Digital music sales in the U.S. are stagnating. You won't read much about this in the news, and analysts tend to gloss over this recent trend in favor of reporting companies' year-over-year digital growth or digital's share of total revenue. Since new music stores and services get so much attention, digital is seen as the bright spot in the music business. But digital is not just maturing, it may be getting stuck in a rut.

In one regard, a mid-year slowdown is normal. Digital sales stagnated in 2007 and 2008 as well. This year's digital sales trends, however, are slightly more worrying for a number of reasons. First, this year's slowdown is deeper than that of previous years. According to Nielsen SoundScan, unit sales of digital tracks have slowed considerably since the beginning of the year. In August, average weekly sales were 16-20% lower than the average in February. Last year, the weeks in August were down 6-11%. Variable pricing is partly to blame, and higher prices mean more revenue to offset the losses in quantity.

Ringtone sales are way off and are taking from growth in download sales. Even though ringtones and ringbacks do not carry the financial heft of digital downloads, labels and publishers have been hit by a sharp drop in their sales volume. According to Nielsen RingScan, combined ringtone and ringback sales have dropped almost 23% through August 30. Ringtone (not including ringbacks) fell 33% in 2008.

Year-over-year growth in digital tracks sales is currently low double digits and could finish the year in the single digits. Lastly, more popular tracks (top 200) are up 21% on the year while total tracks are up only 12%. That means less popular tracks are not performing very well.

Variable pricing does not appear to have helped increase digital album sales, an outcome hoped for by labels that raised prices. The four-week moving average for weekly digital album sales was lower at the end of August than before variable pricing and before Michael Jackson died (which resulted in a six-week bulge in weekly sales). Weekly digital album sales in August were 6.4% lower than in March, 6% lower than April and 7.8% lower than the weeks in June before Jackson died.

Because physical revenues (CD sales) are dropping so fast, one must look at actual digital revenue - not digital's percent of total revenue - to gauge the health of digital. (Even if a company's digital revenue remained flat, deep drops in physical revenue would lead to larger and larger digital shares.) When viewed in this way, digital's performance over the last four or five quarters does not look very impressive. Because it is the only pure-play, publicly owned music company, Warner Music Group's financial information offers the best glimpse into digital trends at the company level.

WMG's sequential growth in digital revenue has slowed to a crawl and there has been very little growth in the company's domestic recorded music digital revenue over the last year and a half. In the fiscal quarter ending June 30, WMG's digital revenue was up 5.4% annually but only 1.2% sequentially. The previous quarter had nearly identical year-over-year and sequential growth. Domestic digital revenue was up 4% year-over-year in the most recent quarter (ending June 30, 2009) and was up 8.9% year-over-year in the previous quarter (ending March 31, 2009). Month-to-month sequential growth in domestic recorded music digital revenue has been light or negative for the last five quarters.

One of digital's benefits is the potential for improved margins. WMG has a mixed story in this regard. WMG's recorded music operating margin has dropped from 7.7% in fiscal Q3 2006 (when digital's share of revenue was 13%) to 6.4% in fiscal Q3 2009 (when digital accounted for 26% of revenue). There is potential for higher margins - variable pricing, deluxe digital album editions - but margins are likely being muddied by downward pressures on CD prices and digital marketing's learning curve. Publishing's operating margin, on the other hand, has risen from 6.0% to 6.8% during the same period.

There are a few variables that will impact digital revenues in 2010:

-- The Christmas season. Sales spikes come at the end of the year, when gift cards and new devices take consumers to download stores in great numbers. This year, there is no clear driver of increased sales. iPods are a mature product and probably won't drive much growth in download sales. A good portion of iPhone users download MP3s, but track sales do not appear to be affected by growth in iPhone ownership. That leaves gift cards, which enable teens without credit cards to purchase MP3s and give new customers exposure to purchasing downloads.

-- A rebirth of ringtones. Although ringtone sales have been falling, they may get a boost from iTunes' coming entry into the ringtone market. It won't be just the lower prices that will help sales. The mere availability of ringtones at the world's most popular download store is sure to have an impact.

-- New album formats may not result in an increase in unit sales, but they should result in a higher average price paid. By offering multiple versions of albums and allowing consumers to choose between a range of prices, labels should increase revenues from each album.