The Perfect Storm: 2000-2011

Aram

June 13, 2012

¶ 1 Leave a comment on paragraph 1 0 The year 2000 marked a turning point for the music industry; on this much, everyone can agree. Sales began to descend from the heights reached between 1995-1999, with a rapidity that justifiably alarmed artists and labels alike. With very few exceptions, each year since then has marked a continuation of this dismal trend, and by 2011, global sales amounted to only about 68% of what they had been a decade earlier. While these losses were mitigated to a degree by the rise of new revenue models and sources (as I discussed in the previous chapter), music sales remain the “bread and butter” for record labels, and, accurately or not, are seen as a barometer of the broader industry’s overall health. As I have argued throughout this book, online music sharing, though it makes a convenient scapegoat, has played only a minor role in this process. Instead, we can understand the economic transformation of the music industry as the result of a complex web of factors, amounting to a “perfect storm” to puncture the previous decade’s bubble. Most of these factors directly mirror those that contributed to the bubble in the first place, while others are more generally related to broader innovations in technology, culture and the marketplace at large.

¶ 2 Leave a comment on paragraph 2 0 One of the most important factors underpinning these changes is a profound shift in consumer psychology. The industry tends to promote a simplified version of this process, arguing that, in the wake of P2P and other forms of sharing, consumers have come to “simply believe that online music, books and movies should be free.”[1] Yet the major labels have, on occasion, acknowledged that there’s more to the story than mere freeloading. As EMI owner Terra Firma Capital explained in its 2008 Annual Review, the label’s “revenue had been declining due to the structural shift in the consumer music market and to a slow response, both by the industry and the company, to the move towards digital consumption. . . . This shift has been particularly detrimental to the consumer-facing Recorded Music business.”[2]

¶ 3 Leave a comment on paragraph 3 0 What does this “structural shift in the consumer market” consist of? We can understand it in the same terms that apply to any vibrant and competitive marketplace: convenience, quality and value. Digital music provided fans with an unprecedented degree of choice over their consumption habits, control over their music listening experiences, volume of content to choose from, and portability in their music-listening venues. Whereas physical music formats like LPs, cassettes and CDs required consumers to carry around a bulky plastic object in order to listen to ten or fifteen preordained songs by a given artist in a given order, MP3s and Internet streaming enabled them to compile their own tailored listening experiences, suited to their individual preferences, habits, time frames and locations.

¶ 4 Leave a comment on paragraph 4 0 Once this shift occurred in consumers’ behavior and psychology, they could no longer recognize the same use value in the CD format, and were therefore unwilling to accord it the same degree of market value. This process was accelerated by the massive distribution and adoption of CD “ripping” and “burning” technologies (some of which are created and manufactured by parents and affiliates of the record labels themselves, e.g. Sony), which took place independently of online sharing activity. Moreover, as the Terra Firma report acknowledges, the labels themselves can be faulted for taking a decade to absorb the significance of this shift in market demand (despite early research published by myself and others), and for failing to accommodate it sooner, despite the existence of willing retailers, distributors, service and technology providers and, of course, consumers. To put it simply, the recording industry has always benefitted economically from promoting consumer adoption of new music distribution formats; in the case of digital music, it chose to ignore and fight the new format instead, and lost out on the potential rewards.

¶ 5 Leave a comment on paragraph 5 0 This failure on the industry’s part to exploit new digital technologies and modes of consumption dovetailed with the end of the CD replacement cycle (see Figure 5). By 2000, nearly every Beatles fan in the world owned the “White Album” on CD, and yet it wasn’t until late 2010 that this classic recording finally appeared on iTunes, available for legal download for the first time ever.[3] Naturally, music sales lagged during this interim. And again, despite the prevalence of the P2P-killed-music narrative, major labels have occasionally acknowledged the role that format replacement plays in maintaining and growing their market size. Warner Music Group (WMG) has been one of the most vocal labels on this subject, consistently acknowledging in its public filings between 2006-2010 that “negative growth rates on a global basis” can be attributed in part to the fact that “the period of growth in recorded music sales driven by the introduction and penetration of the CD format has ended.”[4] WMG’s North American chief executive Lyor Cohen acknowledged this fact as well, calling the end of the CD replacement cycle the “biggest challenge” facing the company in the early years of the 21^st Century. In a 2006 interview with the Los Angeles Times, he argued that:

