NQ Logic

Technology | Strategy | Consulting

The Future of Music

The second week of December witnessed an unusual flurry of activities from the music industry.

On December 8th, Vevo, a New York-based online music video portal backed up by Vivendi's Universal Music Group was officially launched. Considered to be the "Hulu-for-Music-Video", the new venture has seen EMI and Sony Music, two of the three remaining majors, joining the company’s ownership since then. Google will take a cut of the advertising revenue in exchange for running the infrastructure. EMI is hedging its bets and broadcasts some videos already on Hulu, the successful online joint venture between NBC, Fox and ABC that mostly offers TV shows and movies for free in the US.

The very same day, MySpace Music, a joint venture between MySpace (owned by News Corp) and major labels has completed the acquisition of Imeem, the streaming music service for an undisclosed amount yet rumored to be an inconsequential U$1 million in cash. Imeem started in 2003 as a social network based entirely around music and had managed to build a vibrant community of more than 16 million users worldwide. Threatened by a potential lawsuit from the independent music consortium The Orchard, Imeem decided to seek some help from its competitor MySpace.

On December 12th, Lala, an online streaming music website backed by Warner Music Group has officially announced its acquisition by Apple for U$17 million. Although Lala’s licenses for streaming music are not transferable, Apple has acquired the engineering team and their experience with cloud-based music services. Lala, which began as a CD-swapping service in 2006, had evolved its offering to let users either stream from the web any of its 8 million songs once for free and then for 10 cents for an unlimited time, or download an MP3 song for between 79 and 89 cents. Although Lala managed to secure a mere 100,000 customers with less than $10 million annual revenue, in their acquisition, Apple has acquired a technology that will help iTunes to offer live streaming from the cloud, expanding even more its substantial 70% market share in the digital music sales in the US.

Also launched in the same week was MOG All Access service, a venture backed by Universal Music Group and Sony Music, which for U$5 per month lets users access their 6 million songs from the internet only, completing a sporadic online streaming offering with Rhapsody, a joint venture between Real Networks and MTV, and the more than famous Napster, now owned by Best Buy.

All these surprising activities have involved both very large corporations and very small amounts of cash around the very narrow theme of live streaming from the cloud. Something must be at stake if such activity occurs in the reported troubled and now apparently bankrupt music industry.

How Is the Music Industry?

All indicators are red.

Recorded Music Sales in US (1987- 2007)
Source: The New York Times (November 25, 2008)

Global recorded music spending has been plunging since 1999 in all countries, across all market segments and on all formats, except for the digital format. This 10-year trend has not slowed down and has approached today the level at what was the industry in the mid 80’s, halved since its peak 10 years ago.

Global Recorded Music Volume Trends in million Unit Shipped (2009)
Source: www.ifpi.org

What are the Causes?

[1] Continuous technology improvement helped boost sales across the last four decades. Music fans have had to constantly replace and upgrade their music collection moving from the scratchy LP’s, to easy-to-port Cassettes, to high sound quality CDs, to finally digital file formats (MP3 and others). Unfortunately for the Majors (EMI, Warner Music, Universal Music, Sony-BMG), the ultimate format upgrade to digital content was done without neither their help nor their approval, creating a tremendous hole on their balance sheets. Today with the help of free MP3 converting software, music fans are digitizing their entire music collection themselves, and do not purchase the latest new format, that was responsible of the massive sales of the past four decades. Digitalization was free of charge.

[2] Apple has proved that selling a song individually (Singles) could make sense economically for the music distributor, but it has had a large economical impact for the Majors. Albums were a source of great amount of profit in maximizing marketing effort of bundled songs of varying quality for a higher price. Today the same amount of marketing effort has to be done for each and every Single, leaving aside the less accessible songs as a niche purchase to ultimate fans. De-bundling albums increased Majors’ marketing cost.

[3] At the same time, consumers who might have been forced to purchase a full album before are now rushing to snap just the two Singles they wanted in the first place, leaving the Majors with a shortfall of revenue between the price of an Album and the price of two Singles. The revenue cannibalization has had a key impact on the Majors’ revenue over the past couple of years. De-bundling albums decreased Majors’ revenue.

[4] Moreover, because of its small price strategy, Singles’ margins are a lot smaller when compared to Album’s margins. Singles are not much of a profit maker, been seen instead in the industry as a way of promoting the Album, the real money maker. While numbers reveal that digital downloads and Singles pricing strategy seems to appeal to consumers with a steady demand, it will not be sufficient to replace the missing growth seen in the music industry for the past decade. De-bundled albums and digital download decreased Majors’ profit margin.

