

21

28

37

46

55

Change

37%

32%

32%

24%

18%

HDD based players

2.5

6.5

10.9

17.4

24.6

Penetration

11%

23%

29%

38%

45%

Change

161%

163%

69%

60%

41%