The Devaluation of Recorded Music: A New Business Model for the Music Industry

Richard Strasser. The Business of Entertainment. Editor: Robert C Sickels. Volume 2. Praeger Perspectives Westport, CT: Praeger, 2009.

The release of a new album is usually heralded with much fanfare and enjoyment for those involved in the creation, manufacturing, and sale of the compact disc (CD). However, when the iconic artist Prince released his album Planet Earth, the music industry was not in a celebratory mood. Instead of releasing the album through traditional retail channels, Prince, on July 15, 2007, in a deal believed to have earned him $2 million, released the album through The Mail on Sunday newspaper. By bypassing retailers and delivering a CD through the newspaper, Prince’s spokesperson stated that the artist’s “only aim is to get music (directly) to those that want to hear it.” This audacious move by Prince infuriated retailers who say that such “giveaways” reinforce that recorded music has no intrinsic value. In a keynote speech at the New Music Conference in London, Entertainment Retailers Association of UK Vice-Chairman Paul Quirk stated that, “The Artist formerly known as Prince should know that with behaviour like this he will soon be the Artist Formerly Available in Record Stores.” He went on to state that the British Music industry should “not believe the hype about downloads … music retailing is currently more than 90% physical and less than 10% digital, the way people talk you would conclude the percentages were reversed.” However, according to Nielsen SoundScan data, CD sales recently fell 19 percent compared with the same period from the previous year. Data from 2006 sales indicate that physical sales are down by 35.26 percent to 13,880,000, while digital sales have more than doubled to 53,018,000, an increase of 100.49 percent from the previous year. A report by the research group Berg Insight suggests that digital “music sales will overtake physical sales in Western Europe by 2011.” These figures seem to suggest that the traditional recording industry is slowly giving way to the digitization of music content. However, what is not clear is what business model will succeed the current system, as multiple actors have entered the music industry and are trying to carve out a niche in this lucrative field. Furthermore, the very concept of music as a business is being tested as Michael Bracy, policy director of the Future Music Coalition, questions, “How do you ‘monetize’ the digital music industry?” In fact, the same Nielsen SoundScan data indicates that “while more people are legitimately buying music online, 10 times as many songs are still downloaded for free.” To answer these questions and examine the new directions digital music is taking, it’s important to first understand the traditional business model and then explore how the digitization of music is opening new avenues in the music industry.

The Traditional Recording Business Model

The traditional business model for the recording industry has been in effect for well over 50 years. Each actor within this value chain is part of a sequential system that adds value to process as product passes from creators to the consumer. At the apex of this system are content creators who straddle both the recording and publishing industries. This includes artists, composers, performers, and to a lesser extent artist and repertoire (A&R) departments of record labels. Apart from acquiring new and promising artists to long-term exclusive contracts, A&R entails the development of repertoire as well as the overseeing of production and creation of an artist’s image. The goal of content creators is the recording and production of CDs. To achieve this, content creators enter into exclusive contracts with record companies who translate artistic productions into consumer products. To encourage content creators, labels finance them through advance payments while retaining control of the manufacturing and sale of the recording. To capitalize on economies of scale, most companies have their own production plants. The big-four record labels—EMI, Warner Music, Universal Music, and Sony BMG—leverage global CD pressing facilities to accomplish worldwide economies of scale. Because consumers generally do not purchase unfamiliar music, airtime on the radio and other means of exposure for a particular artist or band is essential. Labels have well-established relationships with traditional media channels such as press, radio, and TV stations. As with distribution, major record labels (majors) have a global network of branch offices that can handle sales, distribution, and marketing in any desired market. Distribution companies usually work toward large retailers, such as Best Buy and Wal-Mart, who purchase a high volume of albums from wholesalers. This distribution channel favors artists with a well-established audience (i.e., stars) while disadvantaging marginal artists (niche performers) who find it hard to be distributed in the market.

Various economic factors influence the traditional physical-only distribution scheme. Demand factors such as available leisure time, the demand for leisure, related increases in disposable household income, and demographic profiles have shaped the entertainment industry from the consumer perspective. Supply-side factors have ensured a stable system that guarantees profits for the recording industry for several decades. These factors have favored large entertainment conglomerates by providing barriers to entry; allowing for control, development, and marketing of new content; and stabilizing industry structures and segments, especially distribution systems. Driving both of these economic factors is the creation of technology and new formats. New music formats and playback technologies have been important in the development of new musical genres (e.g., the synthesizer and art rock) and have led the music industry out of temporary setbacks (such as in the late ‘70s and early ‘80s) and into new growth phases.  However, to many in the recording industry, recent technologies have been highly disruptive to existing music markets and well-established distribution mechanisms. At the heart of this disruption has been the creation of peer-to-peer (P2P) file sharing.

