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Last year was terrible for the recorded-music majors. The next few years 
are likely to be even worse

IN 2006 EMI, the world's fourth-biggest recorded-music company, invited 
some teenagers into its headquarters in London to talk to its top 
managers about their listening habits. At the end of the session the EMI 
bosses thanked them for their comments and told them to help themselves 
to a big pile of CDs sitting on a table. But none of the teens took any 
of the CDs, even though they were free. “That was the moment we realised 
the game was completely up,” says a person who was there.

In public, of course, music executives continued to talk a good game: 
recovery was just around the corner, they argued, and digital downloads 
would rescue the music business. But the results from 2007 confirm what 
EMI's focus group showed: that the record industry's main product, the 
CD, which in 2006 accounted for over 80% of total global sales, is 
rapidly fading away. In America, according to Nielsen SoundScan, the 
volume of physical albums sold dropped by 19% in 2007 from the year 
before—faster than anyone had expected. For the first half of 2007, 
sales of music on CD and other physical formats fell by 6% in Britain, 
by 9% in Japan, France and Spain, by 12% in Italy, 14% in Australia and 
21% in Canada. (Sales were flat in Germany.) Paid digital downloads grew 
rapidly, but did not begin to make up for the loss of revenue from CDs. 
More worryingly for the industry, the growth of digital downloads 
appears to be slowing.

“In 2007 it became clear that the recorded-music industry is contracting 
and that it will be a very different beast from what it was in the 20th 
century,” says Mark Mulligan, an analyst at JupiterResearch. Last year 
several big-name artists bypassed the record labels altogether. Madonna 
left Warner Music to strike a deal with Live Nation, a concert promoter, 
and the Eagles distributed a bestselling album in America without any 
help from a record label. Radiohead, a British band, deserted EMI to 
release an album over the internet. These were isolated, unusual deals, 
by artists whose careers had already brought years of profits to the big 
music companies. But they made the labels look irrelevant and will no 
doubt prompt other artists to think about leaving them too.

The smallest major labels, EMI and Warner Music, are struggling most 
visibly. Warner Music's share price has fallen to $4.75, 72% lower than 
its IPO price in 2005, and it is weighed down by debt. EMI's new 
private-equity owner, Terra Firma, paid a high price for the business in 
August 2007. Now, having got rid of most of EMI's senior managers and 
revealed embarrassing details of their spending habits (£200,000 a year 
went on sundries euphemistically referred to in the music business as 
“fruit and flowers”), Terra Firma is due to produce a new strategy later 
this month. But many observers reckon the private-equity men are out of 
their depth.

The two biggest majors—Universal, which is owned by Vivendi, a French 
conglomerate, and Sony BMG, a joint venture between Sony and 
Bertelsmann, a German media firm—derive some protection from their 
parent companies. Universal is the strongest and is gaining market 
share. But people speculate that Bertelsmann may want to sell out to 
Sony next year.

Three vicious circles have now set in for the recorded-music firms. 
First, because sales of CDs are tumbling, big retailers such as Wal-Mart 
are cutting the amount of shelf-space they give to music, which in turn 
accelerates the decline. Richard Greenfield of Pali Research, an 
independent research firm, reckons that retail floor-space devoted to 
CDs in America will be cut by 30% or more in 2008. The pattern is likely 
to repeat itself elsewhere as sales fall.

Circular arguments

Second, because the majors are cutting costs severely, particularly at 
EMI and Warner Music, artists are receiving far less marketing and 
promotional support than before, which could prompt them to seek 
alternatives. “They've cut out the guts of middle managers and there are 
fewer people on the ground to promote records,” says Peter Mensch, 
manager of the Red Hot Chili Peppers and Shania Twain.

Third, record companies face such hostile conditions that their backers, 
whether private equity or corporations, are loth to spend the sums 
required to move into the bits of the music industry that are thriving, 
such as touring and merchandising. The majors are trying to strike 
“360-degree” deals with artists that grant them a share of these 
earnings. But even if artists agree to such deals, they will not hand 
over new rights unless they get better terms on recorded music, so the 
majors may not see much benefit overall. Tim Renner, a former boss of 
Universal Music in Germany, says the majors should have acted years ago. 
“Then they had the money and could have built the competence by buying 
concert agencies and merchandise companies,” he says. Now it may be too 
late.

By mid-2007, when the majors realised that digital downloads were not 
growing as quickly as they had hoped, they landed on a more adventurous 
digital strategy. They now want to move beyond Apple's iTunes and its 
paid-for downloads. The direction of most of their recent digital deals, 
such as with Imeem, a social network that offers advertising-supported 
streamed music, is to offer music free at the point of delivery to 
consumers. Perhaps the most important experiment of all is a deal 
Universal struck in December with Nokia, the biggest mobile-phone maker, 
to supply its music for new handsets that will go on sale later this 
year. These “Comes With Music” phones will allow customers to download 
all the music they want to their phones and PCs and keep it—even if they 
change handsets when their year's subscription ends. Instead of charging 
consumers directly, Universal will take a cut of the price of each 
phone. The other majors are expected to strike similar deals.

“‘Comes with Music' is a recognition that music has to be given away for 
free, or close to free, on the internet,” says Mr Mulligan. Paid-for 
download services will continue and ad-supported music will become more 
widespread, but subsidised services where people do not pay directly for 
music will become by far the most popular, he says. For the 
recorded-music industry this is a leap into the unknown. Universal and 
its fellow majors may never earn anything like as much from partnership 
with device-makers as they did from physical formats. Some among their 
number, indeed, may not survive.

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Eugen* Leitl <a href="http://leitl.org">leitl</a> http://leitl.org
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