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¶ 7 Leave a comment on paragraph 7 0 Warner’s infrastructure was way too expensive. Throughout the 1980s and early ’90s, the success of the compact disc format allowed music companies to build enormous, expensive staffs. When the industry began to decline in the late 1990s, most companies decided that rather than cut staff, they would take shortcuts to sell more records. That’s why Britney Spears, the Backstreet Boys and ‘NSync appeared, because labels had to find huge pop hits to pay for their staffs, no matter how short-lived those hits were.[5]

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¶ 9 Leave a comment on paragraph 9 0 This exceptional candor on Cohen’s part suggests another important factor affecting music sales at the turn of the century: the waning of the “blockbuster economy” and the collapse of the boy band/pop aesthetic. The same blockbuster processes that contributed to an inflation of the music market in the 1990s undermined its value a decade later: by cutting down on aesthetic diversity, the labels put too many of their eggs into a single basket, and once that basket sprouted a hole, the eggs were lost. P2P, and other forms of digital music, played a role here. While music promotion and distribution channels were highly concentrated in the 1990s, it was unnecessary for labels to diversify their offerings, and unlikely that most consumers would develop the expectation of greater variety. But as innovations like MP3, portable digital devices and streaming music gained widespread market traction, music fans began to experience the “long tail”[6] through metaphors like “custom radio,” “play lists,” and “shuffle,” listening to a wider range of musical styles in a broader array of contexts. By the same token, the promotional stranglehold maintained by the monolithic gatekeepers of radio and television was loosening thanks to the growing popularity of independent online music sites and services, both licensed and unlicensed. By the mid-2000s, there was neither the economic necessity or the market demand for the kinds of blockbuster acts the recording industry had emphasized in the 1990s. Yet the labels were essentially stuck with this model, having jettisoned both the artists and the infrastructure to accommodate smaller, more targeted markets. As a result of this mismatch between the expectations of music buyers and the capacities of music sellers, the market suffered.

¶ 10 Leave a comment on paragraph 10 0 Another major factor in the contraction of the global music market was the “unbundling” of songs. As I discussed in Chapter 2, the introduction of the LP vinyl music format after World War II contributed to the ascendance of a new product category – the album – in which songs were bundled together and essentially sold at a discount relative to their aggregate price. By the 1960s, the album had become more than just an economic and technological convenience: it had become the dominant metaphor through which recording artists and their fans communicated. Programmatic recordings like the Beach Boys’ Pet Sounds (1966) and the Beatles’ Sgt. Pepper’s Lonely Hearts Club Band (1967) conceived of the album as a contiguous suite of interrelated songs, rather than a more or less random assortment of radio hits. Increasingly elaborate and well-designed album cover art and packaging helped to communicate this aesthetic to fans, and to establish a sense of the work as a discrete category.

¶ 11 Leave a comment on paragraph 11 0 Yet not every album was like Pet Sounds. A significant portion of album releases continued to contain mostly “filler” material punctuated by a handful of hits. This was an economic calculation on the music industry’s part, tailored to make consumers pay more relative to the number of songs they genuinely wanted to hear, and it inflated the value of the music retail industry above the level of actual demand. As iTunes, Amazon and other retailers began to offer digital “singles” in the 2000s, and as iPods and other new digital music players offered fans the ability to create their own play lists and to listen in “shuffle” mode, consumers began to spend their money more strategically, purchasing only the individual songs they wanted to hear. Naturally, this deflated the music retail market by cutting out the portion spent on filler. As MTV co-founder, former AOL Time Warner COO, and current Clear Channel CEO Bob Pittman acknowledged a few years ago, the reversion to digital singles as the dominant sales format has had a far more ruinous effect on record industry revenues than file sharing has. In Pittman’s words, “Stealing music is not [what’s] killing music. . . . When I talk to people in the music business, most of them will admit the problem is they’re selling songs and not albums. I mean, you do the math.”[7] After doing the math, Harvard Business School professor Anita Elberse concurred with Pittman, concluding that it is indeed a significant factor in decreased sales revenues. As she wrote in a recent article: “I find strong support for the hypothesis that revenues for [albums] substantially decrease as music is increasingly consumed digitally. While the demand for individual songs is growing at a faster rate than the demand for albums is declining, the dollar amounts gained through new song sales remain far below the level needed to offset the revenues lost due to lower album sales.”[8]