P2P Revolution

The origins of P2P file sharing began well before the advent of Napster and other P2P sites. In 1986, Sony introduced the Digital Audio Tape (DAT), a revolutionary system that allowed for digital recording and “perfect” reproduction of the master recording. Due to copyright problems, electronic firms delayed development of consumer products, and DAT remained a high-priced professional medium. In 1990, Sony and Phillips, the creators of the CD player, produced the standard for the Recordable CD-ROM (CD-R). Although copying of recorded music or recording of radio broadcasts has been possible since the availability of cassettes and associated players/recorders, the digital format enabled the creation of perfect, identical copies on a large scale, either for private use or for organized music piracy. The International Federation of the Phonographic Industry (IFPI) reported that total sales of pirated media was worth U.S. $4.6 billion in 2003 (i.e., pirate sales accounted for 15% of the legitimate music market) and that in developing country markets such as Brazil, China, and Mexico, physical media piracy levels are over 50 percent. Although the physical manufacturing of pirated CDs and DVDs has created significant problems to the recording industry, both from an economic and intellectual property rights perspective, the introduction of online piracy has presented even greater challenges to the recording industry.

In the past, systems for sharing files and information between computers was extremely limited by computer processing speed and the long time frame associated with downloading music files. The scenario changed dramatically in 1999 with the development of the file-sharing company Napster. Napster operated on a centralized server that monitored which files were available at any given time. Proprietors of Napster could determine which files were being made available by their consumers. Although the company posted a disclaimer on its Web site, stating that illegal use of the network was not permitted, it did not enforce this ruling. By 2001, Napster had a daily average of 1.57 million simultaneous users and 60 million daily users worldwide. Ultimately, a group of record labels whose works were being pirated on the Napster network shut down the company. The case against Napster was based primarily on the fact that the company had not only the ability to monitor which files where shared but had the power to prevent copyrighted works from being pirated. This void was soon filled by imitators such as Audiogalaxy, Morpheus, Gnutella, KaZaA, and more recently, BitTorrent, eDonkey, and Warez. These file-sharing networks developed a decentralized system where the network proprietor did not maintain a centralized database but rather distributed an index of information among user computers. Grokster consisted of a series of user networks, known as supernodes, that held and maintained an index of works. As with Napster, many of these filesharing companies were successfully sued and terminated by entertainment companies and their representatives. Yet, early attempts by the major record labels to establish an online presence to counter the success of the file-sharing networks failed due to the lack of user friendliness and a commercially viable business model to compete with free downloading. Complicated user interfaces, comparatively high up-front costs imposed by monthly subscription fees, and the limited size of song catalogs, especially across the label divide, did not convince consumers to embrace label-owned companies such as MusicNet and PressPlay. Furthermore, underdeveloped digital rights management (DRM) schemes only fed the online music community with content to be transmitted on file-sharing sites.

Yet, it is these illegal file-sharing companies that have become the backbone for the distribution of legitimate music content. In principle, file sharing is an innovative technology that has increasingly useful application in the music industry and several nontraditional music sectors, such as communication (voice over the Internet services such as Skype, on-demand streaming audio/video or other media push services such as Redswoosh), service industries (Linux’s Lindows, which offers software via P2P networks), and organizations that share information, such as academia and different government agencies.

While the first download offers were available from 2001 (MusicNet and Pressplay were launched in December 2001), the breakthrough for online music retailing occurred in 2003. In this year, music labels gave permission to online companies to distribute substantial amounts of products online according to license terms in return for royalty payments. With the general commercial acceptance of P2P systems and the growing ability for users to have access to music over broadband, companies began developing a variety of e-business models for the music industry. Currently, there are four different configurations for the delivery of music content over the Internet. Two models are structured on the way music is accessed: either via streaming or downloading. The other structures are based on business models that provide the consumer with the ability to purchase or “lease” individual songs, the so-called subscription or “a la carte” models. It is the “a la carte” model used by companies such as iTunes that is currently driving online sales and the comeback of the single format. With the “a la carte” method, music is copied to the user’s hard drive against a payment, allowing the user to subsequently listen to the content without being connected to the Internet. In this model the consumer acquires the music permanently (full sale), but downloaded tracks usually come with some restrictions on usage. DRM technology is designed to control use of digital media by preventing access, copying, or conversion of files to other devices. The iTunes store makes use of FairPlay DRM technology. FairPlay is built into Apple’s QuickTime, a multimedia framework for which the current range of devices includes the iPod, iPhone, and the iTunes Store. The success of the “a la Carte” model can be attributed to consumers’ desire to “own” purchased music and the relative ease of application. This purchasing method is linked to an older demographic who have been conditioned to the traditional physical music retail format and are now reconfiguring their music collections. However, when downloading, consumers chose to overwhelmingly (85% of the time) download only one track from an album rather than purchasing the full album. Frequently cited figures indicate the continued growth of online purchasing. According to Natalie Kerris, a spokeswoman for Apple, iTunes had sold more than 1.5 billion songs three years after its inception, making it the fourth largest music retailer in the United States. A report by SoundScan stated there were 140.9 million legal downloads in the first half of 2004, compared to only 19 million for the last half of 2003. In 2006, a report by Research and Marketing indicated that annual U.S. online digital music sales were estimated to be $1.1 billion. By 2008, iTunes accounted for 30 percent of all U.S. music sales, making it the largest U.S. music retailer.

