Economics, intellectual property rights, music industry

The Future Of The Music Industry. It’s so simple.

Sometimes it really does take ages for people to understand things have changed (and sometimes I have to include myself here). The Music Business will be a wonderful case study to illustrated the argument – in ten years. Right now, the industry is still struggling to come to terms with its new economics.

Yesterday Wired News informed about a policy conference held by the Future of Music Coalition in Washington, DC this week. The predominant idea was apparently that everybody involved in the business – musicians, independent and major labels, politicians, consumer electroncis and computer manufacturers as well as consumers should try to seek a compromise regarding the alleged problem of unpaid digital downloads. Jenny Toomey, exectuive director of the organising committee summerised the general approach as follows – „I think we’re looking for a kinder, gentler, more equitable model where more people can make a living off of this stuff.“

Sweet. Lovely. But I don’t get just why so many people in the industry can’t seem to see the wood for trees. There’s no real need to sit down and hold hands for all these groups with seriously conflicting interests. This is one of the instances where the market is actually going to solve the problem (in the longer run).

Sitting down and holding hands will only serve the interests of those who are trying to extend the cash flows of times past into the digital age while they are transforming their business to become less dependent on record sales – there’s a reason why vertically integrated media conglomerates are flooding our screens with instant-star shows. Teenagers (still one of the industry’s most important target group) may buy (~15%) less records these days than they did before Napster, but now they watch more advertisments.

Information goods are tricky when it comes to economic analysis. This even more true in the case of music. As opposed to most other products, economics have a hard time telling us about „the optimal level“ of music production and consumption. What’s even more important – most models don’t take the intrinsic musical motivation into account. Given that most people create music without ever even intending to make money with it, those models are not exactly representing reality.

The new digital distribution model allows to target smaller audiences and make more money than before – if you do it correctly. However, while a lot of musicians who have not been able to live off of their art in the past will increasingly be able to do so in the future, it will be much more difficult to get into the average Madonna income range by performing music. The current winner-take-all market structure will likely disappear.

I find it startling that artists like John Flansburgh of They Might Be Giants say that they would prefer the semiotic control of a major label’s product manager to the control exercised by an audience/market. Wired cites Flansburgh saying that „it’s ironic that we’ll miss the majors when they are gone.“ Madonna might. You probably won’t.

While electronic markets for music are still in their infancy, things are already changing with the advent of useful machine listening software. Just think about a catalogue of all the music that matches your style preferences, whoever wrote it, whoever performed it.

According to the article, The Hooter’s Eric Bazilian stipulated that „[t]here’s an incredible amount of mediocrity,“ due to the reduced costs to produce songs and put them on the web. That is very true. But there are also so many gifted, struggling musicians who never had a chance to create a market for their music because of the Major label’s gate keeper function. Now they are able to reach an audience and transform their cultural achievements into a product. I don’t understand why a musician would believe that it is a good thing to keep music from being published?

There will be new sources of information, like trustworthy journalists reviewing new songs, online fora. People providing valuable services, possibly for money. Or, as I believe, there will be quality settings in the machine listening software allowing the customer to get exactly the recording quality she wants.

Don’t tell me people would not want to pay for such a search engine which, in turn, would be able to pay for the creativity. Not the amount BMG pays Withney Houston, obviously.

But there will be a whole new middle class of artists. And they don’t need to sit down with anyone. They just let the technological development work in their favour. And in ten years, they will teach the music industry case study. If the latter should not be able to use its political clout to perpetuate its current powerful structure into the digital age.

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intellectual property rights, music industry

The widening perception-realtiy gap.

I was just about to tell you about the following press statement by Forrester Research – eloquently titled „Downloads Did Not Cause The Music Slump, But They Can Cure It“ – concerning their understanding of the whining record industry’s situation when I went to the kitchen to get some coffee. While waiting for the coffee getting ready, I switched on the tv and witnessed something I was not prepared to see tonight: The real reason for the record industry slump. Bad artists, lack of creative impulses. Short term product/cash flow orientation. Here’s what I am talking about. A semi-rap song which features the chorus of Glenn Madeiros’s 1987 one-hit-wonder „Nothing’s gonna kill my love for you“ – sung by a female singer who is not the artist being marketed.

The guy is a former semi-popular soap opera actor. And he has had a hit in 1998 with yet another cover version. All that sounds favourably to the account managers of the banking industry labels havbe become today.

Now I don’t think that starring in a soap opera automatically disqualifies people to call themselves musical artists, as the Kylie experiment clearly demonstrates. But it doesn’t reduce the burden of proof. For Oli P that burden is clearly too much to bear.