¶ 12 Leave a comment on paragraph 12 0 Sales have also declined over the past decade as a result of the continuing evolution of the music retail industry. As I mentioned above, MAP pricing schemes artificially sustained the sales price – and therefore the aggregate sales value – of CDs beginning in the mid-1990s. This ended abruptly in 2000 (see Figure 8), when attorneys general from 43 US states launched an investigation into its potential anti-competitive implications. Two years later, the suit against the labels was settled for $143 million in cash and donations, with no admission of wrongdoing by the labels. However, then-Attorney General of New York Eliot Spitzer announced that the agreement was “a landmark settlement to address years of illegal price-fixing.” In the eyes of regulators, there was little question that this scheme had impacted music spending. In fact, former Federal Trade Commission chairman Robert Pitofsky estimated that consumers had overpaid roughly half a billion dollars for music during the half decade that MAP was in place.[9]

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Figure 8: 21^st Century Music Retail Transformation and Global Music Sales Revenue
 

¶ 14 Leave a comment on paragraph 14 0 With the end of MAP, CD price points plummeted in the US, and so did retail margins. This happened at just the moment when real estate costs began their greatest climb in American history, causing home values to double in less than a decade,[10] as retail space underwent a similar escalation in cost. While big-box stores like Wal-Mart and Best Buy could absorb these losses, music specialty chains began to turn belly-up. HMV scaled back its operations, closing its last American store in 2004. Tower Records and the Musicland Group (owner of Sam Goody) filed for bankruptcy in 2006. In 2007, Virgin Group sold its North American megastore business to a real estate conglomerate, which then decided to close every store.

¶ 15 Leave a comment on paragraph 15 0 These closures had a profound effect on the music retail market, beyond the mere loss of brick-and-mortar square footage. By 2003, due in large part to its massive, post-MAP discounts on CDs, Wal-Mart had become the top music seller in the world. Yet, because its focus was solely on bringing in foot traffic, its music selection was far more limited than those of Tower or HMV. Why waste valuable shelf space on “niche” music when Shania Twain marked down to $9.99 is all you need to bring in hordes of potential big-ticket shoppers? As the music chains disappeared, so did the music from off the beaten track and below the Top 40. This inevitably undermined music sales overall; though popular music is, by definition, the most popular, independent record labels have historically made up about 20% of the marketplace, and major label “back catalog” (typically older releases and former hits) made up about 30-40% of the remaining sales. In other words, by 2003, the world’s biggest music retailers were selling only a tiny fraction of the commercial music library, and even the popular titles they did carry addressed only about half of total market demand in terms of volume.

¶ 16 Leave a comment on paragraph 16 0 This winnowing of the brick-and-mortar music selection didn’t sit well with music buyers. Some shifted their purchases to online CD retailers like Amazon, which had (virtually) infinite shelf space, and therefore a broader range of music for sale. Others began to buy their music from digital retailers like iTunes (which was still burdened by the yoke of DRM). And others shifted their music discovery and acquisition onto online sharing platforms like P2P, or streaming platforms like Pandora. As real estate prices continued to climb and consumers became more comfortable with buying their music online, this process began to accelerate. By the end of the decade, big-box retailers had scaled back their already limited music shelf space to make way for other low-consideration entertainment goods (such as movies and games), while iTunes surpassed Wal-Mart as the world’s top music seller in 2008. Given the fact that digital goods tend to have a lower retail margin than physical ones, in addition to the unbundling process I described above, this change, like each new development in music retail over the past 15 years, only further undermined the total value of the music retail market.

¶ 17 Leave a comment on paragraph 17 0 There has also been a less quantifiable, but in many ways far more valuable, casualty: the sense of localized music community best represented by independent record stores, and celebrated in books such as Nick Hornby’s High Fidelity and films such as Empire Records. This community has been slowly eroding ever since the “mom-and-pop shops” came under siege in the 1970s, but the total commoditization of music at the hands of Wal-Mart, and its consequent dematerialization in the digital ether, were the final nails in the coffin. As I discuss throughout this book, I believe there are many social and cultural benefits that accrue from online music sharing, but none of them can exactly replace what’s been lost.

¶ 18 Leave a comment on paragraph 18 0 Despite the death of the mom-and-pop shop, the digital age has been a massive boon to the sale of used and independently distributed music – neither of which appears in the IFPI’s market figures (because they don’t generate revenue for the member labels). These markets have never been conclusively measured, to my knowledge. However, there is compelling evidence that both have grown significantly in the past decade, competing with RIAA and IFPI constituent recordings for consumer music expenditures. According to a 2007 Billboard article, for instance, the market for used recordings may have doubled or even quadrupled during the early years of the new century. Among the retailers they interviewed, “used CD sales have grown from about 5 percent to sometimes 10-20 percent of overall CD revenues.”[11] While this may be a relatively short-term phenomenon, a self-limited consequence of the commoditization of CDs and the shift of the marketplace to digital distribution, the same can’t be said for independently distributed music, which has no reason to halt its ascent.