Although “a la Carte” downloading is still the preferred method of purchasing digital music, streaming music is becoming a viable alternative. Streaming services allow visitors to hear music in real time without downloading the file to the consumer’s local hard drive. Consumers do not take ownership of the streamed songs but have the ability to scan and explore vast collections. This has led to the development of streaming subscription models that give subscribers access to catalogs of music content for a monthly fee. Companies such as RealNetworks’ Rhapsody and Napster provide the consumer with a large volume of music for a monthly fee. On November 2003, 3.2 million Americans visited http://Napster.com, which was relaunched as a paid online music service in late October 2003. In comparison, Apple’s iTunes, drew 2.7 million visitors in November 2003. By March 2007, Napster expected revenues to be more than $28 million with more than 830,000 subscribers making it the number one download store. The subscription model is increasingly reliant on advertisement revenue, rather than recording label funding. This requires companies to be able to obtain a high number of subscribers to be financially viable.

While subscription models provide the online consumer with large catalogs, portable music systems allow for the portable access of subscriptions. Using Microsoft’s Janus DRM, companies such as Napster offer consumers the ability to enjoy large collections of music not only on their PCs but on their portable devices as well. If the consumer does not pay his/her monthly subscription, the music is cancelled. Usually the number of copies that can be made is limited through DRM technologies. When this limit is reached (sometimes three but often more copies) the song can no longer be downloaded to further devices or copied. The ability to transfer content between portable devices is limited by format and DRM technology employed by the online music service. (i.e., with Open MG/Magic Gate in the case of Sony Connect).

A variation on the music subscription format is streaming radio. This system gives consumers access to a variety of genre-specific radio streams for a specified monthly fee. Streaming radio is often bundled with other subscription packages offered by a music company. Finally, a relatively new form of paid serves is subscription file sharing. Unlike previous P2P networks, these systems only allow file sharing to take place between paying subscribers or between purchased songs. Because the music is transmitted through DRM systems, the sampled works can be controlled, and ownership is limited.

In 2004, the online music market accounted for a small share of total music sales revenues (global sales equaled approximately 1-2%). By 2007, global digital music sales were estimated at approximately U.S. $2.9 billion, a roughly 40 percent increase over 2006. This accounted for an estimated 15 percent of the global music market, up from 11 percent in 2006 and zero in 2003. U.S. online sales now account for 30 percent of all revenues. The digital music industry is characterized by an insatiable demand for new material supplied by a plethora of new players. In the medium term, overall demand for music may increase through digital distribution and other new forms of music consumption. With the general increase in the number of people who are accessing music via the Internet, there are several players—notably from the nonmusic sector—who are becoming involved in online music distribution. Companies such as Microsoft, Cola-Cola, Wal-Mart, and different Internet Service Providers (ISPs) are entering the arena. This rapid surge in players has led many industry commentators to predict increased competition, larger marketing budgets, and consolidation. A key requisite for the development of efficient online music delivery is competitive and widespread access to broadband infrastructure. The delivery of online content also necessitates new technologies and an environment that facilitates the creation, acquisition, management, and delivery of content. Secure payment systems are essential for the functioning of a viable business environment. Moreover, a diversity of interoperable standards and hardware are likely to prove most beneficial to competition and efficient online content markets. These demands have opened the way for a plethora of alternative business models and a vast array of companies interested in accessing the lucrative music business.

Alternative Business Models and Actors

Many in the music industry have viewed the proliferation of broadband connectivity to the average PC user as a disruptive technology. However, the development of greater connectivity has opened the way for improved revenue streams and opportunities for music consumption. High-speed connections have allowed consumers to download music rapidly, thus bypassing traditional methods for enjoying music (including unauthorized file sharing). Many of these new entities include players that have long had sustainable links to the music industry, such as consumer electronic manufacturers, software and hardware companies, and DRM firms. Service providers who manage, host, and secure content are going to have to become a new phenomenon in the music industry, especially with the potential growth expected in new broadband technology. Most of these alternative companies make use of a hybrid file-sharing system similar to the Napster model, which relies on users connecting to other nodes within the immediate vicinity to request files. These systems are very popular for various reasons, most notably the ease of use, strong search capabilities, and the ability to download large amounts of data in a convenient fashion.