But back to the press statement referred to above. It’s announcing yet another study regarding the once famed and now bashed market for digital music. Forrester is basically agreeing with me and the record industry manager Argumention below that things will get better once the industry finally comes to terms with reduced excludability and concentrates on improving the customer value of its product. This is the core of the statement (note: The music bill of rights is a set of features designed to enhance the musical expericence defined by Forrester):

In the next two years, labels will struggle to deliver on the promise of digital music, but their services will fall short because they fail to match the Music Bill of Rights. But by 2005, labels will endorse a standard download contract that supports burning and a greater range of devices. Downloading will start to soar in 2005 as finding content becomes effortless and impulse buys easy. Labels will make content available on equal terms to all distributors, while online retailers become hubs for downloading. By 2007, the new business model will generate $2.1 billion, or 17 percent of the music business. Big hits will spark traffic, as people download music directly to their cell phones, portable players, or PCs.

We’ll see if they will still need semi-singing semi-popular soap opera semi-heros by then.

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compulsory reading, intellectual property rights, music industry

They’ll fuck up the pricing for at least five years!

This article in the Economist – about virtual Christman shopping and AOL TimeWarner’s hopes to get their by creating a new e-commerce platform – prompts me to tell you three things:

Firstly, my spacebar justbroke for no obvious reason (but being sick of being hit several thousand times a day).

Secondly, AOLTW is a tad bit late to establish a general shopping platform. It will cost them a fortune to get the critical mass anytime soon which limits their ability to lower prices as the competitors can and do (and is important especially in these economically troublesome days). This leads me to the last� – only somewhat related point:

Thirdly, I wanted to let you know the one quote that will make you relax about everything digital-good-commerce-profitbility related for at least three years to come. It is from some now likely fired e-record-company executive who mentioned back in 1999 that Ecommerce companies (especially those companies trading digital goods) „… will fuck up the pricing for at least five years.“ Very true. But they haven’t quite understood yet that negotiating tougher measures on Capitol Hill and its equivalents, coming up with yet more international regulation will not solve the fundamental problem of creating value for the customer. Scientifically put, you can find the argument in this article from ! 1988 –

Pethig, Rüdiger, Copyright and copying costs, Journal of Institutional and Theoretical Economics/Zeitschrift für die gesamte Staatswissenschaft, 144 (1988), 462-495

The same point has been made a little more eloquently by some Microsoft employees who last week published this paper. Here’s a useful quote:

Consider an MP3 file sold on a web site: this costs money, but the purchased object is as useful as a version acquired from the darknet. However, a securely DRM [aka Digital-Rights-Management -the system in your computer that is supposed to stop you from copying from a CD, for ecample] wrapped song is strictly less attractive: although the industry is striving for flexible licensing rules, customers will be restricted in their actions if the system is to provide meaningful security. This means that a vendor will probably make more money by selling unprotected objects than protected objects.

Interesting, isn’t it? Well, legality can increase utility for a customer. Virus-proof downloading can do the same. A whole series of other stuff can, too. There’s a lot of variables to be worked on.

But as long as the relevant people don’t understand that they need to make buying a download more valuable than getting it at the p2p-service of the day, as long as they don’t understand that hackers are negotiating the prices for the rest of the digital community, the will continue to fuck up their pricing.

That record company executive said five years backin 1999. Actually, I think he was an optimist.

But time will tell.

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compulsory reading, intellectual property rights, music industry

Thomas Stein, President of BMG Europe:
Downloading copyrighted mp3 files for private purposes is legal in Germany

For all those not familiar with German copyright law, the codified German equivalent of the US principle of „fair use“ of copyrighted material is §53 UrhG. In general the clause states that copies (in this case of songs) for personal use are legal. Standing jurisdiction upholds the right of everyone to give away 7 copies of, say, a CD (no idea how they arrived at that number – maybe that was a statistic average number people involved in close knit interaction at the time the law was challenged in court decades ago).

That is absolutely legal in Germany, as long as you don’t take money from your friends. The soon to be implemented European directive on digital age copyright makes things a lot more complicated, but at least tries to keep that fundamental right in the legislation – personal non profit copies will generally remain legal (then Europewide).

No one has ever disputed that offering ripped mp3 files through a file sharing service is an infringement of copyrights. The person offering has no license to do so and the anonymity and amount of downloads of p2p services basically does not favour arguments based on the „copy to friends“-provision.

But downloading is a bit trickier. Lawyers were arguing back and forth to come a conclusion wether it would matter for a download to be covered by the protection of §53 UrhG if the copy obtained by the person downloading has been legally licensed for distribution or if the person downloading would have acted in bad faith on the presumption that was not. The record industry’s position was always that a legally licensed original was necessary for the private copy privilege. That is – until last thursday, I suppose. I was so shocked by the statement that I almost forgot to mention it:

The President of BMG Europe, Thomas M. Stein, was a guest at Johannes B. Kerner’s daily talkshow because he’s a member of the Jury of the currently broadcast German version of „American Idol“. And after admitting that he could have never become a „German Idol“ due to his bad voice he simply let it slip out like the most natural thing in the world. Downloading mp3s is legal in Germany, according to Thomas Stein, CEO of BMG Europe.

