The business model disruption framework as it applies to music has multiple moving pieces: Tastes change, attitudes toward intellectual property sharing differ significantly by demographic, and the place of recorded music in modern life is also in a period of deep transition. The Recording Industry Association of America (RIAA), which began as a standards body, became perhaps the most disliked lobbying group in the country by suing music lovers, which was a curious strategy, to put it charitably. Music is a small but visible industry (moving and storage was about the same size, but Mayflower never had the Grammy Awards), and it was also disrupted early in the Internet's life cycle, before telecom or newspapers, for instance. How did technology-related events and trends disrupt the music industry's business model to such an extent that its trade association felt compelled to adopt such an extreme position?
It is tempting to say that Napster changed everything, and peer-to-peer (p2p) file sharing is clearly a hugely important factor in the media landscape. It is not the only factor, however, and a series of services have in fact disappeared, sometimes permanently: In addition to Napster, Pirate Bay and Limewire have been subject to legal challenges. But as we will see, the music industry business model had a number of problems before the Napster watershed.
The goal before the Internet era was to sell physical artifacts that carry music: cassettes, long-playing (LP) records, compact discs. As platforms evolved, record companies could sell the exact same content multiple times, which was one driving impetus behind the high-resolution formats that came to market in the late 1990s: Super Audio Compact Disc (SACD) and High Definition DVD (HD-DVD). Unfortunately for the record labels, at the same time that Napster and later the iPod popularized MP3 files, the audio-buying public was viewing SACD versus HD-DVD as a reprise of VHS-Betamax: People remembered buying machines that became worthless when the other standard emerged as dominant, making software, spare parts, and resale difficult. By the time Sony's SACD format won the standards war, the market had little enthusiasm for music players that required a new form of physical media.
Record companies recognized million sellers with gold records as far back as 1942, but it was in the period between 1970 and 1980 that the industry saw huge sales of LPs: A handful of efforts from Michael Jackson, Pink Floyd, Fleetwood Mac, the Eagles, and other artists sold in excess of 40 million copies over their lifetime. For a number of reasons, labels sought a 10-million-seller rather than ten 1-million-unit milestones: The industry first became album driven (in that 8 to 12 songs were bundled into a 40-minute LP rather than being sold individually), then hit driven. The profit formula also was predicated on keeping artists in a disadvantaged position with regard to contract provisions and enforcement: Senator Orrin Hatch (a Utah Republican who has written more than 300 songs) once remarked that music is the only industry in which, after you pay off the mortgage, the bank still owns the house.1
Control of physical factories was essential: While pirate physical copies of LPs then CDs were available in some foreign countries, the complexity of manufacturing helped maintain the labels as an oligopoly. The labels viewed cassette taping with alarm in the 1970s, but the audio quality of tapes was inferior in most cases, as was the quality of the cover artwork, for which the LP format was ideally suited from a graphics perspective. Finally, the artist and repertoire function of discovering new bands was essential: Much like baseball scouts, certain individuals developed a track record in discovering successful new acts.
In addition to the supply chain of discovering talent, packaging albums, and distributing physical media, two other processes deserve mention. Touring was often an important tool for building support for a new release. Also, music is a prototypical information good insofar as it presents a sampling problem: The only way to know if you like a book, video game, movie, or song is to experience the artifact itself. Statistics, reviews, and word of mouth help, to be sure, but radio played a key role in solving the sampling problem for recorded music. Later, just at the dawn of the CD format, MTV pioneered the music video that performed a similar function. Getting a song onto radio and, later, cable television often made the difference between a hit and a miss. Not surprisingly, money and favors could be exchanged in this pursuit, most notoriously in the payola scandal that cost disc jockey Alan Freed (who coined the term “rock ‘n’ roll”) his career in the 1950s, but also as recently as 2005, when then New York attorney general Eliot Spitzer settled out of court with three major labels, each of which paid a multimillion-dollar penalty.