Music Consumer Profile in the US (1999- 2008)
Source: www.riaa.com

[5] In 1988 music was mostly purchased by people younger than 25 years old; 10 years later in 1998 most music purchases were done by people older than 30. And today the large majority of the purchases are done by people older than 40 years old. The music industry has not been able to rejuvenate its audience base, merely cultivating the same generation of customers across the decades. The same people who purchased the most records 20 years ago are still buying the most records today. Unfortunately Majors have not managed to build a deep portfolio of artists to satisfy their biggest customers and the Catalogue artists (artists with long shelf lives like The Rolling Stones) are becoming more difficult to capture for obvious reasons. Rarefying catalogue artists to satisfy their biggest customers segment.

[6] Music, like movies and books, is bought with discretionary money only. The two segments with less disposable discretionary money are the below-25 and above-65. Used to charging a high price for Albums, Majors forced the less fortunate to investigate other, cheaper alternatives. With a high price tag, majority of teens still cannot afford the amount of music they would like to consume and are not likely to convert later on in life. Youngsters do not buy music.

[7] Surprisingly enough, the majority of new releases today are aimed at the below 25-year-old segment more responsive to marketing techniques and whose tastes were developed in the hip hop and techno music era. These easy-to-replicate and vanilla music outputs are reinforcing the quickness and superficiality of the current music trend. To minimize its loss and on the hunt for a massive flash hit, the Majors are turning the table to mass produce in quick cycles what the younger people want to hear. This process is making Majors heavily depend on mass marketing budget. The constant quick, new hit impacts the music consumption behavior and the business itself in the long term. Quick music hit fuels the switching habits.

Global Recorded Music Volume Trends in million Unit Shipped (2009)
Source: www.ifpi.org

[8] The above top five countries represented 74% of the market in terms of 2008 trade value (U$13.6 billion). The Majors’ addressed market is too narrow and does not satisfy the needs of the entire world in terms of taste. 90% of the planet is not considered by the Majors. Notwithstanding the wallet share being smaller, the large majority of the “golden billion” and “next two billion” people would like to buy and can afford music at lower price points. Moreover, the top five countries are also too overexposed to marketing techniques, and in markets with a high competition with other hobbies for diminishing discretionary income. Music market is too narrow and too saturated.

World Music Market Share (2007)
Source: Nielsen SoundScan

[9] Over the past decade, in an effort to reduce internal costs, the industry witnessed a wave of consolidation. Today the four Majors (EMI, Warner Music, Sony-BMG, and Universal Music) represent over 87.5% of the market and are only leaving an undersized space to a multitude of independent labels to survive. The obvious consequence of lack of competition has been the high price point sale of the music products, but a more important consequence of such an important market power by the Majors has been the reduction of the ecosystem not only upstream (production) but also downstream (distribution). Majors have tremendous Market Power, reducing the production and distribution ecosystem.

[10] In order to diversify their distribution channel, Majors have extended their reach in the past decade to supermarkets and large retailers (e.g., Wal-Mart), under the condition of large stock purchase and small margins. Supermarkets in return only selected limited collection to whose CDs that can sell quickly, or cheaply priced back-of-the-catalogue offering. The strategy worked well enough to not only increase supermarkets’ market share to more than 25%, but also force to go out of business the majority of small, yet specialized music stores offering wide music diversity to consumers. Supermarkets, the biggest distribution channel, are pushing price down and reducing consumer choices

Is There Piracy Impact on Music Sales?

Piracy has a long history with music. Already in the 1920's, when radio stations started playing records, performances were not tracked. In remedy, BMI (the performance rights societies) later imposed to radio stations to track what they were airing and collected the appropriate copyright fees.

More recently, the International Federation of the Phonographic Industry (IFPI) the organization that represents the interests of the recording industry worldwide with some 1,400 members in 72 countries and affiliated industry associations in 55 countries, has been claiming for years that peer-to-peer file sharing is the main cause of the music industry collapse. With the help of third-party surveys and independent research, the federation says that illegal file sharing has a damaging impact on music sales, where 95% of music downloads is illegal, and 10% of the entire downloads equate to lost sales. In the US, the Institute for Policy Innovation concluded that global music piracy causes U$12.5 billion of economic losses every year.

On the other hand, some studies have contradictory findings to the above and major artists propose the counterargument that those who download are those who purchase the most, using the file sharing capability as a discovery mechanism.

It is really difficult to measure the actual net impact of file sharing in terms of dollar amount per year on lost music sales. Mass piracy has always existed since the introduction of the blank cassettes, and has been part of the discovery mechanism of music, whether it is making copies on cassettes or sharing files online or offline physically. But today, 15% of teens who file share their music collection are not making up for the decrease in sales (but is a fair contributor to the drastic decrease). Digital technology has empowered customers to make piracy a viable, fast and easy alternative to a more fundamental problem that existed in the music business for years.

