An Essay on the State of the Music Business

The Internet has been adapted in our world faster than any other media. It has taken seven years to reach a 25% market share– as opposed to radio, which took twenty-two years; television, which took twenty six years; and the phone, which took thirty five years to be owned by 25% of the consumers in the market . The PC itself needed 15 years, and even the cellular phone did it in about 13 years. The digital world is unquestionably the future and offers much hope. But adaptation is required, and the record industry has not fared well yet, even if music is now just a click away from a user’s desktop or phone.

There will always be short-run costs that can’t be adjusted quickly when a new technology appears. Fixed costs make it harder for firms and businesses with large infrastructures to be able to profit or avoid early losses in the first period after a major change. However, we are now well past the Napster revolution in 1999 , and labels have not perhaps been as mentally agile as they should.

The Market and a Change in Demand

A statistical overview of the market today is illuminating. The 2008 end of the year shipment statistics report by the Recording Industry Association of America (RIAA) shows an increase of 28.1% in digital units sold between 2007 and 2008 and a 30.1% increase in dollar value. This is due to the rising sales of digital albums and singles, and to downloads of music videos. Mobile ringtones sales have actually decreased a small percentage because of the option to download an mp3 music file and have that be played as a ringtone. Ringback Tones, the songs that are being played while a caller is waiting on the line, are nevertheless showing an increase. While digital performance royalties increased 74% between these two years and US author’s society BMI saw revenues and distributions rise for the 2008/09 financial year , physical sales of recorded music decreased heavily between 2007 and 2008, with a 24.7% plunge in CD shipments, a 71% drop of CD singles sales and a 54% freefall for DVD videos and music videos. Total units sold in 2008 were 26.1% less than in 2007 and the revenue decreased by 28%!

In 2008, physical products still counted for 68% of total shipments, the rest being digital. This is of course changing at a rapid rate, as in 2007 the comparable data was 77% and 23%, respectively. Total dollar value fell by 18.2% in 2007-08. Still, Nielsen-Soundscan’s senior analyst Valentina Nucete concluded that in the past five years the decline in physical sales grew at a much faster pace than the increase in digital sales .

This change in demand towards digital music has not yet fulfilled the promise of restoring the market back to the golden ‘nineties. There are, ostensibly, three additional elements that are holding back industry revenues.

First, there is a shift from full album purchases to single song downloads . Music albums were either complete products or bundles of ten to twelve songs with two or three “hits”. Consumers who only wanted these hit songs had no choice but to get the whole album, allowing the record labels to wrap a small product in a bigger and more expensive package. However, the era of digital downloads brought up to the surface the culture of single song sales. Naturally, this affected total revenue negatively.

Second, there were many different substitute goods for recorded music that exploded with the new technology, especially video games and online movie sales. The Internet, of course, made much more entertainment options available to many more people at a much cheaper price. “The show was stolen” from recorded music and consumers’ time and money distributed differently to the detriment of recorded music.

Thirdly, the most obvious factor affecting the demand of legally produced recorded music is the availability of pirated product. Illegal downloads, it is said, still represents 95% of all downloads. If that percentage were lowered even by a little, the revenue grossed by the labels would rise significantly.

Vigor in Anti-Piracy

It is this third factor that deserves attention, for in the current juncture it appears that some progress is being made at last. It should be understood that a claim of infringement against Internet Service Providers (ISPs) is by the ISP. There is the issue of intrusion in a client’s privacy. Second, even if the ISP admits that something can be done about piracy, the music industry is only the first in line: the film, gaming and software industries are likely to follow and will want to get rights to compensation. For instance, in June of 2007 a Belgian court had to reassure itself that there was a practical way to target and filter out any infringement before it ruled against the ISP. When expert testified that there were eleven filtering technologies available, the Court then held the ISP liable rather than the user and was able to discard a defense based on the protection of privacy rights. Other European governments are starting to follow suite. (Editor’s Note: See this edition of The MBJ for more updates on ISPs and copyrights in Europe)

The Declining Value of Music and Mechanicals

Even if ISPs were held more accountable, enormous problems remain concerning the decline in revenue of the majors. A historical outline should make this clear.
Statistics show that in real terms recorded music prices were falling since the beginning of the 1990’s—much before the birth of Napster in 1999. A table of wholesale prices of recorded music products between 1990-2004, published in Peter Alhadeff’s article The Value of Music is revealing. Alhadeff uses data from the RIAA’s annual reports to value music and compares it to evolution in the consumer price index, which measures inflation. Although nominal prices increased between 1990 and 2003, real prices fell steadily during the industry’s “golden years” (so-called because the conversion to CD’s was in full swing and labels released both new and old catalog material in the new format). Alhadeff explains that the majors could not push the prices of their “hits” or “stars” up and maximize revenue. Hit music, unlike the rest of the less successful albums, was sold not just in record stores but also in hypermarkets (Wal-Mart, Best Buy, and so on). These retailers were willing to lower the price of music sold in their stores just to drive traffic in and get people to buy other more expensive consumer durables. Since there was almost perfect competition at retail for hits, recorded music devalued against the consumer price index by more than 25 per cent without the labels being able to stop this.

Another area, incidentally, where the value of music suffered, and which also affected the creative community, has to do with the payment of the mechanical right of reproduction of a song. In this case, the ‘mechanical’ royalty paid by the labels to copyright owners of musical creations can be shown to have dropped consistently against inflation since 1975 (even though back then it was 2.75 cents a song and now it is 9.1 cents). Here, as a matter of fact, the labels did use their stronger lobbying power in congress to trump artists and their publishers.