Technology Evolution and Industry's Response: The Case of Home Taping and MTV
In the late 1970s, the labels had succeeded in making disco music a perfect fit for the mass-distribution model. The problem was that the intense focus on the genre had run the industry into a cul-de-sac: As me-too acts multiplied, the American audience's appetite for disco dropped sharply, and there were few acts of other styles in the pipeline. Despite this saturation, the industry focused its public relations, legal, and lobbying efforts on stigmatizing and if possible outlawing the practice of cassette recording. One industry campaign featured a cassette-shaped skull and crossbones with the tagline “Home taping is killing music.” Rather than exploiting this new, popular technology, labels fought it. The RIAA's president claimed that for every album that was bought, another went unbought because of taping. The RIAA also claimed that 425 million hours of music were taped even though blank tape sales were only half of that total.
Record sales had fallen 11.4% in 1981 and were rumored to be headed for another double-digit decrease in 1982. That year Columbia Records alone fired 300 people from the label while such superstar acts as Blondie and Fleetwood Mac canceled tour dates.
Enter MTV, a venture launched in 1981 by Warner Communications, which sold it to Viacom in 1985. MTV introduced a new musical vocabulary including heavy doses of synthesizers and electronic drum machines into the American market, initially including British pop acts like Duran Duran and the Eurythmics that enjoyed huge success in the 1980s. The technology innovation of replacing or augmenting the top-40 single with a cable TV music video changed the promotion landscape dramatically and introduced fresh “inventory” into the supply side of the music pipeline. In the end, the “crisis” in the music industry was not the fault of the tapers—who did not cease and desist even as the industry subsequently logged unprecedented profits—but had to a large extent resulted from stagnation in musical innovation at the major labels.
Michael Jackson's Thriller LP is widely credited as the first release to consciously utilize the new MTV promotional medium (e.g., by hiring commercial directors to make music videos as mini-movies): It sold between 26 and 40 million copies, depending on who's counting. At the same time, MTV's technology further intensified the music business's blockbuster economics that are in part responsible for the current situation. Being able to pass video costs on to the performer allowed labels to avoid confronting the vast potential of the new medium while limiting risk.
The 1990s witnessed at least a dozen changes to the music industry business model that helped set the stage for the knockout punch that Napster delivered. Any one by itself was not crippling but, en masse, these changes shifted the foundations of the industry sufficiently that labels were unable to respond to the challenge of p2p, in large measure because the customer value proposition was perceived to be unfair to both consumers and artists, who continued to enjoy favorable fan response.
These changes combined to create a slowdown: Compared to the doubling that occurred between 1989 and 1994, purchases of recorded music increased only an average of .4% per year between 1996 and 2002, as Figure 18.1 illustrates.
Against the backdrop of so many challenges to the core business model, from stale inventory of new acts, to poor perception of the labels by consumers, to heavy overhead in the cost structure of music production and distribution, Napster hit the industry like a lightning bolt: In November 2000 alone, 1.75 billion songs were downloaded via the service. That number, annualized, projected to 21 billion songs, or about 1.5 billion CDs. In 2000, the U.S. retail channel moved about 1 billion CDs. In essence, the “inferior” technology (with a poor interface, complicated naming conventions, and obvious audio inferiority) effectively surpassed the entire retail channel as a distribution mechanism in one year. In addition, it was a highly centralized system in contrast to later file-sharing arrangements, but at its peak there were reportedly 25 million users and 80 million songs, and the system never once crashed.
With public perception of the labels already low because they were perceived to be exploiting both customers and artists, ripping off the companies was morally less complicated for college-age students than was, say, stealing books from a public library. When the labels began suing music lovers (or mistakenly suing people who did not listen to music), that perception took a further downturn. Meanwhile, the holding companies within which the labels resided were dissatisfied with their poor performance: Labels simultaneously faced pressure from artists long ill-served by standard contract practices, from listeners, from retailers that moved CD selling space to more profitable ventures, and from their bosses.