"Piracy was/is only one expression of a much more fundamental problem: the customer can choose to pay or choose not to pay" — Eric Garland, BigChampagne CEO, an online media measurement company

What Is the Real Problem?

Music has always been one of the most fundamental human expressions since the beginning of time. Music is everywhere and will likely exist forever for us.

"Without music, life would be a mistake" — Friedrich Nietzsche

Consumers of all ages are listening to more music than before, and with portability and usability of digital files, related software and devices, music consumption will not slow down any time soon. Consumers like music

Daily Music Consumption in UK (2007)
Source: British Music Rights

The global music business is a U$160 billion industry. The value chain is rich and deep in every country in the world. Musicians, like sportsmen and actors, are the only few kinds of people that can reach international stardom status. Michael Jackson’s funeral was watched by more than one billion people around the planet, and since his death, his US sales totaled 7 million albums, 10.2 million track downloads and 1.3 million DVDs.

Numbers published by the Recording Industry Association of America (RIAA) says that in each year in US, approximately 27,000 new releases hit the market, and the four major labels release about 7,000 new CDs a year, but that less than 10% of albums are profitable. Artists produce music.

It is neither the changing needs nor the piracy of music that are the real problems. To the contrary, more people want music, and more music has been produced than ever. The real problem resides in the business value chain between the artists and the music fans. The four large Majors have been for years capturing the majority of the profit without distributing any benefit to members of the value chain (see Steve Albini example). Majors have managed over the past decades to centralize both the supply side (artists) and the distribution channel to their financial advantages, turning a creative experience into a sellable, marketable and merchandisable product. In forcing consumers to pay a high price on music, and in forcing artists to sign multi-release contracts that barely help them to make a living out of their creative passion, Majors have succeeded in alienating the key actors of their industry. Majors are in the business of selling units with maximum profit for themselves, not connecting music fans with artists.

Global Music Ecosystem Estimate in U$ billion (2008)
Source: www.ifpi.org - Recording Industry in Numbers 2009

Over the last decade, technology has allowed, if not empowered, both artists and fans to finally meet again, reinventing a new ecosystem from scratch. The digital revolution, in helping to lower the cost of production while marginalizing the cost of distribution to zero, gave them a chance to bypass altogether the music industry value chain that was built for and by the Majors. And it should not come to a surprise that small independent bands are following the risky but rewarding footsteps of leading bands like Radiohead and NIN, refusing to sign contracts with Majors, and distributing their own songs while making a decent living out of it. The digital music ecosystem has eliminated the middleman music record companies, not the music itself.

What’s Next?

The music industry is fast changing before our eyes and the current corporate players have not been able to invent a successful business model that meet both artists’ and consumers’ needs. What the down-spiraling sales is telling us is that the old business model in which Majors were able to extract a massive one-off payment from consumers on products they do not need, capture unfair equity share in profitable artistic creations, license at unreasonable fees any broadcasting of artist appearances, preventing access from music catalogues for unique commercial reasons, and even sue their own customers, is ultimately broken.

A new business model for the music industry has yet to be invented, but the current industry condition is teaching us that it will have to be around the following characteristics:

[1] The ultimate format for music is digital. Moreover its apparent simplicity is actually its force. LPs, cassettes are only serving a very narrow public today. Soon in the next decade CDs will follow the same path, restraining their focus to a small community. Thanks to the easy digital transformation format, artists will be able to serve a larger and global audience at the marginal cost (today 10% of planet represents 75% sales). It will also reinforce technical standards that will help to have a better quality experience on all devices available currently or in the future, but most importantly will create a way to measure interactions and build a transparent system for attribution (money) and instant ranking (reward mechanism).

[2] Music is ubiquitous, multimodal and enriching. Music will be everywhere, all the time and on all devices. Music, seen as a simple and sometimes archaic content, is an incredible supplementary one that enriches other experiences enormously in life. Many runners use their digital portable player to keep up their motivational focus, but few watch movies while running. The idea of a romantic dinner at a restaurant does not go very well with a full-screen TV, but rather with a classical quartet. Movies without well-executed soundtracks are somewhat flat, and people use music to express themselves and their moods, even with music as trivial as ringtones.

[3] Music is social and has always been. The incredible characteristic of music as a passive content is that it has always the capacity to enable social interaction from a global societal point of view and on a broader scale. People like to talk about music, experience live music as a group, give suggestion about music and share music among themselves. Peer-to-peer file sharing merely gave the means, but the human desire to enjoy, connect and share through music has always been there.