Now I don’t know if that is a consequence of a court ruling or of a revised industry policy in light of the soon to be implemented EU directive or legally correct (to make that necessary disclaimer). But it certainly is a bold statement for a record company executive.

Update

the video file in question is no longer available

This is a video file of Mr Stein’s appearance on the show. You will find the statement I am talking at about 12′ 08“ – the host asks – „downloading mp3 files is illegal?“ to which Mr. Stein replies „not if you do it only for private purposes…“. Those of you speaking German, please check, as I still don’t believe what I heard.

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intellectual property rights, music industry

The secret war. Frontline news.

This week, the Economist has published a little article about a new technology allowing the electronic recognition and identification of music. It’s well worth reading, although the article does not hint at the enormous importance of this technology (which is still being developed, to be clear about this).

You will probably remember that the music industry is currently involved in a severe battle concerning the perpetuation of non-digital age copyright structures into the digital age. I have already explained at lenghth in this „diary“ why their success would be economically inefficient and socially problematic, to say the least.

What you haven’t heard a lot about in the last years is that the copyright battle is only one front of the war that is changing this world’s cultural landscape. And while you might think that the music recognition technology alluded to in article linked to above is only about a giving you a hand in remembering tunes you heard on the radio once or twice, its implications are much bigger. Think about it – most of the songs you hear on the radio today have been selected or produced by the oligopolic major labels for one reason or another. Given the enormous amount of music out there, we need some sort of screening as we do not have the time to listen to all of the material on the market – of which, in addition, we would not like a lot.

While screening the market is a necessary element in the „music value chain“, the gatekeeper function of the major record labels is somewhat problematic in a cultural sense. There’s a lot of music out there which you might like, but will never be able to hear because it lacks the commifying support of the record industry, aka marketing and distribution. Digital distribution has already reduced the importance of the latter element in that equation, but the first one is still the most important service provided by record labels. In fact, their basic role in the industry is that of a specialised venture capital provider – and given the traditional (non-digital) cost structure of marketing a new act and their average success/failure rates, the comparison does indeed make sense. As a consequence, our record stores are mirroring a „winner take all“-market, in which very few earn very much and most earn very little.

The internet, especially sites like, most prominently, mp3.com, now owned by the French media conglomerate Vivendi, have alredy reduced the salience of physical distribution for new acts. But even with advanced systems of collaborative filtering, comparing your personal taste to that of other users on the same system, a statistically significant amount of initial consumption is needed. So marketing is still an issue, although digital distribution has increased the options for a lot of musicians previously unable to earn a living by making music. However, for broad consumption, these days, they still need a bank.

But with advent of machine listening, as described above, things will probably change considerably. It is advancing a reduction in the expected value of a specific piece of music (now that value increases with the amount of marketing put behind an act) and thus creating a musical landscape less characterised by „winners who take all“. It is doing this by really cutting the middle man, the oligopolic gatekeeper’s and fund provider’s current commidification services, out of the connection between the artist and the consumer. Think of a big market place which artists can put their music on, and consumers can look for music they like, regardless of the support they have previously received from a label. The computer has a list of criteria to listen to, possibly including production quality, lyric content, and the like – I doubt, the support by record labels will be an important element of the song’s meta data.

No wonder the middle man is scared, don’t you think?

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Economics, music industry

The strange story of Vivendi Universal

It’s been a while since I’ve looked at my last case in business school. But I am pretty sure, my successors today will certainly, sooner or later, be looking at a case study concerning the making and breaking of Vivendi Universal. There might even be two solutions to that case, one written back in autumn 1999, the other written in spring 2002. One praising the former CEO Jean-Marie Messier for his alleged vision of the converging digital world to come, the other one bashing him and the company he assembled before being sacked this summer as an obvious mistake. It might have been different back in the good old time, but in these days the half-life period of a given „right“ business decision is probably measurable in fashion seasons.