Enter Apple, a company with a substantially more positive public persona. The iPod was neither the first nor the most powerful MP3 player. It did employ systems thinking to create a seamless, easy user experience, and co-founder Steve Jobs' background in Hollywood while at Pixar gave him familiarity with the entertainment industry. Here as elsewhere, the business model was more a shift in perception rather than a technology breakthrough. As one industry analyst noted in 2002, “The music label executives we spoke with are so sure piracy is destroying their business, that they seemed strangely uninterested in the truth.”2 Apple was able to bridge the CD and MP3 models for a significant portion of the market by simultaneously satisfying the labels (in part with copy protection) and customers (with ease of use, clever marketing, and hardware integration) in ways the labels by themselves could not.
Another brand play was being made by artists themselves. While the most common tactic is buying (or rerecording) one's back catalog, other artists are releasing directly to various forms of download. Perhaps the most famous and successful episode for experiment was Radiohead's experiment in name-your-own-price downloads, which let fans (legally) pay nothing for the album In Rainbows. While many paid nothing (or downloaded p2p copies), the average amount paid was £4 ($5.70 at the time). Once it was released in physical formats, the album sold 3 million units in all formats; a limited edition box set of LPs and CDs with other extras sold 100,000 units at $80 apiece. Thus, the band conducted a real-world experiment in versioning information goods, letting the market segment into multiple price tiers in exchange for varying bundles of value. The experiment has also never been successfully repeated, even by the same band.
By 2010, download sales, never on the scale of physical CD sales, had stagnated.3 Streaming services such as Pandora and Grooveshark were adding users at a rapid rate at the same time that iPod sales slowed (nearly a fifth between 2009 and 2010) in the face of smartphone and tablet adoption.
Touring remained big business: The 13 highest-grossing tours ever, each of which made more than $200 million in 2010 dollars, all occurred after 2001—in other words, after Napster. Significantly, nearly all (with the exception of the Backstreet Boys in 2001) were acts in their 40s or older: the Rolling Stones, U2, Cher, Madonna, the Police, and Bruce Springsteen, for example. Although so-called 360-degree deals are coming into favor (where the label helps promote, and takes a cut of, merchandise and tour revenues, for example), generally bands rather than labels keep most of the tour profit.
Because the hardware is locked down more tightly than CDs or DVDs, game platforms have generated surprising revenues for bands and labels: Inclusion of a track in a sports title or in Rock Band or another music game generates revenues, though labels typically are—unsurprisingly—unhappy with the royalty rates. In the three years after the launch of the plastic-guitar game genre, revenues were reported in the $2.3 billion range, but sales dropped rapidly when the fad passed; in 2010 Viacom sold its music-games business, which like other console games faced a major disruption of its own from low-tech social games such as FarmVille.
It's hard to imagine an industry responding much worse than the record labels did when faced with such a significant challenge. Taking profit margins almost as a birthright, most decisions—including appeals for legislation—were premised on maintenance of the status quo. Several decisions have proved crucial, most falling into the mind-set/worldview camp rather than a technology challenge per se:
For the music industry to recover even partially, online distribution will need to be managed in a seamless web of actors, channels, and audiences. Live music, television, streaming, and licensing can all contribute to overall revenue. Both extreme localization and global megastars play a role in the ecosystem. Finally, the place of a music label in talent identification, content generation, and digital distribution needs to be redefined from a blank sheet. Music matters to many people, but making it profitable for the various entities in the industry remains a challenge.
1. Orrin Hatch quoted in “Rights Issue Rocks the Music World,” USA Today, September 16, 2002, www.usatoday.com/life/music/news/2002-09-15-artists-rights_x.htm.
2. Josh Bernoff of Forrester Research quoted in Dan Bricklin, “The Recording Industry is Trying to Kill the Goose That Lays the Golden Egg,” September 9, 2002, www.bricklin.com/recordsales.htm.
3. Glenn People, “Growth in Sales of Digital Downloads Slows to a Trickle,” Reuters, December 10, 2010, www.reuters.com/article/2010/12/11/us-downloadsidUSTRE6BA09620101211.
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