¶ 19 Leave a comment on paragraph 19 0 For one thing, there’s simply more of it. With cheap music production tools like Apple’s GarageBand, as well as thousands of free and open-source audio production programs, the sheer volume of independently-produced music has escalated dramatically over the past decade. A recent report by media researchers Michael Masnick and Michael Ho shows that music metadata company Gracenote has increased its database of recorded music tenfold in the new century, from 11 million songs in 2001 to over 100 million in 2010.[12] While not all of these new entries are necessarily newly released, they certainly represent songs that are newly available in the marketplace. For another thing, “long tail” economics have leveled the playing field somewhat, allowing independent music to share virtual shelf space with the biggest sellers on iTunes, Amazon, and Spotify.

¶ 20 Leave a comment on paragraph 20 0 While there’s no way to quantify the total size of the independently-distributed music market, there are some market indicators that suggest its size is growing significantly. First of all, independent music isn’t just available on digital music services – people actually listen to, stream, download, and purchase it. Chris Anderson showed this to be the case in his book The Long Tail, in which he demonstrated that 45 percent of sales revenue at digital music seller Rhapsody could be accounted for by “products not available in [the] largest offline retail stores.”[13] Similarly, Pandora founder Tim Westergren recently testified before Congress that 70% of the artists whose music is played on the digital radio provider (generating performance royalties) are independent. We can also see hints of this market’s size by looking at individual aggregators of independent music. CD Baby, a rapidly growing company that sells over 4 million songs by over 300,000 independent musicians, reports on its web site that it has paid out over $200 million to its artists to date,[14] suggesting a retail value in the range of $250-300 million. Similarly, independent digital music distributor TuneCore, founded in 2005, currently accounts for about one-tenth of the songs – and 4% of the revenues – on iTunes, or about $70 million annually from that source alone. According to founder Jeff Price, the company has already paid over $300 million in royalties to its member artists.[15] And, as I mentioned in the previous chapter, crowdfunding company Kickstarter raised $20 million for independent musicians in 2011, and is on course to double that in 2012. In short, there are hundreds of millions – or even billions – of dollars spent on music purchases each year that don’t figure into the IFPI’s official tally, and this number appears to be growing sharply. Doubtlessly, at least a portion of these expenditures are responsible for diminishing major label music sales through competition.

¶ 21 Leave a comment on paragraph 21 0 Finally, just as the booming economy of the 1990s inflated the value of music sales during that period, the sagging economy in the 21^st Century has deflated the market, a factor exacerbated by increased competition for consumer discretionary spending from growing sectors like home video, video games, internet access, and mobile applications.[16] After a decade of unprecedented expansion, the US economy suffered two major recessions in the course of a decade, while median household income dropped from its historic peak (see Figure 7). While these factors aren’t typically acknowledged by piracy crusaders seeking to place most or all of the blame for their misfortunes on P2P and online music sharing, the major labels have occasionally acknowledged that their market, like any, is subject to the vagaries of the global economy. Predictably, this has happened more frequently in the discussion of good news than bad. For instance, in a 2005 press release, the IFPI acknowledged that improvements in the music economy over the past year had been due in part to “economic strength and strong releases help[ing] CD volume growth.”[18]

¶ 22 Leave a comment on paragraph 22 0 In short, we cannot blame P2P – or any single factor – for the heavy decline in global music sales over the past decade. However convenient it may be to scapegoat online music fans for the industry’s woes, the preponderance of evidence points to a far more complex, and interesting, picture. The 1990s’ perfect bubble was popped by the new century’s perfect storm, driven by factors including the end of the CD replacement cycle, the transformation of the music retail sector, increased competition from used and independent music as well as other entertainment products and services, and a dismal economic climate. If “piracy” played a role at all, it was more likely in the form of massive commercial CD duplication (primarily in emerging markets), which according to the IFPI has grown from roughly 165 million units in 2000[19] to 1.1 billion units in 2008, accounting for $4.6 billion in sales that year.[20] Nor are the many factors of the music industry’s perfect storm discrete. We can’t confidently ascribe 10% of the market contraction to one, and 20% to another. To the contrary, they are deeply interrelated; the bad economy helped to drive the housing bubble, which helped to push brick-and-mortar retailers out of business, which helped drive consumers to digital goods, which accelerated the unbundling process, and so forth. At the end of the day, all we can say is that these many factors, taken in aggregate, represent the conclusion of an economic cycle for the music industry, and inaugurate another, with its own threats and opportunities.