Rhapsody buys Napster as it battles Spotify

With its Napster acquisition this week, Rhapsody, the venerable U.S.-only digital music subscription service, is in battle mode as rival Spotify attempts to carry its strong momentum in Europe to America.

Rhapsody, which has about 800,000 paying subscribers, isn't saying yet how many more people Napster will add to its service, but bulking up its business is critical to compete against Spotify, which has about 10 million subscribers, 2 million of them on paid plans.

"I don't know how much Rhapsody paid, but any time you can acquire paying subscribers, that's a good opportunity if the price is right," said Gartner analyst Mike McGuire.

The deal between Rhapsody and Best Buy was an all-stock deal. A Rhapsody spokeswoman said the company isn't disclosing the value of the minority interest it gave up to Best Buy in exchange for Napster.

Rhapsody, in its various incarnations, has been providing subscription-based digital music streaming for about a decade. That business has been overshadowed in the U.S. by the a la carte purchasing of individual songs and entire albums, primarily from the iTunes Store.

However, the subscription model may be gathering momentum, helped by its success in other media, like the subscription-based streaming of TV shows and movies popularized by Netflix.

According to a recent Forrester Research survey, adult Internet users in the U.S. spend an average of US$81 per month on media products, and the way they pay for that content is undergoing a "fundamental transformation," wrote Forrester analyst James McQuivey.

"To thrive, media product strategists must shift to a model in which paid content is more virtual than physical -- and more rented than owned," McQuivey wrote in the report titled "People Pay For Content; They Just Don't Own It" published in March.

In a typical month, 18 percent of U.S. adult Internet users buy physical CDs, and 13 percent purchase songs and albums online, while 2 percent pay to subscribe to streaming music services like Rhapsody, according to the Forrester report.

Music subscription services got a bump up after Apple started letting these providers offer their services via applications from the App Store, said Gartner's McGuire.

These applications and other improvements have made Rhapsody and services like it more convenient and simpler for people to use, he said.

A clear sign that consumers are receptive to subscription-based music streaming services is the warm welcome they have given to Spotify since its launch in the U.S. in July of this year.

Spotify has also gotten a big endorsement from Facebook, which featured the company prominently at its recent F8 developer conference as an example of the tighter application integration possible through the latest upgrade to the Facebook platform.

The Rhapsody application for Facebook now offers similar integration to Spotify's. However, Spotify is a more compelling product for advertisers because of its larger user base, said Altimeter Group analyst Rebecca Lieb.

"Spotify has 10 million global members, and part of their deal with Facebook is, if not compelling, then strongly driving those users to share on Facebook's platform," she said via e-mail. "Even with the Napster acquisition, Rhapsody can't approach those numbers."

Thus, there isn't a major brand marketer out there not having discussions with Spotify, because advertisers go where the reach is, which is on Facebook, and that is creating intense, unprecedented competition for other cloud music players, Lieb added.

Rhapsody is sticking to its strategy of offering only paid subscription options, as opposed to Spotify, which has a basic free tier in addition to its fee-based alternatives.

For now, Rhapsody is focusing on the Napster transition. It expects to have all Napster subscribers migrated to the Rhapsody system by the end of November, the spokeswoman said. Napster customers will get equivalent value for MP3 credits they hold.

Once the Napster migration is completed, Rhapsody will release a new combined subscriber figure, she said.

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