Depending on the nature of the players, very different motives drive their online music activity. This has lead to new co-operations within the music industry as players try to integrate upwards or downwards along the recording industry value chain. Yet, the range of new retail interfaces available to the consumer is considerable, including: online music stores of the major recording labels, third-party online music stores (e.g., Apple, Napster), ISPs and content portals, mobile content suppliers, software and hardware companies (Apple, Dell, etc.), online retailers (Wal-Mart, Amazon, etc), and DRM providers (Microsoft, Real Networks). Most notably companies that traditionally have had no relationship to the entertainment industry have began to be actively involved in the music business. Cell phone and communications companies (Sprint, AT&T, etc.), consumer brands (Coca-Cola), physical retailers (systems set up in places such as Starbucks that permit music downloading by customers), and even credit card companies (American Express) are looking to the music industry as an ancillary income generator.

M-Commerce

Technologies often develop in tandem with new markets. This has certainly been the case with the music industry and mobile communications sector. The growth of the global system for mobile communication (GSM) has been important for the development of mobile commerce (m-commerce). M-commerce systems involve the direct transfer of music to mobile devices such as cell phones, PDAs, and other handheld devices. The m-commerce market is built on certain value propositions such as mobility, availability, and ubiquity (interconnectivity and roaming). In most cases, music is accessible to the user via a specific player (music jukebox) tied to a particular software program or a type of hardware to play the music (PC, portable device, mobile handset). Added to the development of devices has been the bundling of music content to various devices. For Sony’s new Walkman phone, the company had preinstalled new unreleased tracks by Robbie Williams. Wireless operators are also selling full-song downloads. Sprint recently began selling full tracks that subscribers can download to their phones, with Verizon (V Cast) and AT&T expected to open similar services in mid 2008. Sprint’s service has a dual-delivery feature that sends one version of the purchased song to the mobile phone and another version to the PC.

The need for converged products in digital audio players independently from other electronic devices has meant the demise of the Walkman and portable radio. An essential reason for the creation of independent devices is the need for portability (carry-on functionality while jogging, etc.) not provided by devices such as the laptop. The mobile phone has been the most technically feasible and acceptable single carry-on device to consumers. Other devices that offer audio codec as a secondary feature are smart handheld devices and handheld gaming consoles. Whether consumers will replace dedicated media players with converged devices such as mobile phones, personal digital assistants (PDAs), or combined camera/media players is still to be seen. Currently, connection speeds, processing power, battery limitations, and screen size make it very difficult for the portable phone to replace digital audio players or other content devices. Originally phones used as tools for downloading content, apart from small files such as ringtones, were restricted to countries such as Japan and Korea. Yet, with the development of the iPhone in 2007, customers are able to download content via Bluetooth and telecommunication networks. With improving audio compression technology, the iPhone is positioning itself as an important player in the music industry.

Within the first 30 hours of the iPhone’s release, Apple sold over 30,000 units. Apple expected to sell its 1 millionth iPhone by the quarter ending in September 2007. However, due to overwhelming demand, Apple achieved this goal by the beginning of September of that year. In contrast, it took the company seven quarters to sell its 1 millionth iPod. Apple says that it’s still on track to meet the goal spelled out by CEO Steve Jobs to sell 10 million iPhones by 2008. Development in m-commerce will expand rapidly with cheaper and faster wireless connectivity via DSL Internet access and improvements in 3G networks. While the benefits of technology convergence are experienced in the home, in the workplace, and on the move, their rapid adoption raises problems with the compliance of such products, both in terms of regulation and cost, especially in comparison with single-purpose products. One of the most important consequences of the blurring of technology borders is the increasing globalization of services. This move calls for standardization and interoperability between networks and services across the globe. Currently, there are no international agencies to allow for the seamless transition of such technology. Apple must negotiate with individual service providers in each country to sell the iPhone, thereby limiting the range of such units and their overall adoption in the market.

Software Companies

A recent entrant into the music industry has been software companies, who have used digital music offerings to power different revenue streams. Entering the music industry is an attractive proposition for software companies because selling low-margin digital downloads and subscription services helps to encourage widespread software usage and increases the importance of specific audio and video formats. Two of the largest software companies, Microsoft and Real Networks, integrated to produce the MSN Music Store. The launch of the MSN Music Store serves several business goals for Microsoft. First, the store helped to increase the importance of the Windows Media Player 10 jukebox, which includes Windows Media DRM. Secondly, all tracks within the store are encoded using the Microsoft proprietary WMA codec, helping to further expand the format’s usage. Thirdly, music helps leverage and increase the Internet audience on their MSN Network service, Microsoft Internet portal. Finally, the move was an important component of Microsoft’s plans to create the digital living room, expected by the company to be a major growth area. The MSN Music Store is available both as a Web-based experience and as part of the Windows Media Player 10. Furthermore, it is an integral component of the Windows XP Media Center Edition 2005. Attracting users to the jukebox is a critical factor in the digital delivery of music, but it also allows Microsoft opportunities to control new media revenue streams (Video-on-Demand or Pay-Per-View Movies, live DRM to host concerts, sports events). To increase the perceived value of the Windows Media Player 10 jukebox, Microsoft has created a “Digital Media Mall,” with a host of other digital music services, including Napster, Puretracks, Wal-Mart, Virgin, and CinemaNow (for movies), aggregated into one application. As with Apple’s integration of music service and hardware via iTunes and the iPod, Microsoft has developed synergies between Windows Media Player 10 and Zune. The new Microsoft DRM system called Janus will allow music-service subscribers to listen to rented music on portable devices. Regulatory agencies in both the United States and the European Union have recently urged Microsoft to debundle the Windows Media Player 10 from its overall operating system. On February 28, 2008, the European Commission fined Microsoft $899 million (U.S. $1.3 billion) for failure to honor the 2004 antitrust ruling against it. Furthermore, in the wake of a landmark $761 million legal settlement of its lawsuit against Microsoft, RealNetwork’s Rhapsody will be integrated into Microsoft’s MSN search, instant messaging, and music store services. In effect, Rhapsody will become MSN’s default subscription music service, thereby killing Microsoft’s ambitions of developing its own service.

