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Music-Online
Study documents vast changes expected in music industry; Role of “label” will be reduced; but artist power increasing
By Bill Densmore
Newshare staff
Jul 22, 2002, 00:33

Internet file sharing – both legal and illegal -- means that artists, performers, and possibly web-based music sites, will assume more power and a larger share of music-industry revenues, an exhaustive study by the publisher of Screen Digest magazine concludes.

As a result, the study recommends the music industry “turn from a defensive mode into a mode where they pro-actively support new business models through licensing of content or simplification of the licensing process.” It warns: “The longer consumers are exposed to free (illegal) offerings from services like Napster, then the more difficult it will be to convert these consumers to a pay service. The longer the free ride, the less money these consumers will be willing to pay for a subscription service.”

The 240-page study by Screen Digest Limited says the industry will not achieve anytime soon an absolute technical solution to downloading piracy costing the industry $4.2 billion annually, and so labels will have to focus on “keeping honest people honest” by offering them reasonably priced downloadable songs. The increasing success of compilations marks a dramatic industry shift in consumer interest away from the album toward the song, the study adds.

Included among other 18 points in the study’s executive summary:

-- “The main currency of the record industry will be the song instead of the album.” This will force the record industry to adopt new, variable, demand-based pricing and adopt a new infrastructure for identifying the sale of individual tracks.

-- Streaming subscription services which permit a consumer to access their music from any device anywhere will become the dominant way of delivering music. This will require technology that permits the consumer to be uniquely identified no matter where their access point.

-- Internet users and music listeners are demographically
similar. They are typically under 30 and the heaviest music buyers are flocking to the Internet to satisfy their music appetites. This makes illegal downloading a critical threat to the industry because it historically has derived most of its revenues from a small number of young, heavy music buyers.

-- A handful of Internet mega music sites will emerge which provide subscription, community, e-commerce, information and other services beyond mere downloads or CD sales.

“Traditional retailers are losing one of their prime assets – control over access and relationships with the consumer,” says the study completed in May. “Increased competition will erode music retailers’ margins and lead to traditional players losing market share . . . [and] access to consumer data will allow artists to establish direct contact with their fans, which will allow them to take a more prominent role in managing this relationship.”

Study authors Jurgen Preiser and Armin Vogel also conclude that the role of traditional record labels will be reduced to marketing and talent discovery rather than distribution. Yet the labels could benefit financially, the study concludes, because while their revenues and role may shrink, their manufacturing and distribution expenses will decline even faster, making them smaller, but perhaps equally profitable businesses. And the labels will fight hard to try and gain control over access to consumer data generated by music sites that use their content, the study predicts.

“Label earnings could increase, even though the artist receives a higher share and marketing costs will have increased (a 25 percent to 30 percent rise in each). These increases would be financed by lower retail margins and lower manufacturing and distribution costs. The overall revenue could even be higher for the record industry as the calculation does not take into account an increase in overall sales spurred on by lower consumer prices or the opportunity to sell more deep catalog items,” says the study.

Industry manufacturing and distribution costs will drop by 75 percent with the switch to digital distribution, the study forecasts, and retail margins will drop by 64 percent. But marketing expenses will rise by 29 percent and royalties/advances paid to composers and performers will rise 27 percent. Overall profit will rise 7 percent, the study forecasts.

“[T]he position of the traditional record labels has become weaker,” the study says. “The decreasing importance of manufacturing and distribution reduce their dominant position in the value chain. The record companies are also threatened by the increasing number of competitors eager to establish a presence in the digital marketplace. This makes it more difficult for record labels to control all rights over an artist’s product (e.g., his URL) and might force them to pay higher royalties.”

The study predicts that the Internet will become the most important delivery mechanism for music and that the shift from physical distribution is inevitable, even though the speed of the change will depend upon how quickly so-called broadband connections become commonplace worldwide. Currently, broadband deployment – Internet links which allow downloading a song in a minute or two rather than 10 times that time -- is stalled in the United States and in its infancy elsewhere in the world other than western Europe.

OPTIONS FOR SUBSCRIPTION SERVICES

Presently, the music industry is physical product driven, the study notes. Sales of LPs, music cassettes and CDs account for 90-95 percent of a record company’s revenues, and 70-75 percent of a publisher’s earnings, it says. This could change. The study reviews the options for subscription pricing of music services offered via the Internet.