The problem at hand is that there is no theory of the firm which could possibly make sense of what Messier did in the late 1990s. From a theoretical (economic) perspective, the conglomerate he created does not make a lot of sense – back then a lot of decisions seemed to be „driven by … naive heuristics …, or the pure seductive power of Hollywood.“ (Bane, William P.; Bradley, Stephen P.; Collis, David J (1994): Winners And Losers: Industry structures in the converging world of telecommunications, computing and entertainment, good article, written back in 1997, when people still dared to admit they did not have a clue about the future…) In the end, there has been not even been a real transformation. So far even the media businesses remain largely distinct. What happened was that Messier used one company as a bank/collateral to buy others and then get rid of the original one. This process will be completed once Vivendi Universal will have divested its remaining energy and water supply assets. Jean-René Fourtou, Vivendi’s interim CEO made this strategy pretty clear at a press conference in Paris yesterday, confirming once more that „Vivendi Universal is basically an entertainment company“.

Thus, looking at the results of Messiers conquest, one can see the following three things:

  • The collateral – 41% of a profitable French utilities company, known as „Générale des Eaux“ since 1853, now conducting business as Vivendi Environnement.
  • The bet – synergies, economies of scale and scope. The future value of a vertically integrated content production and distribution empire. But so far the empire is merely a bunch of still largely unrelated communications and media assets, most importantly the previously Seagram-owned Universal Entertainment group. As most acquisitions were made by share swaps, the real result of those transactions is that direct ownership of these assets has been transformed into indirect part-ownership of Vivendi Universal. The price paid for by Vivendi was, in the end, paid for hierarchical coordination of the day-to-day business conducted by the acquired companies. Eg, Vivendi board hierarchical conrol in combination with Bronfman family control of Vivendi’s board vs complete Bronfman family control in the case of Universal. But running the conglomerate proved to be a lot more difficult than anticipated. The problem in the current CEO’s own words is that “ Vivendi Universal [has] suffered a lack of management under Mr Messier and [is] ‚chronically over-diversified‘.“ (LINK).
  • The price paid – currently 19bn Euro debt, piled up during Messier’s conquest. It was probably necessary to oust him. Some people are good are good at conquests bad at consolidation. But that is what the new company needs most now.
  • No wonder, there is no economic explanation for this – apart from capital market imperfections. No one would have invested the amount of money Mr Messier could use to acquire the businesses he wanted in a new company. To acquire assets on the scale on which Mr Messier operated, he simply needed hierarchical control over a significant amount of financial resources. His conquest was a very expensive operation. But back in 1999/2000, a lot of overpriced companies bought other overpriced companies with their overpriced shares. No one back then thought of the possibility to wait and buy cheap after the burst. That’s the nature of a bubble. You somehow feel it’s there. But then, you would not bet on it if no one else does, would you?

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    compulsory reading, intellectual property rights, music industry

    The future of the music industry.

    Last week’s ousting of Bertelsmann’s CEO Thomas Middelhoff prompted a lot of newspapers to reconsider the challenges the internet poses for companies with a business model based on the exclusive licensing and diustribution of intellectual property rights. And so I, too, want to repeat my opinion in this matter.

    Granted, the fundamental dilemma posed by changed economics of reproduction and distribution has not yet been solved: How to make people pay for formerly excluable intellectual property rights if they can obtain them for free without restrictions on the Internet. But then, consider the financial and especially societal costs of digitally fingerprinting people’s hardrives and controlling their use of the net. Assuming technical feasibility, Orwell’s nightmare would have become reality. OK, differences in degrees are certainly possible. But the trade-off remains: Which price will information societies be willing to pay to reinstore excludability of information goods at least to a certain extent?

    One of the biggest problems in this extremely important debate has so far been flatly ignored. It is the social institutionalisation of the current notion of property. Based on this notion, it is relatively easy for the music industry to claim the moral high ground and persuade politicians to restrict the private flow of information. Coupled with the increased perceived need for security after 9/11 this is a powerful political position.

    But everyone trying to climb the moral high ground should stop for a moment and reconsider what’s actually going on there. To know the history of copyright laws since Gutenberg would be a good starting point. After familiarising themselves with this fascinating topic people would have to accept that the current industry and cash flow structures are a consequence of a specific technology and its economics. New technology means new economics and in turm, new industry structures.

    Right now, those who became powerful in a world of restricted bandwidth are trying to preserve that position and the related cash flows in a world with different economics. Assuming that the industry structure evolved to suit the economics of its business, it becomes self evident that this structure is not going to fit into the new environment.

    In this respect, I recommend the excellent analysis of Harvard’s William Fisher, Digital Music: Problems and Possibilities, as a starting point.

    The cultural landscape of the future will reflect the changes in economics. The days of financing the likes of Britney Spears through sales of records as well as the need to have music companies of a significant size to keep a risk-diversified portfolio of acts are likely to end as the last bandwidth restrictions fade. That does not mean there won’t be stars in the future, just that they won’t be able to make the amount of money through record sales they could before. But the same development opens a market to so many musicians who have not been able to live from making music before. I think that is a good thing.

    But, of course, you have to decide for yourself.

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