Internet Service Providers

Another nontraditional entertainment sector to enter the music industry has been Internet Service Providers (ISPs) and Web portals. In many cases there currently exists a “blurring of boundaries” between content providers, broadcasters, and telecommunication service providers. In the ever-changing music environment, network operators are looking at business models that generate revenue, especially with the loss of traditional outlets such as fixed-line telephone systems. Furthermore, ISPs have begun delivering bundled services in order to combat competition and sustain customer bases. This has taken the form of video delivery, greater broadband capability, and better document storage and backup abilities. It is expected that licensed material will drive subscriber numbers, especially with premium broadband packages that offer the end-customer an “all you can eat” content service. The ISPs are also looking at the current range of online music purchasing processes, such as pay-per-track services, digital radio (e.g., [email protected]), and music TV. For many years, ISPs have been entering into a series of commercial relationships with content aggregators and content owners to offer authorized material. The ISPs and Web portals have one significant advantage over many other players in the online music business: a large Internet audience. According to an OECD report, computer and Internet-related sites such as Yahoo! and MSN Networks have captured around 40 percent of all Internet visits with entertainment products. The ability of ISPs to position themselves as distributors of music depends on partnerships formed with content generators and their ability to share in the revenue streams generated. Currently, Verizon Online DSL, in conjunction with MSN premium, gives customers preferred access to Rhapsody, allowing them the opportunity to listen to music and radio services. Recently, hostilities between content generators and ISPs have heated up with the introduction of the Communications, Promotion, and Enhancement Act (COPE) of 2006. As part of a major overhaul of the Communications Act of 1996, the COPE Act includes network neutrality provisions and an amendment that prohibits service tiering. The bill, which passed the House but is currently stalled in the Senate, would spell out broadband Internet consumer rights but without nondiscrimination language urged by net neutrality advocates such as Google, Yahoo!, and eBay, who want unfettered access to the net. The Justice Department has sent comments to the FCC warning that “regulators should be careful not to impose regulations that could limit consumer choice and investment in broadband facilities.” Network operators such as AT&T and Verizon, as well as cable companies such as Comcast, warn that a restrictive bill will limit the development of high-bandwidth services and reduce income streams for future developments by the network operators.

To capture music content, ISPs are reliant on numerous music intermediaries that provide rights clearance, hosting and delivery of content, and billing infrastructure. White label music services have filled this void by handling aspects related to a digital music store such as capturing, storing, and retrieving music content. The ISPs are able to obtain clearance rights for music content without the need to negotiate with content providers. Companies such as Loudeye/OD2 and MusicNet also provide DRM technology, usage reporting, digital music royalty settlements, and other services. Both Loudeye/OD2 and MusicNet serve a diverse range of clients including, Amazon, AT&T Wireless, Barnes & Noble, Gibson Audio, House of Blues, and http://MyCokeMusic.com. Up until it closed operations on January 19, 2007, BitPass offered solutions that included payment processing, customer service transactions, and promotions management for the delivery of content.

Although ISPs are slowly entering the music industry, many in the music industry have not welcomed their presence, especially in regards to copyright infringement. The music industry and its representatives have attempted to hold ISPs liable not only for tolerating illegal P2P traffic but for actually facilitating it. Furthermore, the music industry contends that ISPs have no intrinsic interest in limiting infringer use, as greater broadband use increases ISP subscriber numbers and generates greater advertising income. The music industry has sued ISPs to reveal the names and addresses of suspected music copyright infringers, but ISPs have refuted these allegations and pointed to the technological neutrality of their broadband technology. Furthermore, ISPs contend that monitoring and enforcing compliance of copyright imposes significant costs. This was the argument of the ISP Charter Communications in response to RIAA subpoena to reveal the names and addresses of its subscribers. The subpoena process adopted by the music industry against ISPs has been examined by courts, especially in a series of legal actions involving the RIAA and Verizon Communications. The U.S. Court of Appeals ruled that subpoenas could not be issued against an ISP that does not store copyrighted material on its computer servers. If the RIAA wished to obtain the identities of users suspected of illegal file sharing, the RIAA would need to file civil law suits against such individuals. In a final effort to obtain this information from the ISPs, the RIAA appealed to the U.S. Supreme Court. Yet, in October 2004, the U.S. Supreme Court rejected to hear an appeal by the RIAA, thereby ending its litigation of the ISP industry. Furthermore, the U.S. Digital Millennium Copyright Act (DMCA) of 1998 established a scheme that is designed to limit ISP’s liability for copyright infringement, provided they meet certain requirements.

