According to knowledgeable sources, Yahoo bought music-software developer Mediacode in December to help create a digital jukebox and media player -- the key components in many music download services. The Mediacode team includes two founding members of Nullsoft, which created the popular Winamp music player and is now owned by AOL.
In addition, Yahoo also has begun kicking the tires of online music services as it rethinks its strategy, which hinges on streaming media, not downloads. For example, Yahoo has held discussions with Musicmatch, one of the largest Internet music services, in what could be a prelude to acquisition talks, according to sources familiar with the meetings.
Sources characterised the discussions as preliminary and said Yahoo has not yet made any offer. They added that Yahoo meets with companies often to discuss possible deals and has received inquiries in recent months from a handful of Web music services, including BuyMusic.com and Napster owner Roxio.
Yahoo declined to comment on any of these talks. "We do not seek to comment or speculate on market rumours," Yahoo spokeswoman Charlene English said.
Napster and BuyMusic also declined to comment. Musicmatch spokeswoman Jennifer Roberts would only say, "We talk to lots of companies, but we're just focused on running our business."
Jumping into music downloads would be a switch from Yahoo's past music strategy, which has focused on streaming audio and video through Launch, a subsidiary that it bought for $12m (£6.5m) in 2001. Yahoo also distributes Roxio's Napster music service, which lets customers buy music downloads and sign up for subscriptions.
Singing for their supper?
Launch depends on advertising to support a free version of its service, as well as subscription fees for a premium version. Yahoo does not report financial results for Launch, but sources familiar with the figures said the site is about break even.
Yahoo executives, including music division head and Launch co-founder Dave Goldberg, previously have disparaged music downloads as a money-losing business. Music-store companies have conceded that margins are slim to nonexistent, with sales consumed by licensing fees for record companies, delivery costs and credit card fees.
Few analysts expect music downloads to make money anytime soon. Apple Computer, whose iTunes Music Store dominates the market, makes its money on the sale of companion iPod music players and concedes the service is not yet profitable.
Still, many large companies, including Microsoft and Coca-Cola, now have plans to offer music downloads. America Online has also joined the game, taking a shortcut by bundling Apple's iTunes store with its online service. Even RealNetworks, which has bet on subscriptions through its Rhapsody product, recently launched a retail song store.
All of these companies argue they can't afford to stand still in a rapidly changing market where consumer demand is still being formed. If demand takes off, they are confident the services will become profitable. In the meantime, they can rely on music downloads as a "loss leader" to help sell related products, such as concert tickets, posters, T-shirts and even soft drinks.
Yahoo's management also is starting to see the value of a more comprehensive strategy, if only to defend against its own users defecting to rival offerings, sources said. "Theoretically, if you don't have it, they will go elsewhere," said a source familiar with Yahoo's plans.
For months, music insiders have been expecting Yahoo to up the ante in its music bet, a move they say would change the dynamics of the industry. As one the most highly trafficked sites on the Web, Yahoo is better positioned than most to sell music services. In addition, Yahoo could sell music through partnerships with high-speed Internet access providers such as SBC Communications.
"Yahoo seems to be a real obvious major player in the space," said Jeff Cavins, chief executive of Loudeye, which builds music stores for other companies. "Digital music for Yahoo is a natural way to create incremental revenue and profit."
Yahoo has made several stabs in that direction. Last year the company explored ways for Gracenote, a music database provider, to build software that would let Yahoo customers buy and play back digital songs, sources said. But the partnership never bore fruit, so Yahoo turned to Mediacode.
Mediacode, led by former Nullsoft engineers Ian Rogers and Rob Lord, has created software that lets people access their media libraries from multiple PCs. For example, songs stored on a PC at home can be played at work.
Finding the right match
Although Yahoo acquired Mediacode's engineers to build its own player, the company could hedge its bets by acquiring existing technology.
Musicmatch has attracted more than 160,000 paying subscribers, and it already has secured licences to hundreds of thousands of tracks owned by the major record labels.
Musicmatch traditionally has guarded its independence, and said it doesn't require a partnership to grow. Still, it has suffered some recent setbacks.
In October, Apple dropped Musicmatch as its software provider for Windows iPod owners, opting to create its own application instead. Since then, Hewlett-Packard also dropped Musicmatch and decided to bundle iTunes with its computers.
Musicmatch said HP provided a much smaller customer base than Dell, its main distributor. It also has partnered with Coca-Cola in the United Kingdom.
"We've demonstrated our ability to be successful as an independent," Chris Allen, Musicmatch's senior vice president of marketing and strategic planning, said in an interview last week. "Our intent is to march forward along those same lines."
