The Internet Is Changing the Music Industry

• "The threat to the music industry is not MP3s, but the arrival of a consumer distribution channel that is not controlled by the music industry." Jeremy Silver, vice president of New Media, EMI [10].

Over the past decade, digital technologies have permeated the music industry. Music has been encoded in digital form and stored on CDs, laser discs, and digital versatile discs. Such digital technologies have become popular due to their quality and portability. In the past, bandwidth restrictions have impeded distribution of music in digital form over the Internet. However, these restrictions are disappearing due to advances in networking (broadband) technologies. Consumers are now able to procure and play high-quality music in digital form directly through the Net, accelerating the development of the Net as an infotainment hub, whereby it will become the main conduit for both information and entertainment.

According to the Recording Industry Association of America (RIAA), Net-based sales of CDs and digital downloads in the U.S. have reached $500 million in 2000 [8]. Napster, the company embroiled in a legal tussle with RIAA, has more than 80 million registered users. At its peak, there were 250,000 daily downloads of its software. An average registered user has access to 220 songs at any given time. As bandwidth increases and better compression techniques become available, the Internet will be a major distribution channel of music in digital form. Collectively, the music industry is concerned about such effects of disintermediation [1]. This development has important ramifications for the music industry, which will have to reexamine its value propositions in the light of new business possibilities. At the heart of all the changes introduced by the Net is the advent and proliferation of MP3, the audio portion of a video compression standard defined by the Motion Picture Experts Group [6]. Traditional standards allow music to be sampled at 44,100 times per second (in stereo-2 channels) with each sample having 16 bits. In comparison, MP3 uses music compression algorithms like advanced audio coding to replicate original music at a bit rate of 128Kps. This represents a compression ratio of 11:1. Although MP3 has a much lower bit rate than traditional standards, music quality does not suffer because human ears cannot discern the difference for bit rates beyond 128Kps. But with this compression ratio, a CD that has 12 songs encoded in traditional standards can contain more than 130 songs encoded in MP3. The advantages of MP3 are particularly significant in light of advances in broadband technologies and reduction in storage costs. Increasing availability of broadband access and reducing costs of hard disks allow downloading and storing of songs in MP3 economically attractive. Because it is operable across many technology platforms and has no security or copyright features, MP3 is immensely popular [4].

MP3s began with a huge underground movement of college students on the Internet who converted songs from their CDs into MP3 files, and circulated the files over the Net, allowing people worldwide to download these files and play original music on PCs using free software. This MP3 movement sparked worry in the music industry, where key players (the retailers, record labels, and artists) were concerned about losing money [4]. Although some have attempted to alleviate this concern by showing an increase in CD sales from 1999 to 2000 [5], RIAA has attempted to shutdown as many illegal MP3 distribution Web sites as possible with legal action. RIAA is fiercely protective of its members’ music copyrights and has actively engaged in legal action to prevent any misuse of its members’ music. To date, RIAA has brought lawsuits upon Napster, MP3.com, Aimster, and others in its bid to control piracy.

RIAA argued that Napster facilitated music piracy on a large scale with its 80 million registered users trading millions of songs daily. Copyright disclaimers on Napster’s Web site were not adequate; copyright laws state that a person is liable for copyright infringement when he or she materially contributes (either directly or indirectly) to that activity with the knowledge of its implications. RIAA suggested that the burden is on Napster to operate in a secure and legal environment. Furthermore, RIAA reiterated that it was not against the MP3 technology per se, but rather the illegal use of the MP3 technology.

In March 2001, RIAA won its lawsuit against Naspter. An injunction was granted against Napster, requiring it to install filtering technologies in its file trading directories to prevent illegal exchange of MP3 files. While it was legal for people to convert songs from their CDs into MP3 files for personal use, it was illegal to distribute these MP3 files without consent from the copyright owner. Since then, Napster has entered into alliances with Gracenote and Reltable to improve its filtering technologies. This approach appears to be working. In April 2001, the swapping of MP3 files through Napster had fallen drastically by about 36%. Similarly, the average number of songs available to each registered user dropped from its peak of 220 to a paltry 37 by the end of April 2001.