Search Engines

Search engines, such as Google, Yahoo!, http://Ask.com, and Live Search, have traditionally functioned as information retrieval companies designed to search for data on the World Wide Web. As with other technology companies, search engines have began to offer their customers a range of music products and services. Yahoo! has several tools available to its clients, including the ability to create mashups via Application Programming Interfaces (APIs) at their Web sites. Mashups are Web applications that combine data from several sources into a new integrated system. YouTunes is a mashup that finds YouTube videos for the top 10 songs at iTunes. The mashup will take the iTunes data and run a search at YouTube for all video titles that match the song titles listed sending it to a consumer’s computer as a clean list. Yahoo!’s Pipes works in a similar fashion to YouTunes but collects data from RSS feeds. The site is currently in beta and due for full commercial release within the next year. Apart from offering Web applications, search engines are beginning to act as online retailers. The recent acquisition of MusicMatch by Yahoo!—an online retailer and software firm—for U.S. $160 million sheds light on the dynamic state of the music industry on this market. Yahoo!’s free music portal is already completely ad supported and offers Internet radio, music videos, and music news. In 2005, Yahoo! developed the Music Unlimited subscription fee music site as an attempt to undercut competitors such as Rhapsody and Napster and integrate the service with other Yahoo! products. The site boasted over 1 million songs encoded as WMA files protected by a DRM scheme similar to Napster and Rhapsody (music will only play on the PC they reside on). On February 4, 2008, Yahoo! announced that Rhapsody would be the exclusive on-demand service for Yahoo!, replacing Music Unlimited. This action would leave three online music subscription companies: Rhapsody, Napster, and Microsoft’s Zune Marketplace, which, in 2008, attempted a hostile takeover of Yahoo!. However, at the time of writing, Microsoft’s $44.6 billion offer for Yahoo! had still not been accepted. A combination of the two companies’ Internet efforts would create a very strong competitor against Google, which currently accounts for 54 percent of all online searches in the United States compared to Yahoo!’s 22 percent and Microsoft’s 10 percent. Although Yahoo! and Microsoft have a long history of partnerships, the synthesis of the array of services, ranging from entertainment to instant messaging, will be difficult to combine, even with the projected revenues from online advertising.

Hardware Manufacturers

The digital music industry has had a profound influence on the PC and electronics industry. Currently, the entertainment market is considered a high-growth market, and the electronics industry is seeing a growing global market for digital consumer appliances both for consumer electronics manufacturers and PC vendors (including chip vendors). Recently, several hardware manufacturers have shown an interest in developing ties to music content providers. Hardware manufacturers such as Samsung, Dell, Sony, and Apple are generating online music offerings (i.e., hardware-Integrated Services) to sell more of their music players. Digital music and the rise of portable audio players is also redefining the boundaries between the somewhat traditionally separate PC, software, mobile handset, content, and consumer electronics sector, which are now competing head-on for the sales of portable audio devices. As the digital music value chain becomes more integrated, interdependency between the individual players and device manufacturers is occurring. (e.g., cooperation between device manufacturers, music services, and software providers) The backbone of the digital music industry has been the portable audio player. Great consumer acceptance, falling prices (in particular for flash memory), rising capacities, and more diverse offerings with multiple storage capacities has increased the number of digital devices available. Analysts forecast that this category will continue to grow while the audio consumer electronic market, especially the CD market, will decline.

The portable mp3 player category has in terms of unit sales more than doubled in 2004 to over 6.9 million units, and dollar sales have nearly tripled in revenue to U.S. $1.2 billion, compared to figures from 2003 and more than $80 million in 2000. According to the Consumer Electronics Association (CEA) factory-level mp3 player sales rose 31 percent with 2006 revenue calculated at U.S. $5.56 billion. The mp3 market has enjoyed a double percentage gain since 1998. Furthermore, a 2006 study by Ipsos research found that one in five Americans aged 12 and older owned an mp3 player. The study indicated that over half of teens (54%) own an mp3 player, averaging 16 hours of use per week.

