Have the record labels become the new dinosaurs?

Monday, October 15, 2007

Over the past 10 years, there has been a paradigm shift in the music industry. The record labels were slow to evolve with the changing times and as a result, they’ve been suffering from a steady decline in revenue. Recent events are only making things worse for the once mighty industry. Like a wounded animal, the music labels are lashing out against potential consumers and business partners without a clear and coherent plan for survival.

Slow to evolve

The problem for the music industry started in the late 90’s, when the .mp3 format became popular. By shrinking the file size to roughly 1/10th the size, it became feasible to store a large collection of music on your computer. The combination of disk storage growing at an exponential rate, broadband internet connections becoming common and a new common music format have the makings for a paradigm shift.

For years, the record companies have been able to force consumers to pay outrageous prices for music. Even if you just liked one song, for the most part, you had no choice; you had to buy an entire CD or simply do without. In some cases, singles were available, but they were never a popular alternative due to price, size, etc.

Peer to peer file sharing services began to pop up which made searching for and sharing content very easy. The first popular service, Napster, was shut down because it was a centralized service. That is, you had to log in to a centralized Napster server before connecting to another peer client to share music. The RIAA was able to shut this down as they were able to prove music was being illegally traded and Napster was never able to control the content that was being shared. This gave way to decentralized peer to peer networks that essentially can never be shut down because nobody owns or controls the networks. You can’t very well sue a gun company when someone uses a gun to kill someone. Just the same, you can’t effectively sue a software maker for making peer to peer client software. It’s just a utility that lets you share files, legal or illegal. It’s no more the obligation of the software company to control how the program is used than it is the obligation of the gun company to control how the gun is used. Additionally, even if the RIAA could sue a particular software company, similar software would pop up with origins in other countries. It’s a pointless battle to fight.

Rule #1: Provide the customer the opportunity to pay for a product they actually want.

When you are the single source of content that people want to buy, you can be arrogant and set your own prices. You can make your customers pay for things they don’t want like forcing them to buy an entire CD instead of a single song. You can dictate the format that your customers will be forced to use.

Of course, when the same product is available elsewhere, now you have a problem. This is what happened to the record labels. Music piracy became very popular, not because there are so many people that want to be thieves. Rather, it’s because consumers were able to obtain exactly the product they wanted, in the format they wanted. The fact that the music was available for “free” probably didn’t hurt. Yes, it was stealing and it is clearly wrong to do so. However, the fact that it happened was unavoidable. The record labels were arrogant. They did not acknowledge their customer’s demands for online music for years. By the time the labels realized they need to do something, they didn’t know what to do. They started offering subscription based services like Rhapsody, etc. However, the music was heavily laden with DRM (digital rights management) restrictions and wouldn’t even allow you to burn it to CD, etc. In effect, if you wanted to obtain music online, you had a choice: pay an on-going subscription fee or just download (steal) the music in an open format like .mp3. Is it really any wonder why piracy was and still is so rampant in the music industry?

The problem has been compounded over time. Because piracy was the only practical way to obtain the bulk of ones music collection, it has become culturally acceptable in our society to some extent. This is especially true with the younger generations. There is a real problem when we have a younger generation that completely doesn’t understand the concept of paying for music.

The online music sales model does work

Apple was eventually able convince the labels to sell their music online through the iTunes music store. This was a great stride in the right direction. It allowed you to own the music and even burn it to CD, etc. Unfortunately it still came with DRM restrictions. Though many people refuse to purchase music with DRM restrictions, Apple has been successful with selling music online. To date, Apple has sold more than 3 billion songs and is now the #3 music reseller, behind Wallmart and Best Buy. Clearly the online model has proven successful.

The only real barrier to sales is the use of DRM. Consumers do not want DRM. Consumers do not want to have to register one computer and not forget to unregister that same computer before they get rid of it. Consumers want fair use of their music. They want the ability to burn it to a CD or transform it to another format, possibly for another music player that they have. These are basic freedoms that consumers have every right to demand. The record labels need to fall in line here, or continue to suffer from rampant piracy.

Seeing the light

Under pressure to open up its DRM scheme to other vendors, Steve Jobs wrote an interesting article back in February 2007 that outlined the problems with the music industry and called for the labels to drop the requirements for DRM.

The independent labels were ready to drop the DRM requirements, but the “big four” (Universal, Sony BMG, Warner and EMI) were not ready to do so. In April 2007, EMI, the smallest of the big four, fell in line and announced that they would sell DRM free music through Apple’s iTunes music store.

This was a huge step in the right direction, but it came with a caveat. The music would even be offered at a higher quality (256bps vs 128bps), but come at a higher price. The DRM free music would be sold at $1.29 per song whereas the DRM laden music would continue to be sold for $.99 per song. This wasn’t ideal for consumers, but it was a reasonable compromise. The record labels wanted to charge more for their music and this was a way to do it. To date, only EFI has “seen the light” and realized that DRM is not an effective means of preventing piracy.

