The Music Industry and the Digital Age Thanks to Stern 2010 Students Tess Carter, Chris Cramer, Adam...

The Music Industry and the Digital Age

Thanks to Stern 2010 Students Tess Carter, Chris Cramer, Adam Gromis, Cindy Miño and Rebecca Solow for their contribution to and preparation of many of these slides

Professor Sonia MarcianoAugust 2010

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Objectives• What does a label do?• What constrains the returns of a record label?• What does it take to “win”? (and what has

changed with the introduction of the Internet)

“The music industry is a strange combination of having real and intangible assets” -- Richard Branson

"The hardest thing in the world to do in this business is start a band nobody's heard of." -- Tom Whalley, Interscope Records

Main players in the music industry

Composers and Lyricists Artists Record

Labels Retailers Consumers

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4

Some of the Artists Who are Signed Become Stars…Could they Become Stars Without a

Label?

MySpace 4.3 million artists

Major Labels4,000 artists

0.09% of MySpace

Stars 600 Superstars

15% of major label artists

Explain to a 5 yr Old What a Label Does?

Signs with BMG

Signs with Warner

First album to reach Billboard

top 5 chart

Released from

Warner

19761979

19951999

Increasing success and increasing

conflict with Warner.

Or explain why Prince went back to a major?

Let’s watch a fairytale…http://www.sleepytales.com/play.php?vid=111

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Creates his own record label and

distributes his music.

What Does a Label Do?

Accounting – Order-to-cash cycle, financial and managerial reporting, royalties

Business Affairs – Negotiations, producer agreements, licensing arrangements

Marketing – sales, promotion, advertising, publicity, artist relations

Artist & Repertoire (A&R) – find new artists and develop

Human Resources

Firm Infrastructure

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Find: Identify artists who

satisfy demand

Polish and package

Promote and

Distribute

Identify taste trends/marke

ts opportunities

Retain the value of

the label’s investment

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Identify taste trends/markets opportunities

Imagine some combination of IT and human infrastructure as well as a deep industry networks designed to be just ahead of the next thing. Likely a big opportunity to exploit social networks.

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• Record companies oftentimes buy smaller independents

• Record companies go for artists who already have a following

Find: Identify artists who

satisfy demand

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$200,000-600,000

$200,000-600,000

$200,000-600,000

$100,000-$300,000

$300,000-900,000

Advance

Recording

3 Videos

Tour Support

Promotion / Marketing

Cost of Breaking In a New Artist: $1M-3M

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Polish

Promote DistributePackage

Manage recording process

Transform artist—engineer their image to fill market need/want

Manufacture music output

Polish

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Exercise bargaining power over promotional

channels

Exercise bargaining power over retail channels

Negotiate cooperative advertising arrangements

with retailers

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Polish


Negotiate prices and terms

Receive and fulfill customer orders

Execute credit and collection

Retaining/Capturing Value from the Diamond

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Make me popular

1

Give me breathing room!

3

Monetize my music

2

What does the artist want?

How is it accomplished?

Play it as often as possible

• On the radio• In a club

Get it in a bunch of outlets

• Use all distribution methods• IPP

As artists become superstars, allow for more creativity

Who gets this done?

Label Promotion Managers

Use assets of the firm and relationships they

developed

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Value chain case study: BMG

Marketing& Sales

InboundLogistics

Operations OutboundLogistics

After-Sales Service

Ma

rg

i

n

Firm Infrastructure

Procurement

Technology Development

Human Resource Management

Primary Activities

Inbound Logistics

• Identify and acquire new

artists

• Acquisition of written music

and lyrics

• Purchase and storage of CDs

• Development of market

knowledge

Operations

• Connect artists with songs and producers

• Produce songs and

albums

• Tour support

• Position artists in the marketplace

• Develop artist image and

brand

Outbound Logistics

• Determine mix of media

to produce

• Track and process

customer orders

(wholesale and retail)

• Warehouse and distribute

products

• Protection from piracy

Sales & Marketing

• Create marketing

campaigns, including

promotions

• Create advertising

and publicity tactics

• Develop and manage

relationships with retailers

After-Sale Service

• Operate fan clubs

• Liner notes and cover art

• Special access to artists

• Giveaways

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Value chain case study: BMG

Marketing& Sales

InboundLogistics

Operations OutboundLogistics

After-Sales Service

Ma

rg

i

n

Firm Infrastructure

Procurement

Technology Development

Human Resource Management

Secondary Activities

Firm Infrastructure

• Independent vs. Conglomerate

• Requires upfront capital investment to develop new

artists

Human Resources

• Royalties and advances

• Contract producers vs.

In-house

• Legal staff

Technology

• Production requires

technology investment

• Market research to understand

customer tastes and position

artists

• Develop new formats for music

distribution

Procurement

• Source written music and lyrics

• Purchase raw materials for production of

CDs

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Is the Shift in the Channel Necessarily Bad for the Label?

Inbound Logistics(Artist and music acquisition)

Operations(Album production)

Outbound Logistics(Product distribution)

Marketing & Sales(Promotion, advertising)

After-Sale Service(Fan clubs, liner notes)

Costs of Production

A&R / Production: $1.08+

Manufacturing: $0.75+

Distribution / Sales: $1.40+

Marketing / Promotion: $3.01+Overhead: $1.94+Royalties: $1.99

---------------------------------------Total Costs: $10.16

Wholesale Price: $10.75

Operating Margin: $0.59 / 5%

Package Promote Distribute


Transform artist


Exercise bargaining power over promotional

channels

Exercise bargaining power over retail

channels

Negotiate cooperative advertising

arrangements with retailers




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FIND

Identify new talent

Sign label that owns talent

RETAIN/Capture

Keep talent from leaving

Troubleshoot when artist

jeopardizes image

Intellectual Property

Protection

POLISH

Value Chain: Before Digitization

Diamonds still need to be discovered,Internet just impacts the way they are discovered.