The study says Internet subscription services will gradually replace traditional mail-order clubs for CD distribution, but says there is no good data on what consumers will be willing to spend, monthly or annually, for unlimited access to music, but suggests a modest monthly expenditure could mean a big revenue increase for the industry.

The study provides good news and bad news for those considering subscription services.

On one hand, the study estimates, “[I]f all existing music consumers in North America and Western Europe (around 50 percent of the total population) were willing to pay an average $10 a month for an ‘all you can hear’ service, the size of the music market would increase by 50 percent.”

On the other hand, the study says “first indications of consumer interest in music subscription services show that about 10 percent of online users would be interested (although interest among heavy music consumers is far higher) and willing to pay $30-$40 a year, provided that it: (a) guaranteed a certain file quality (b) was free of viruses and advertising (c) included exclusive content about, and possibilities to community with, artists.” The study adds: “Such low consumption of $40 a year would half the size of the music market, should all purchasers of CDs shift to music subscription in the long term.”

One loss for labels is the cultural adjustment by the public to Internet file-sharing services.

“ . . . [T]wenty-five percent of Internet users and 60 percent of Napster users do want to continue using file sharing services,” the study says. “This continuing demand indicates that the court decision in the Napster file-sharing services case is simply not being accepted by the consumer and that the technology behind file sharing is here to stay.”

NEW BUSINESS MODEL – SYNDICATION

Another loss for labels –- and for retailers –- will be the new role of Internet music sites, which will be in a position to forge direct relationships with consumers on behalf of artists or themselves, the study says. In a sense, the study says, these sites will emerge as virtual record labels, or as retail syndicators of the music owned by the current labels.

The study concludes that each label should position itself as a product packager, or wholesaler, syndicating its music content to Internet content sites that have a broader range of other attractive, non-music offerings which attract consumers.

“In this manner, it could syndicate its subscription service, plus accompanying content, to destination sites and portals, both of which have far more experience interacting with consumers,” the study says. “By choosing this route, the record labels could avoid significant investments into branding their subscription platforms as a music destination.”

“Access to consumer data will allow artists to establish direct contact with their fans, which will allow them to take a more prominent role in managing this relationship,” the study says.

The study says Internet music sites will have to provide added value and services besides CD sales, otherwise they will have no competitive differentiation and will fail based upon cutthroat price competition. The added services should include, besides direct CD sales, digital downloads, sampling, visual artist/album information, ticket sales, streaming audio and video, chat rooms, purchase history and recommendations and after-sales service, the study adds.

“With destination sites and portals becoming the gatekeepers in the digital value chain it is not easy for the record labels to maintain ownership of consumer data,” the study says. “Consumer data represents value in itself as it can be sold or rented to advertisers. Crucially, the data also enables the industry to monitor the effectiveness of the labels’ marketing/promotion efforts.”

NO ONE LABEL CAN BE A MUSIC PORTAL SUCCESS?

The study says labels aren’t qualified to run a third-party destination site because they don’t have experience interacting directly with consumers and don’t have any service offerings beyond music. Also, the study says any single label does not have enough of a backlist or current stable of music to be attractive consumers.

“It is important that the emerging mega music destination sites cover the full range of artists, instead of preferring one label’s artists (as seen with Getmusic.com) and remain independent (a problem that CDNow.com might face).”

The effort of websites to become virtual labels will not succeed, the study suggests, if they view their role as identical to current real-world labels. Rather, they should confine their efforts to the “artist and repertory” (A&R) aspect of the current label role. The investment risk of recruiting, grooming and signing new artists could be reduced through the Internet, the study says. This “will lead to a shift in the focus of the value chain toward the discovery and promotion of content.”

PRICING THE BIGGEST CHALLENGE

Perhaps the largest area of uncertainty for labels is pricing, the study suggests. Currently, consumers have a choice between illegal sharing and downloading of individual songs, or a small number of industry-sanctioned subscription websites. The existence of the illegal offerings has made it difficult for the industry to establish subscription or per-song price points which will draw consumers, the study says.

For years, record labels have sold music by the album or CD. Collections of 10-20 songs have been physically packaged at a retail price in the range of $15.00, the Screen Digest study notes. It predicts this will change, and that labels will have to adjust to marketing single tracks – or songs, at a dis-aggregated price. The study says the digital marketplace remains too volatile to predict the typical price of a downloaded track, but that the track, not the package, will be the critical price issue for the industry.