Testing the waters

Universal is “testing the waters” so to speak by offering DRM free music through a few vendors like Amazon.com, etc. However, they are specifically not offering DRM free music through Apple. This seems odd to me. Apparently, Universal is not happy with the agreement they’ve made with Apple. Apparently, Apple gets $.29 for each $.99 song it sells. Considering Apple sets up the store, pays for the storage, pays for the bandwidth to deliver the music, pays for the development of the iTunes software which acts as the jukebox and integrates with the iPod, etc. , they pay for the sales / credit card transactions, etc. The price Apple charges seems reasonable to me.

If Universal is unhappy with the price they get for each song, why not offer their music through the iTunes plus store at $1.29. Surely they’d get more money per song, right? Instead, they are selling their music through Amazon.com who is selling their DRM free music in the .mp3 format for just $.89 per song. So, one has to question what this is all about. Clearly it’s not an issue of how much money per song Universal wants to get. It’s about unseating Apple’s market leading position with on-line music sales. Universal figures that if they can further split the market, Apple will have less leverage then they currently have. It’s a bold move, but Apple clearly has the leverage here and they know it. Universal refused to enter into another long term agreement with Apple, yet, they know they can’t pull their music library from Apple because Apple is the #3 music seller overall and the number #1 music seller online by a large margin.

A recent article in Business week talks about Universal’s recent actions.

Universal knows they don’t have enough power by themselves, so they are trying hard to get Sony and Warner to stand against Apple in an attempt to renegotiate their terms. We’ll have to see what happens. Here are a few quotes that I found amusing:

“Morris and his allies hope to move digital music beyond the iPod-iTunes universe by nurturing the likes of Microsoft’s Zune media player”

The assumption Universal’s Doug Morris is making here is that the iPod is popular because of the iTunes music store. This is just wrong on so many levels. For starters, Apple’s own estimates are that on average, the amount of iTunes music store (iTMS) content on the average iPod is about 3%. The iPod’s popularity existed before Apple even had a music store for iTunes. The iPod is popular because it’s the best portable music player on the market. Period. It’s the best design, it’s easy to use and navigate through the menus. The click wheel design has proven to be very popular and much less cumbersome than what’s being offered by the competition. Additionally, the iTunes software (not the store) is considered by most to be the best music juke box software. The seamless integration between the computer, the iTunes software and the iPod hardware has set the iPod in the dominant position.

“The service, which is one of several initiatives the music majors are considering to help reverse sliding sales, will be called Total Music. (Morris was unavailable for comment.)

This isn’t only about Jobs; Morris badly needs to boost his business, and Apple is the one to beat. The iTunes store has grabbed about 70% of downloads in the U.S. And the iPod–well, what’s left to say about that juggernaut? Plus, music companies have been here before. A few years ago they launched services with the aim of defeating Napster-style file-sharing–and failed miserably. And let’s not forget that existing subscription services have signed up only a few million people, vs. hundreds of millions of iTunes software downloads.”

Getting to the point, Universal, like other big labels, is facing declining sales and they don’t know what to do. Apple has helped them by providing an effective online sales channel in an attempt to curb piracy. With 3 billion songs sold, it would seem Apple has been effective. Now, they are getting greedy and realizing that online sales will eventually eclipse the sales of CDs sold in stores. As such, they want a bigger piece of the pie. The labels are frustrated that nobody has been able to compete successfully against Apple.

“While the details are in flux, insiders say Morris & Co. have an intriguing business model: get hardware makers or cell carriers to absorb the cost of a roughly $5-per-month subscription fee so consumers get a device with all-you-can-eat music that’s essentially free. Music companies would collect the subscription fee, while hardware makers theoretically would move many more players. “Doug is doing the right thing taking on Steve Jobs,” says ex-MCA Records Chairman Irving Azoff, whose Azoff Music Management Group represents the Eagles, Journey, Christina Aguilera, and others. “The artists are behind him.””

Subscriptions? Really, is this their magic plan? Yes, subscription services would be the most profitable for the music labels, but fortunately, consumers have been smart enough to reject this nonsense to date. Now, the plan is to get the hardware makers to pay a subscription fee? Are they kidding? I’m still using a 4th generation iPod that’s now several years old. I can’t imagine any hardware vendor in their right mind actually biting on this one. This is clearly an act of desperation.

Also what’s with the “The artists are behind him” quote? I certainly can’t speak for every artist, but I never hear artists speaking favorably about their record labels. It’s generally understood that most artists make very little from record deals and they generally end up having bad relationships with their labels.

Bad will

Generally speaking, I’ve always understood the artists deal with the record labels as a necessary evil. We know the record labels have made lots of money over the years. There have been countless hard luck stories about how they’ve treated the artists. They’ve charged unreasonable prices for music and as such, are not well liked by consumers.

To make matters worse, the RIAA has been busy trying to sue people for stealing music. Don’t get me wrong, it’s their right to do so. In fact, if they don’t try to fight piracy in some way, they are sort of condoning it.