Identify new talent


FIND

Easier to spot new talent

Open channel to reach talent

directly

Talent already comes with

established online fan base


Transform and market

artist

Bargaining power over promotions

Bargaining power over

retail

Negotiate prices, terms,

advertising

New Activities, but talent still needs record companies’ resources and connections to reach a large scale of popularity and marketability

Immediate access to fan

base

Endless marketing

possibilities

POLISH

Social media enables word-of-mouth

promotions

Lower distribution

costs increase power

Instant feedback

loop; what works/doesn’t

Talent and value retention has always been a challenge:Artists leave, change labels, look for more creative freedoms,

endure mental breakdowns


Troubleshoot when talent jeopardizes

image

Retain/Capture

Online, bad (and good) news travel

fast


Digital makes it easier to go independent

Piracy is nothing new, digital only makes it easier

Piracy has always existed in the industry. Digital merely provides a new medium for old trials.

Revisiting Value Chain: After Digital


Transform artist


Exercise bargaining power over

promotional channels

Exercise bargaining power over retail

channels

Negotiate cooperative advertising

arrangements with retailers




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Identify new talent



Troubleshoot when artist jeopardizes

image


Easier to spot new talent

Open channel to reach talent

directly

Talent already comes with

established online fan base

Eroded bargaining power over

promotional channels but more outlets

Stronger bargaining power over retail

channels but less retail

Lower physical distribution costs

Partial loss of control over production & distribution

Digital makes it easier to go independent

Online, bad (and good) news travel

fast

Ease of piracyNew model for monetizing value

Package Promote DistributeFIND

Retain/Capture

POLISH

Record company value adding activities remain the same

Value Chain: After Digitization

Similar industry threats exist, only facilitated by the

new digital medium

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Effect of the Digitization of Music

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Rank Q3 2004 Q3 2005 … Q2 2008

1

2

3

4

5 &

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Is the Shift in the Channel Necessarily Bad for the Label?

Inbound Logistics(Artist and music acquisition)

Operations(Album production)

Outbound Logistics(Product distribution)

Marketing & Sales(Promotion, advertising)

After-Sale Service(Fan clubs, liner notes)

Costs of Production

A&R / Production: $1.08+

Manufacturing: $0.75+

Distribution / Sales: $1.40+

Marketing / Promotion: $3.01+Overhead: $1.94+Royalties: $1.99

---------------------------------------Total Costs: $10.16

Wholesale Price: $10.75

Operating Margin: $0.59 / 5%

16.98 10.75

1.36

1.36

2.55

0.97

0

2

4

6

8

10

12

14

16

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Retail Price Cost of Goods Sold

Staff Cost Distribution Cost Rent Operating Profit

Value Created Costs Incurred Value Captured

Plus the elimination from the value chain of a lot of retail costs (staff, real estate, etc.)

Average Revenue and Cost of a CD25

Increasing competition Price wars could reduce retail prices

High record label (supplier) powerThis cost will likely stay the same

The retailer is squeezed on both sidesLow operating profit could go down more

Data from BMG Entertainment case

Music Piracy – Conflicting Reports

Industry commissioned studiesUS Loss: $3.703 Billion1

Assumptions:13,200 (in millions) Illegal downloads2,640 lost legitimate sales

Academic papers• Statistically indistinguishable from

zero2

261 Institute for Policy Innovation, Aug 20072 The Effect of File Sharing on Record Sales

Music Piracy

Initial Industry Response

LawsuitsAntagonize your customer base

EducationIt’s stealing

Effect on the industry

Key to reducing piracy????

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25.5%

17.3%

16.9%

15.8%

9.3%

15.3%

Industry (“Majors”) Structure

Total 1999 Market Share from US Album Sales

Others

1888

1901

18981931

1947

Concentration of Players is Related to Both the Economics as Well as the “Mobility” ProblemMajors

Pooling of Risk

Economies of Scale

Bargaining Power Over

Artists

Bargaining Power over Promotional

Channels

Bargaining Power over

Retail Channels

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Record labels have integrated

forward into concert

venues and other forms

of distribution

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History of Disruptions

Great Depression: Crisis at peak of the industry -Edison bankrupt, RCA acquires Victor, EMI formed through merger of Columbia, Parlophone and Gramophone

1877: Edison invents sound-recording devices

1947: Atlantic records founded by sons of Turkish Ambasador

1955: RCA buys Sun Records for contract with Elvis Presley

1964: 8-track tape invented

1960: The Cassette tape invented

1948: CBS introduces a LP 33-rpm vinyl record

1980: Sony invents the walkman

1923: Broadcast radio causes record sales to decline

1983: Digital CD invented

1992: Sony introduces MiniDisc Player

1982: MTV debuts

1930 1940 1950 1960 1970 1980 1990 2000 2010

2003: Apple launches iTunes music store

1999: Napster launches

1990: Sony and Phillips introduce CD-Recordable

2001: Apple launches iPod

2001: XM Satellite radio launches

2004: Pandora launches

1989: Internet invented

The Music Industry and the Digital Age Thanks to Stern 2010 Students Tess Carter, Chris Cramer, Adam...

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