[4] Copyrights in the sense of right to copy must evolve to Userights instead. The current copyrights and intellectual property mechanisms should not be the only way to monetizing artists’ creations, and explorations of other streams can generate more revenue for all parties should be undertaken. Copying music physically is now becoming easy, but managing how the music has been used and is being listened is where the copyrights advocates should redirect their energy.

[5] Music is only one of many content types, and will have to find its place with the other newly digitized content that is coming to grips with new offerings and models, be it news(paper), videos, movies, TV programs, books, or games. Even at a cheaper price, music will have to offer a better experience from the entire music ecosystem than other content to successfully compete for consumer’s discretionary income.

[6] Catalogue access as opposed to catalogue ownership. Majors should open up the catalogue access to encourage consumers to find quick, easy ways to get what they want when they want. Scarcity often fuels piracy. A full non-disclosure access to the entire music catalogue will create an instantaneous market, reduce piracy substantially, and liberate internet traffic from its nominal transaction. This global online catalogue is actually being built by consumers without music record companies’ approval. Leading the way and re-taking control will help Majors to not only centralize the digital source for future monetization but also guarantee quality standards for global contents market competition. This leap will be the hardest to do if ever done by record companies.

[7] Fragmentation yet direct access in the current value chain. Majors have for decades managed to capture for their own profit both sides of the market equation. The supply side (artists) could only survive if they could have financial backing to reach their fans. The demand side (consumers) could only experience (buy, listen or see) what was proposed to them by the main distribution channels. The digitalization of the music business gives a unique opportunity to have the supply and the demand side to meet again without any middleman, giving more choices back to supplier and demand side. Although the fragmentation of the new business model will ultimately favor the consumers, the long tail effect will help niche artists to find directly their audience, and gain the bulk of rewards for their passion.

[8] Music is a service not a product anymore. The format digitization of the music product could not be monetized to the same level as a decade ago, and the commoditization of music should be carefully embraced by all players at the risk of fighting for price. To avoid the commoditization pitfalls, the industry has to increase the value of the products and Majors can become a “utility company” for music. In the future, the digital music product itself will not present the main source of revenue. Presence, interaction, delivery, package, and service (all of them both digital and real) will give enough financial incentives for all players. If the global bottled water market valuation is U$60 billion, the music industry should be able to do it as well.

[9] Dynamic pricing. Apple told us that consumers wanted a different price for a different product. Based on this initial success story, a more dynamic pricing system will emerge soon, involving subscriptions, multi-channel for multi-access charges, bundles and unique content, with countless of added-value services. Digital storage will be local or on the cloud (or even both), with real time or near real time access all the time. The pricing then will fluctuate based on the different parameters that consumers value, while fulfilling artists’ and value chain’s capital needs. Soon enough the industry and consumers will have figure out the best way to monetize the dedicated and unique music service offered. Existing systems, like auctions, shared revenue, subscriptions, ads model, sold as one-off units or gift certificates will evolve and be replaced by a more advanced ecosystem that still has to be invented (B2B, B2C or C2C business models).

[10] Changing industry mindset from a distribution economy (push), to an attention economy (pull), to finally reach a retention economy (capture). With an unlimited amount of content choices, and a limited amount of resources, (future) consumers will force media companies to fight for their attention. This paradigm shift forces content industry companies to evolve from pushing content down the throat of their customers who became over time impermeable to marketing techniques, to pulling attention from them for a later potential monetization. But with an increasingly challenging environment and limited consumer resources for both time and money, the successful companies will be the ones who manage to transform short-term product sales into recurrent service sales. This nascent retention economy is based on mutual trust, impeccable customer experience and flawless services delivery, far away from what exists in the current music business.

The recent quick-fire activities of the music industry illustrates that the future of the digital music business has been finally taken seriously by Major music conglomerates. With an infinite amount of choices and limited amount of time and money, consumers will now decide when, where and how to consume music. The multi-billion dollar question still yet to be answered is: Who can tell you what music to listen to?

Large corporations (Majors, Apple, Google…) are still thinking that their hefty advertising campaigns and recommendations can influence over-stretched consumers; other broadcasting companies (TV, Magazines, Radio, Spotify.com, Lastfm.com…) are still hoping that their powerful brand image could pressure over-stressed consumers; other self-proclaimed specialists (music bloggers, journalists, Pandora…) are fighting their share to convince over-harassed consumers of their diligent expertise; and finally large social networks (Facebook, MySpace…) are trusting their implemented wisdom of crowd referral principle for the final win of the over-socialized consumers. Time will tell who could most effectively capture consumers to make massive profits (with a B like in Billion) in this new digital music space.

Despite plunging record sales, the future of the music industry has never been so promising.

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