That said, suing your potential customer base is generally not a good idea. The RIAA is hoping for high publicity from their lawsuits. They are trying to send a message. The problem is, they end up suing teenage kids whose parents aren’t aware of what their kids are up to. In terms of industry image, this has backfired on the music industry. At least in some cases, I’ve seen this provoke some to pirate more. Worse, it’s inconceivable that a jury recently awarded the RIAA a $222,000 lawsuit against a single mother on the basis that she made 24 songs available for download. There apparently wasn’t even any evidence that files were uploaded from her computer. Now, I have no doubt she did illegally share music files with others. However, I’m quite sure the punishment doesn’t fit the crime in this case. I’m also quite sure this publicity being generated from all of this is not working in the favor of the record labels.

Bypass the labels all together

The result of the bad will generated from the labels isn’t just coming in the form of music piracy. One of the biggest upcoming rock artists, Radiohead, has recently decided to release their latest record without a contract from a record label. While I don’t agree with their “pay whatever you like” business model, I do see that cutting out the “middle man” as an obvious conclusion for many.

“Radiohead’s contract with EMI/Capitol expired after its last record, Hail to the Thief, was released in 2003; shortly before the band started writing new songs, singer Thom Yorke told TIME, “I like the people at our record company, but the time is at hand when you have to ask why anyone needs one. And, yes, it probably would give us some perverse pleasure to say ‘F___ you’ to this decaying business model.””

Clearly, there is a larger backlash coming from the current business model.

“Even under the most lucrative record deals, the ones reserved for repeat, multi-platinum superstars, the artists can end up with less than 30% of overall sales revenue (which often is then split among several band members). Meanwhile, as record sales decline, the concert business is booming.”

Is it really any wonder why artists have a problem with the type of contracts they are given? Lesser known artists don’t do nearly as well.

“”This feels like yet another death knell,” emailed an A&R executive at a major European label. “If the best band in the world doesn’t want a part of us, I’m not sure what’s left for this business.””

The labels are starting to be scared about this – and rightfully so.

Artists also have other choices. They could skip the labels and sell directly to on-line sources like iTMS, Amazon.com, etc.

Conclusion

The record labels have built an empire based on what is now considered to be an out dated business model. As times have changed the record labels have been slow to adapt. Changes in technology have made music piracy not only easy but common. The record labels have been slow to offer what consumers want: CD quality music at a reasonable price ($.99 per song for example) in a non-DRM format. The record labels have been slow to even offer music for sale online and are only just now “testing the waters” with DRM free music sales.

I have a few suggestions for the record labels.

#1 – Offer a product people want to buy.

For any business to be successful, they need to offer a product that consumers want. Ideally, it would help if they didn’t treat their customers as criminals. The music can be stolen without DRM restrictions, so why punish your legitimate customers? I’m not aware of a single song that can be purchased and is not also readily available to steal.

#2 – Work with your partners, not against them.

Companies like Apple have brought the music business into the 21st century by offering a solid business model along with the best tools of the trade in terms of online store. It’s the benchmark by which all other online stores will be compared. Don’t work against companies like this, work with them.

#3 – Think about the message you are trying to send.

The RIAA may be acting on your behalf, but they are neither effective in curbing piracy, nor are they helping the image of the music labels. In one of the links above, they’ve already admitted that their legal actions have been a losing proposition. Clearly, they are spending more money on their legal actions then they are receiving from their settlements and lawsuits. It’s plainly obvious that they haven’t made a dent in curbing piracy either. The money they are spending would be better served in educating people why it’s necessary to support the artists and not steal. Make people want to do the right thing. Some people will steal regardless of what you do and it’s unlikely you’ll be able to make a dent in attempting to prosecute any significant number of them.

#4 – Consumers don’t want subscriptions for their music.

Really, is there anything in history that would lead these record labels to think that subscription based sales works for the music industry? Hasn’t this been attempted already with each attempt failing miserably? I realize greed is the motivating factor for schemes like this, but does anyone consider doing a sanity check here? Imagine selling a lower end device for $79. In just over a year’s time, the manufacturer would have to give that much money to the music labels. That’s insane. Equally insane would be to bake that cost into the new products. Let’s see, I could by brand x for $100 or brand y for $300 and have the privilege of downloading free music legally. Really, Universal’s plan is dead in the water before it starts. A healthy dose of common sense is needed here.

The reality is, the music labels are facing a rapidly declining business. For example, it was reported that Universal’s earnings fell 25% for the first half of this year. Much like the now extinct race of dinosaurs, the existence of the music labels is being threatened. They don’t understand their customer’s wants and needs. They are suing their potential customers and they are striking out against their own business partners. Worse, they come up with the most ridiculous subscription based business models in an attempt to go back to the days of fat margins, etc. These are acts of desperation, and it’s sad to see. Not only are consumers rejecting them, but it seems that artists are beginning to reject the labels as well. Time will tell if artists are able to be successful with this business model. I would image that if you cut out all of the middle men, you don’t need to sell as much music to be profitable anyway.

Finally, I know it’s easy to watch this on the side lines and play armchair quarterback. However, the items I mentioned really should be common sense. Perhaps the labels need to take a fresh look at things. If they are able to adapt and evolve, there is hope for their future. If these labels continue to flail about like a wounded animal, they are doomed to extinction like the dinosaurs they emulate.

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