“In the digital marketplace, the track is the driver of consumption,” the study declares. Yet it says that sales of individual tracks is hampered by the lack of any widely accepted standard for facilitating so-called “micropayments” – the sale of digital downloads or other objects at prices too small to be economically feasible for an individual credit-card payment.

There is no generally accepted definition of a “micropayment.” However, the term generally describes the purchase of goods costing about $1.00 or less. Credit-card services generally charge in the range of 20 cents to 30 cents to process a transaction of any size, plus from 1% to 3% of the total transaction amount. Because of the base fee, individual transactions of $1.00 or less become uneconomical in many contexts.

RADIO AND INTERNET DRIVE MUSIC SALES

The opportunity to sell CDs as a result of Internet usage is cited as an opportunity by the study. The Screen Digest researchers found that 50 million U.S. Internet users – about 50 percent of all online users – have listened to a web radio station, compared to only 30 percent of U.S. online users who have downloaded music.

“One fifth of online music purchasers bought CDs after hearing songs on web radio stations,” the study says. “This highlights the opportunity available to music e-tailers to drive sales through offering online radio at their sites. Whereas traditional radio cannot transform this ability into direct sales, Internet radio possesses exactly that opportunity.”

Another big correlation between the radio and the Internet cited by the study: Over 40 percent of Internet users listen to the radio at the same time they use the Internet. Thus almost half of web users, if presented with a call to action from a radio program such as a link to purchase a track, would be able to immediately respond if desired.

The study says a new opportunity area created by the Internet is the offering of online licensing of creative assets in film, television, radio, print, commercials and interactive media. “The market potential is compelling,” says the study, although such a business-to-business application will require considerable infrastructure investment. The payoff includes real-time pricing and licensing, real-time product delivery, reduced transaction costs, streamed samples and user-friendly search mechanisms, the study says.

CHALLENGE: CONVERTING OLDER LISTENERS TO BUYERS

The music industry sells most CDs to people aged 10-39, but has failed to capture an equivalent share of the much greater spending power of older consumers. As a result, the industry’s greatest challenge – aside from the threat of new Internet-based competitors – is how to turn older consumers into music consumers.

“[T]he age group most interested in music (10-24) is too limited financially to be susceptible to campaigns persuading it to increase its consumption of music,” the study says. “This age group tends toward copying music from friends, buying cheap pirated product or using free offerings such as MP3.com to satisfy a nearly insatiable demand for music with minimal financial resources.”

On the other hand, says the study, “the older age group has vast disposable income and is growing in size and the mature markets.” The study says far more of these older consumers listen to music than buy it. The authors describe this as the “sleeping potential” of the industry.

The study concludes that the music industry must pursue a dual strategy worldwide in order to grow music sales. In developing countries, especially those of Asia and Latin America with huge populations of young consumers, the goal is more sales to the 10-39 age bracket. But in mature economies with aging populations, the goal is to find a way to increase elderly consumers’ purchasing of music.


WHAT PROMPTS BUYING DECISIONS?

How do consumers determine what music to buy? The study, citing industry estimates, says between 30% and 50% of consumers say they became aware of a recording as a result of a radio program. In decreasing order, they cited TV shows, TV advertisements, radio advertisements, record shops, word of mouth, disco, concert and print articles.

The Internet barely registered. But the study says this is because not enough people worldwide have Internet access. For those who do, it says, the multiple approaches to marketing music online makes it “clear that the Internet has already reached a similar level of importance as an information channel for music as radio and TV, but only for this with Internet access.”

Although still way more important than other sources, radio is losing some effectiveness as a sales channel for music because the concentration of radio station ownership in the United States and elsewhere has altered programming formats. Few stations now mention the name of the artist or title before or after playing a song – a common historical practice when more stations had live on-air announcers. As a result, it is harder to make listeners aware of new music, the study says.

Although radio dominates for specific song awareness, the Internet as a general source of entertainment news and information has accelerated, the study founds. Entertainment as an activity accounts for about half of all Internet usage each month, the study says, and, “for about one third of all online users, the Internet has become the primary source of information on entertainment. The Net is now more important [to them] than newspapers, magazines and even TV [for] gathering information on entertainment.”