Consumers as Creators of Music Content

In “The Futurists,” Alvin Toffler notes that “the emergence of the service society has coincided with extended consumer self-service.” For Toffler, the notion of a passive consumer will be exchanged in the future with consumers that are part of the value-chain as coproducers or “prosumers” (producer-consumers). For many analysts, customers today “are concerned about control over available service features and content displayed to them.” The change precipitated by digital technologies and an evolution of consumer consumption habits has had a persistent and profound effect on the online music industry. “Innovation and change lead to an unfreezing of established relationships, expectation and roles.” The challenge for suppliers is to manage the transformation process, that is, to (gradually) explore new forms of interaction and models of collaboration that involve customers in the process and to shape the relationship with them. Therefore, future customer relations in the online community will be built on a triangulation between value propositions and product characteristics, business transaction attributes, and attributes within a computer-mediated environment. Increasingly, companies are looking to incorporate social and business systems that are enmeshed with business output, while adding value and control for customers. For current consumers, especially younger demographics, this translates in online entities that not only supply music content but value-added services, such as chat groups, streamed events, and the ability to burn CDs or personalized playlists of digital singles. This means greater choice and flexibility, with consumers able to enjoy music on their terms (i.e., no need to pay for full albums when only a few songs are desired). Seemingly, many various forms of P2P services and online music stores are able to sustain a greater breadth of music types, thus potentially better satisfying consumer demand and niche markets. Moreover, the way consumers find and buy music is slowly gravitating away from traditional online methods to new systems, maybe leading to more music genres and a lesser focus on a few music stars.

Social Networks as Content Creators

The impact of the online medium on network users (i.e., interactivity and participation) and diversity of material made omnipresent by the availability of online technologies opens up possibilities for new content created by network users. Apart from having ubiquitous access to music, users have become important participants in the chain of content creation, marketing, and distribution. In the context of file-sharing networks that allow the transfer of owned or authorized files, users (e.g., amateur artists) can create their own music and share it with others. This kind of exchange is unique to file sharing in comparison to other online music distribution or traditional music business models. To date, the take-up of this has been limited, and opinions vary as to the scale of its long-term impact.

Online social networks occur in many different venues, from those that offer very little interaction, such as e-mail lists and Usenet newsgroups, to realtime online-chat systems and multiuser domains (MUDs). Users can share information, make files available, contribute to projects, or transfer files. Consumer-to-consumer music recommendation tools allow consumers to share musical tastes in a collaborative forum. These forums take many forms, from the “collaborative filtering” technique adopted by Amazon for recommending products to service-tied systems, such as iMix on iTunes Music Store or Rhapsody’s Playlist Central tool, which allow consumers to purchase or access the songs in the playlists directly. However, there is a growing number of music consumers, especially a younger generation, who aren’t accessing music from subscription or “a la carte” services. Blogging and podcasting allows users to link or post content on the Internet for other people to download or post comments. Similarly, private group sharing sites, such as iMeem and Grouper, enable users to exchange music files. According to a report issued by the Pew Internet & American Life Project, 55 percent of American children aged 12-17 claim to visit social networking sites such as MySpace. In each of these venues, individuals identify with the values, conventions, and practices of the online group. Researchers show that social interactions shape participants’ opinions, decisions, and relationships and take up considerably high amounts of their time. This online interaction has direct consequences on individuals’ interaction with family, friends, and established media outlets.

Social network sites have been an important addition to the online environment. Most are based on social communities of people who share interests and activities. Users interact through a series of tools, including messaging, e-mail, blogs, file sharing, and discussion groups. On July 19, 2005, Fox News Corporation bought MySpace for $580 million. As a fully functional social network site, individuals are able to download music content and share it with their social community. Bands such as Babyshambles and the Arctic Monkeys built fan bases rapidly by posting their music on their Web sites and allowing people to swap mp3s, record performances, and share content through MySpace and other social networks. Since MySpace’s launch in 2003, an estimated 3 million artists have used the site to share information, post tour dates, and exchange music with fans. With 12 million unique visitors per month, the site has attracted prominent bands, such as the Black Eyed Peas, R.E.M., and Nine Inch Nails. In September 2006, MySpace began selling music tracks using an open source standard. The company said they were bypassing DRM content so that MySpace content would be compatible with the iPod. The sale of music content encouraged MySpace to develop other music outlets. In an effort to accommodate artists, the company developed a specific MySpace profile for musicians. Unlike traditional MySpace profiles, artists can upload up to four mp3 songs that users can listen to for free. Some bands allow fans to download some sample tracks as mp3s or direct them to third-party sites for purchase. A recent development has been the collaboration between Snocap, a Web-based music distributor, and MySpace to create a digital downloading store called Mypurchase. The new service will allow bands to sell music through their MySpace profile directly to fans. Consumers will be able to buy, download, and play files on multiple devices, such as iPods and Microsoft’s Zune. What makes this service different from current MySpace offerings is that artists can set the price of the downloads. What is not yet known about Mypurchase is the distribution fee MySpace intends to charge artists. Chief executive Rusty Rueff told Reuters that the “small” distribution fee was not yet “fixed.” Finally, MySpace has leveraged the success of social networking to develop ancillary products and services within the music industry. On October 16, 2007, MySpace launched its first branded music tour. Beginning at the Show-Box in Seattle, the All-Ages MySpace Music Tour stopped off in more than 30 venues through Thanksgiving weekend in Las Vegas.

