By Sarah Rodman

As the music industry watches in horror while physical CD sales tumble and digital sales fail to bridge the gap, online MP3 retailers are trying to stem the bleeding with an age-old technique: slashing prices.

Some new releases are being priced at a mere $3.99 for a limited time on MP3, including last week’s top-selling album in both platforms, U2’s “No Line on the Horizon”; the company offers some full album downloads for 99 cents. Apple’s iTunes store runs spotlight specials for as little as $4.99. And subscription-based service Rhapsody routinely has deals for $6.99.On average, a regularly priced full album digital download costs about $10. 

Online retailers are keeping tight-lipped about these bargain-basement prices, usually available for anywhere from a day to several weeks, but industry analysts say the reason behind them is simple: to attract new customers, particularly the vast majority of people who aren’t in the habit of downloading music.

Amazon MP3, a digital download offshoot of Amazon.com that launched in 2007, is in a particularly good position to convert the physical-CD-buying masses. “Amazon has customer relationships with virtually all of those people because everybody, at one time or another, has registered for an Amazon account and bought a CD from them,” says Eric Garland, the chief executive of online media metrics service Big Champagne, which tracks downloading activity.

And it’s not necessarily about trying to muscle in on the well-established turf owned by iTunes, which in 2008 became the number one music retailer in the United States. “The way one Amazon guy put it to me once: we’re not trying to steal their share of the pie, we’re trying to bake a new pie,” Garland says.

One consumer happily dishing up that pie is Dan Jungmann, 41, of Niceville, Fla., who discovered Amazon MP3 while shopping for other items on the site. Although willing to pay full price for his downloads, he’s more than happy to pay less and was stunned when he stumbled across the service’s 24-hour “Daily Deal,” which features albums for as low as $1.99. He’s recently purchased albums by artists such as Dean Martin and Chris Cornell for less than $3 apiece.

Other artists who have test-driven the fire sale price in recent months include classic Brit rocker Morrissey, indie darling Lily Allen, glam pop-rockers Killers, and country heartthrob Dierks Bentley.

Several of the labels involved in these promotions declined to comment, referring queries to Amazon, which in turn wouldn’t divulge how prices are set, how artists are chosen, and which have been the most successful. In fact, a spokesman for Amazon MP3 wouldn’t talk about most aspects of the sales promotion and the competition posed by other services beyond saying, via e-mail: “We are not focused on other companies, we are focused on customers.”

It used to be that companies could offer DRM-free tracks – tracks free of copy-protection software that made it easy to transfer among formats – as a way to attract customers, but that incentive is no longer enough, says Antony Bruno, digital editor at music industry trade magazine Billboard. “Everyone has basically gone in that direction,” he says, “so now it’s really about price.” And the price is shockingly low for a reason. “It is the schoolyard crack dealer approach,” Big Champagne’s Garland says. “We will essentially give it away in order to get you to try it because we think you’re going to get hooked, and we think you’re going to come back.”

Consider Jungmann happily strung out. “Every week I’d buy one to two downloads,” says the handyman. “And I still do that typically for full price [albums], but now that I’ve found the Daily Deal I look every day.”

So what does this kind of pricing mean for traditional record stores still selling actual CDs? “It means you have to get more aggressive about what you’re doing with your stores,” says Carl Mello, director of purchasing for New England chain Newbury Comics. Last week the chain sold the new U2 album at the discounted price of $9.99 and offered every other single-disc U2 record for $5.99.

These sales aren’t just good for digital retailers, they’re good for record companies, too. The proof is in the numbers, which spike at these price points, Garland says. “Whereas iTunes is getting iPod users to load it up with songs and pay to do that instead of doing it illegally, what Amazon is doing is getting the CD buyers to buy albums without the CD,” he says. “And the record companies love that.”

“I think any way of getting people to pay for the music they’re acquiring is a good strategy,” says Billboard’s Bruno. Mello agrees: “We’re always competing with free these days.”

Cheap just may be the answer. Former illegal file-sharer Jungmann was often dissatisfied with what he found in the peer-to-peer world of Napster and Kazaa. “It didn’t have the sound quality,” he says. Besides, he says, laughing, “It’s too much work to steal stuff.” And that should really be music to the industry’s ears.