Approach: After a short description of the music industry as it was some years ago, I will have a look at the most recent trends. Based on that I will point out the changes in the business model of record labels and identify some important areas in which companies have to act in order to stay competitive. To make this analysis more practical, I want to include the income statement of Warner Music Group, a leading record label to show how it is affected by recent industry chances.
The typical value chain in the music industry shows five steps. It starts with creation of the content by the artist. Traditionally, the artist tried to raise awareness by sending demo tapes to the record companies and participate in band contests. The artist and repertoire (A&R) unit is the division of a record label that is responsible for talent scouting, contracting and overseeing the artistic development. Once the contract is signed, the record company takes care of the financing and records the songs. The next step is the promotion and PR of the album done by the record company. The distribution traditionally was done through merchants and retail stores. Most of them were independent but there were also big retail chains, owned by the major record labels.
After this short description of the traditional music business, I want to show you some charts I prepared about recent trends in the music industry. For those of you, who are interested in the current development of the music business, I recommend to have a look at http://www.grabstats.com/statcategorymain.asp?StatCatID=9.
The first graph I want to discuss shows the development of global recording industry revenues. It clearly shows the decreasing importance of physical products such as CDs, LPs, vinyl singles and music videos. On the other hand, more and more users purchase their music online or via mobile phone. The main online distribution channels are so called digital music stores, subscription and streaming services and legal P2P sites. The revenues generated by mobile customers are mainly generated through ringtones, mastertones and full-track downloads. This trend towards digital music revenue is even clearer is US. Here, the revenue of digital distribution ($5.7bn) equals the sales of physical media.
This strong trend of digitalization bears a great risk for the record companies’ traditional business model, not only from the sales side but for every step of their value chain. Let’s start with content creation. Due to the drop in prices of recording equipment and recording and editing software, the artist is less dependent from the labels. While some years ago, it was costly and time-consuming to produce a high-quality album, nowadays these obstacles do not exist anymore. Once the song is recorded, artists have the opportunity to publish it online instead of raising awareness through demo tapes and band contests. There are several sites connecting artists to potential customers or to mostly independent record label. After redefining its strategy, MySpace became the most famous social network site for this purpose. While most artists publish their songs at youtube, there are many other sites bringing artist and listener together. If you are interesting in browsing songs of yet unknown artists, have a look at www.ourstage.com, www.sellaband.com or www.thesixtyone.com. Through the increasing number of online music publishing sites, it became much easier for the record label to find talent. The increased trend towards self-publishing has led to an ongoing reduction of most A&R divisions and in many companies is still an area that shows cost saving potential. Now we are coming to the recording of the song. As mentioned above, this process became increasingly cheaper. However, I think that the expertise and know-how of a recording company in most cases adds value to the artist, although less than some years ago. The financial benefit that comes along with signing a contract remains an attractive advantage for the artist of joining a label. Although, as we saw, promotion through the web is free and can be done by basically everyone, the extend of awareness cannot be compared to the much greater reach of potential buyers through a record label. It also provides a valuable network and expertise in terms of PR. Furthermore, it allows the artists to arrange concerts at a much bigger scope. Recalling the main conclusions of the revenue chart above, we see that the added value of a record company in terms of distribution is decreasing. While the artists were dependent on the labels because of their access to the distribution channel, the increasing popularity of digital sales allows the artist to offer the songs himself to potential customers. Regarding this trend, the advantage of being contracted by a record company in terms of distribution is decreasing rapidly.
The main conclusion we can take from this analysis is that the value added for the artist of being contracted by a record company is gradually decreasing. The main factors causing this trend are technological advancement and the increased popularity of social networks and content sharing. How should the record company react? As we saw, the main value provided by the label lies in the field of promotion. The companies should focus their business model on the provision of services in this field. For example, cost intensive offline marketing and network-based PR are still two crucial success factors in this industry. Furthermore, the arrangement of concerts and other live performances provides great value to the artists. On the other hand, there are some areas that become less valuable and need to be restructured, mainly the A&R unit as well as the distribution department. The easiness of self-publishing facilitates the work of A&R. Here, it is important to go with the trend and focus on talent search online. The even greater urge to act is in the distribution department. It is important to be innovative and keep up with digital trends to ensure the optimal utilization of the online as well as the mobile distribution channel. Crucial factors are among others the use of the right platforms, effective online-marketing and the alignment of the revenue model. A great way to generate further revenues is to offer additional products and services related to their music portfolio (e.g. ringtones, games, etc.).
To conclude this article I want to emphasis the importance of redefining the business model and to focus on new revenue drivers by a simple calculation. Assuming that a CD is sold for $15.99 and the label gets 60% of the revenue which makes $9.60. When selling it through the digital channel, due to the smaller involvement of the label in the value creation process, I assume a sales percentage of 55%. When the album is sold for the common price of $9.99, the record company receives $5.60. This example shows that even if the labels managed to successfully switch to the digital distribution channel, other revenue driver have to be created to compensate the decreasing income from their former core business.
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