Another popular social network system is the blog. Blogs are online journals where individuals and groups provide commentary or news on a particular subject. Musicblogs or mp3blogs are blogs on which the creator or fans make music available for downloading. Often, blogs are used to promote new bands or releases of established artists and have found support from the major record labels. However, in this interaction labels want to control how and to whom the material is posted. Music companies are concerned that this new online forum may provide listeners with an alternative source of illegally obtained and streamed music content. However, some labels have begun to realize the potential of blogs as an important promotional vehicle. In August 2004, Warner Music Group began to ask mp3 blogs to post music on their sites. Many blogs decided against posting the Warner files because it would be seen by their audience as a paid endorsement of a major label. In response to the music industry concerns about music piracy on mp3 blogs and to tap a vast audience and possible revenues, many blogs have redesigned themselves to be legitimate digital music labels. The mp3 Music Blog Earvolution established Earvolution Records to sell music directly from its blog and other digital retail outlets. Earvolution collaborated with Tunecore, a leading flat-fee independent distributor, to deliver music to iTunes, Rhapsody, Napster, and other digital retail outlets. The flexibility of this arrangement is perfect for a growing label such as Earvolution and a natural extension of a nascent music venture that has a dedicated clientele. The viral nature of blogs has influenced other blogs to develop sustainable revenue streams. GBox provides users a bit of software code, known as a widget, that are embedded on their blogs. This code allows users to broadcast wishlists of songs to friends and family members within their blog, in hopes of getting them as gifts. With the support of two major labels (Universal and Sony/BMG) the company hopes to turn bloggers from passive commentators to salespeople.

Conclusion

Online music has proven to be a major force for the expansion of the music industry for the near future. The development of a multitude of transmission models, from a la carte downloading to streaming to social networks, continues as the market for music expands. Ensuring artistic creation in this environment is dependent on the maintenance of effective copyright protection, payment systems, and the reduction of illegal online piracy. The online music market has begun to diverge with small and innovative players competing with well-established music companies. However, for all parties to succeed in this market there are several key requisites for the creation of an efficient and competitive online music industry. Key to the delivery of music content is access to a competitive and widespread broadband infrastructure; acquisition management and secure payment systems that protect the consumer and provide revenue to both the content creator and intermediaries; and, government agencies that address Internet piracy on a global basis.

From a business perspective, many companies have managed to occupy large parts of the online value chain. In the case of Sony and Apple, close to perfect vertical integration has been reached. Apple does not own a catalog but encodes in proprietary AAC format, uses proprietary FairPlay DRM technology, and has its own music store (iTunes) and its own hardware devices (iPod and iPhone). Sony owns its own content and has the ATRAC3 music codec, the SonicStage jukebox software, the Sony Open Magic Gate DRM system, and its range of Sony Network Walkmen and other portable devices. For other online music providers, the music e-commerce environment is often a result of a large number of alliances, especially during a company’s startup stage. For example, Wal-Mart acts as a standard retailer while sourcing in everything from music content, online music store technology, and codec and DRM standards from other companies. Yet, friction between the content industry and technology providers is impeding the development of new technologies. Disagreements between the music industry (labels, collecting societies, and authors associations), technology providers (PC and consumer electronics industry), and network operators may jeopardize the deployment of successful broadband music services in the future. Traditionally, the music industry has reacted to these problems by litigation. Yet, according to researchers, decreasing piracy does not necessarily imply increasing profits. Rather, maximum profit outcomes occur in the presence of piracy. Seeking regulatory means to stop piracy is likely to be a self-harming strategy. Although the music and movie industries have fallen prey to the plague of digital piracy, similar entertainment industries have been able to prosper in a similar environment. The online gaming industry is thriving, not because it has been able to stop the act of piracy, but because the interactive experience of online gaming cannot be duplicated and pirated. Music by its very nature is a hedonic product whose valuation is based on the experience it provides the consumer.

Prince has been the role model for the development of new methods of reaching his audience. Even in the days of dial-up he sought to make his music available online, first as a way of ordering albums and then through digital distribution. The Internet truism is that information wants to be free; Prince’s corollary is that music wants to be heard. Yet, on September 13, 2007, he announced that he was considering legal action against YouTube, eBay, and the Swedish piracy search engine The Pirate Bay for posting material without his consent. It seems that Prince’s aim is to control his music content for those who want to hear it, not for his fans to make that decision. Ultimately, Prince’s experiments with redefining the music industry only go as far as getting music to his audience. Although for many artists their relationship with the major labels, especially Prince’s relationship with Sony BMG, both in terms of content and distribution, has been clearly established, the tenuous relationship between creator and audience is still evolving. The ability of consumers to control, manipulate, and transmit music in this digital age has given a once passive receiver a role in the creative process. Prince may be able to bypass music retailers, but the advent of social networking has given his fans an equal say in how they consume his music in this digital age.