GLIMPSE OF THE MUSIC INDUSTRY: The Coolfer Blog

Glenn Peoples recently received his MBA from the Owen Graduate School of Management at Vanderbilt University. He runs Coolfer, a blog about the music business.

Glenn Peoples recently received his MBA from the Owen Graduate School of Management at Vanderbilt University. He runs Coolfer, a blog about the music business.

When private equity firm Terra Firma purchased EMI last year, everyone knew radical changes were in store. Guy Hands, Terra Firma’s chief executive, immediately let it be known that he was unimpressed with the company’s vision (and the industry in general), its track record this decade and its general way of doing business. He was appalled that drugs and other party favors had a code name on the budget. He derided the company’s outdated mindset that was at odds with the modern consumer. He even poked jabs at the unusual working hours of A&R reps. When those changes came, however, nobody seemed ready for them.

Hands is not just retooling EMI’s executive ranks and cutting costs, he is drastically changing how the company is shaped and how it thinks of itself. EMI’s downsizing is practically Reagan-esque in its magnitude. Rather than label presidents, the company will place presidents of A&R and regional presidents within a “global functional matrix,” a move that compounds the risks inherent to today’s music industry with the standard two-to-one odds that a major change initiative will fail. Terra Firm has hired a couple brand name digital media VPs with no prior experience in music, and the recorded music division will be headed by a former consumer products company executive. Artist contracts, including those ballooning advances that never seem to be recouped, will get leaner as well. And those are some of the more normal changes taking place.

At the midpoint of 2008, the music industry is in an incredible state of flux, disarray and uncertainty. Events that seemed inevitable at the dawn of the decade-just one year after Napster made its debut-are all happening at once. Workers are being laid off by the thousands-this time at EMI, though several other record companies have experienced mass layoffs this past decade. Radically new business models have appeared, each of them hyped as the industry’s salvation. Digital rights management-the buzzkill known as DRM-proved effective only in stunting digital growth and alienating customers. Capitol Hill is being overrun by lobbyists in a battle over billions of dollars of possible performance royalties for use of sound recordings by radio stations. Power shifts-to management and promoters, away from labels-are threatening the traditional record label model.

Digital and physical music sales continue to go in different directions. Album sales were down 11 percent through the first six months of the year-an improvement over the 15 percent drop recorded the previous year. The rate of the drop in CD sales actually decreased, to 16.3 percent from 19.4 percent. Digital albums rose 34.4 percent over the same period last year, but that rate looks small compared to the 60 percent increase last year. Sales of individual tracks rose almost 28 percent, but growth is slowing. Last year, track sales were up 49 percent. With digital growth slowing and ring tone sales leveling off, the billion-dollar question is where will the industry find the revenue growth to stop the bleeding. Cost-cutting can only go so far. CD revenues are expected to drop about $1.1 billion in 2008.

From radio to music blogs, the Internet is awash in music. As a result, much of the hope for the future of recorded music is placed on “faux free,” or music that only feels free (there’s always a catch). Ad-supported free music sites are in nascent stage, but showing enough promise to attract corporate interest and venture capital. Social networking sites such as last.fm (purchased by CBS for $280 million) and imeem are built around free music streams and personalized online radio.

The other services in the field right now probably have little chance of attaining widespread acceptance. Ad-supported SpiralFrog, which has yet to secure the licensing deals that will create a robust catalog, offers free downloads that are tethered to the user’s hard drive and cannot be transferred to MP3 players. Another ad-supported service is Qtrax, a legal service that bills itself as P2P but lacks the catalog, freedom and intuitive ease of a normal P2P experience. After a few stumbles, Qtrax debuted a lackluster service to laughs, yawns and indifference.

While the first successful ad-supported download service is years away, mobile services are usually seen as a safer place on which to pile one’s hopes and expectations. The success of ring tones suggests that people are comfortable buying items for their mobile phones. Purchasing entire songs, though, is another matter. Sales of over-the-air downloads are a small fraction of the tracks users side load-or upload from a PC-to their mobile phones. According to SoundScan, mobile downloads accounted for only 3 percent of digital sales in the U.S. America’s 255 million mobile subscribers spent only $44 million for over-the-air downloads, a tiny sum compared to total song download revenues of $1.47 billion.

The scant success of mobile downloads calls for a different approach. Three of the four major music groups-EMI is the holdout-have signed on to Nokia’s “Comes With Music” mobile service. This faux free plan builds in the cost of the music. There is no recurring charge, nothing to show up on a credit card bill. Labels and publishers will receive a fixed, per-unit payment that will cover all songs downloaded during the one-year subscription.

Bundling music subscriptions with a device is a step in the right direction, but early reactions indicate it might be a very small step. “Comes With Music” comes with big questions. One is how consumers will react to the price of the handset. For buying the participating handset, consumers may pay a higher price but will get free music for one year. The second question is how customers will react to downloads that come with restrictions. Songs will forever reside on the mobile device, therefore pitting the satisfaction of a large buffet against the desire for interoperability. Record labels have long placed restrictions on subscription services for fear that encouraging binging on unprotected music is a losing proposition.

Publishers are the less sexy, trustworthy sibling to the more volatile, rambunctious record label. Music publishers, which collect royalties for music sales, are being hurt by the decline in CD sales. Publishing is a steady enterprise and companies have been very successful in finding other uses for their songs. Television shows, commercials and video games, for example, are providing greater revenue streams.

Publishers can sleep better at night knowing they are immune, at least for the time being, from the mega-deals concert promoter Live Nation is putting together for superstar artists like Jay-Z, Shakira and Madonna. Live Nation has built a suite of services that ranges from record label to online fan clubs but has no presence in publishing. While Wall Street has voiced its lack of enthusiasm for the deals by sending Live Nation’s stock down, the very act of taking a mature artist from a major label signals the arrival of a new era.

For much of this decade, music companies have been trying to put a square peg in a round hole. What consumers want seems obvious enough-cheaper music, portability of digital files, ease of use, quality songs-but there is still a divide between what is wanted and what is being offered. Labels and publishers put a great deal of their weight behind business models that offer just some of what consumers want. What consumers want, the thinking goes, could too easily lead to piracy. But they would do well to realize that piracy is merely one of the many causes for falling revenues.

And yet this era of turbulence might actually lead to the kind of honest self-evaluation that can help the industry right its course. If not, the merciless process of evolution will have to do the job.

In mid-July, Guy Hands announced to EMI employees that revenues had jumped and the recorded music division had went from loss to profit in the last year. The figures were vague but the message was clear. The new EMI, he wrote, is “not only a far leaner organization, but a more focused and effective one as well.”

For an industry beaten down for years, it was as good as news could get.