Monetizing Demand

Yet, in the midst of all this, trade organizations, governmental agencies and industry analysts concur that demand for recorded music is actually at an all time high. So what are the options to monetize this into more revenue from this demand in the new world? What promise does the future bring for the music industry?

(a) Variable Pricing

The first example of revenue maximization comes from the leading online music retailer, Apple’s iTunes. In early 2009, iTunes began to incorporate variable pricing for its products: $1.29 for hits, $0.99 for a regular song, and a floor price of $0.69 for less popular songs.
The effects, and the limits, of this strategy can be gauged by using a price elasticity of demand (PED) analysis. For instance, if there is a strong demand for a product, such as the demand for hits and superstar’s music, it implies that consumers are less sensitive to price changes and thus, demand is said to be “inelastic”. The demand for catalog songs is usually soft or “elastic”, meaning that consumers are sensitive to price changes. If demand is inelastic, raising the price will raise the sellers’ revenue. An example is that if iTunes pushes a price of a song from $0.99 to 1.29 which is a 30% increase and downloads drop by 20%, the label will still gross more than before. If the drop in downloads were more than 30% then it would create gross losses and price needs to be readjusted. If demand is elastic, lowering the price will increase revenues since more people will presumably buy it. A price for a song that was dropped by 30% from $0.99 to $0.69 would be expected to have more than a 30% increase in total downloads thus creating higher total revenue.

With variable pricing, therefore, and because Apple iTunes is by far the most significant retailer in the online music market, labels have gained some control over pricing. The implication is that labels will be looking at price data very closely in the near future. They will try to price a song as close as possible to its potential value having a positive affect on demand and on their revenue.

(b) Subscriptions

Some new business models that are focused on profiting from recorded music are heading towards the model of subscriptions. These are either ad based or monthly/yearly fee based. Services like “Spotify” in Europe and “Raphsody” are charging monthly fees for the possibility of unlimited streaming. Spotify has a more narrow, free, ad based streaming service and an option to upgrade to an account with no ads and more advantages for a fee. There are Internet Radio stations such as Pandora that charge a fee or are ad based as well. Sirius XM Radio is an example for a satellite radio that charges a monthly fee for the access to its 120 channels. These services all pay performance royalties to songwriters and publishers through ASCAP, BMI and SESAC and since last May some are paying sound recording performance royalties to the record labels as well through SoundExchange, a new collecting society. The terms are constantly negotiated, and many hurdles are still to be passed as these services, and especially other smaller ones, don’t really generate a positive cash flow yet. The most successful models have been able to offer enough free features to classify themselves as a viable competitor in the market . The problem is that these models are still competing with free.

Another model is to have ISP users pay a monthly fee for the use of their broadband for unlimited downloading and streaming of music. Universal Music Group announced this June that it would be pairing with Virgin Media in the UK to offer the subscribers unrestricted access to UMG’s entire catalogue for a monthly added fee . However Virgin media is still negotiating with the other three major labels for the rights to use their catalogs since it needs the whole pie to offer to its subscribers.

Overall, Europe and Japan seem to be moving faster towards mobile music goals. Users in Japan buy a fair amount of music through their cell phones, while in Britain, subscriptions are seamlessly tied with phone cell phone purchases through Nokia’s “Comes With Music” platform. The smart phone maker is the largest in the world, and a US launch is expected 2010. All of this is likely to nudge the frontier of legitimate recorded music sales and help sellers.

(c) From 360° Deals to Live Music

Since recorded music sales plunged, the labels have started to negotiate differently with their artists. Under the banner of the so-called “360° deals”, they are now tapping a wider pool of revenue, arguing that they already invest in the marketing and financing of an artist and his tours. This would also better justify advances, diversifying the inherent risks of their investment.

As music sellers diminish their dependency on recorded music sales, the music business can take comfort from the fact that there are other growth areas. The music publishing industry is well on its feet and more and more music is being licensed instead of sold. Composers, artists and bands can partner with a publisher and be able to profit from the use of their music in any of the other kinds of mediums and media such as TV, mobile, ads or games. Performance royalties, as opposed to mechanical collections, are increasing. If imposed in a wise and not strangling way on the digital radio stations they can provide even more substantial monies for the copyright owners.

Finally, live music will always be there, and will always have a demand. The concert business is doing great and since 1991 concert ticket sales have increased each year and cracked the $2 billion threshold. Another trend we see in live music is that major stadiums are becoming less popular as smaller venues are increasingly being used and actually gross in total more than the stadiums. This is also related to the existence of a “middle class” of musicians and, perhaps, the fall of the superstars.

In this new world, moreover, there is more room and cheaper options available for more independent bands and artists. A Do-It-Yourself attitude is not uncommon, as musicians can record their own albums for a much lower investment, can promote themselves and find innovative and creative ways to use the new media, the Internet and the mp3 format to ultimately benefit from the situation and generate income. Artists still need their “team” of managers, lawyers and promoters to be able to generate income and stay in control of all operations, but the label’s role in the process has declined.

“Nimbit ”, for example, is a web company designed to help any band or artist manage themselves. Artists can create a digital store for their merchandise and music, and implement it on their website or social media group. Nimbit handles production, shipment and payments for a small percentage. They issue download cards to hand out in live shows. These cards have a unique code which enable a free download, after visiting an artist’s website. Use of these cards generates an email list to track the interested party as well as exposes them to more offers and creates a relationship between artists and fans.

* * * * *
Whether the new technologies are seducing fans with a free track or album download, promoting an artist’s live show, selling merchandise online, generating artist-fan newsletters and e-mail lists, or pushing music licensing — the path of making a living from music is still out there. The age of digital media has only just begun.

By Itay Rahat

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