To complement its legal action, RIAA employed a team of Internet specialists to study what technical action could be taken. But RIAA was aware that all such efforts might not be sufficient to combat piracy. RIAA is currently looking for more secure and controllable alternatives to MP3. This has brought forth such standards as a2b, Liquid Audio, Beatnik, and Microsoft Media Technology [4].

Perhaps what is more worrisome to the music industry is not the advent of MP3 or copyright issues but the emergence of a new Internet distribution channel, dictated by consumers [10]. Through this channel, consumers can purchase individual songs instead of entire albums, from whomever they please. With powerful search engines (Napster, Gnutella, and BearShare, to name a few), consumers can find songs quickly without the aid of retailers. Consumers also have to ability to purchase songs directly from artists. This new distribution channel, if widely accepted and practiced, threatens to do away with intermediaries in the traditional distribution channel, which involves the following steps:

1. The artist signs a contract with the record label to leverage on the core competency of the latter, such as marketing and distribution.
2. The artist records the album and the record label produces the album in some media such as CDs.
3. The retailers buy the CDs and other media from the record label.
4. The consumers buy the CDs and other media from the retailers.

With this business model, artists receive a small percentage of the sales proceedings while the record label gets the bulk of them.

Given the Net’s low entry barriers, new entrants in the music industry are outpacing traditional record labels, which have limited experience with new technologies. The music industry is at a point of inflection, where business dynamics change rapidly due to the viability of distributing music in digital form over the Net. As more and more consumers go online to shop for music, key players in the music industry must reexamine their value proposition to remain relevant. Several traditional music retailers have since launched limited services for consumers to download music in digital form. The next section offers some action items for the music industry to reposition itself in order to face the challenges ahead.

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The Future Music Industry

Brick-and-mortar (traditional) retailers are recognizing the value of Internet sales. For example, over the last five years, Tower Records has worked with digital companies like Liquid Audio to provide digital downloads. Tower Records has also used different audio codecs (one of which is the a2b standard) and different digital rights management systems. Some retailers have been mindful of illegal copying and have implemented secure, watermarked digital music files. But at present, Internet sales involve only selected singles rather than complete collections and remain quite limited. For example, Tower Records has only about 100,000 songs available for download compared to tens of millions of songs available on CDs. In a statement, Tower Records indicated it wanted to make more songs available for digital downloading but was somewhat stymied by its suppliers (the record labels) who might want to apply their own digital download model. Other brick-and-mortar retailers have created Web sites to sell CDs or allow consumers to custom-make CDs with (currently limited) selected songs. These retailers can capitalize on their brand names to create a reputation for delivering quality downloads. Consumers are likely to trust these retailers more than unknown Internet companies. To move toward interoperability, brick-and-mortar retailers can take a further step to distribute music online in widely accepted industry standards rather than proprietary standards.

Brick-and-mortar retailers can compete on the basis of consumer services. For example, they can provide facilities in their stores for recording songs (in MP3 or other standards) onto CDs or other media that consumers can bring home. Sony, EMI, and BMG have formed a partnership with companies offering music via kiosks in record stores. This way, consumers can compile their favorite songs onto CDs. Even if consumers have the equipment at home to do likewise, store facilities should be attractive in terms of price, convenience, selection of songs, quality of recording, and speed of recording. These facilities can cater to numerous consumers who have no Net access or who do not have the time and energy to compile and record the songs themselves. Brick-and-mortar retailers can charge a premium for rendering these new value-added services.

These retailers can maintain their consumers by exploiting the sociopsychological aspect of physical stores that cannot be replicated on the Net. Physical retail stores are social gathering places where music lovers congregate to interact in relaxed settings. Cafes with music can be set up in stores, which also sell music-related commodities such as clothing, posters, books, and magazines. Such an ambience provides consumers with the social intimacy absent in the impersonal, anonymous world of the Internet. Consumers can interact with familiar staff and like-minded music fans face-to-face. With engaging and meaningful experiences, consumers may be encouraged to return to these stores. Tower Records has begun such practices. Nevertheless, this is a challenging enterprise, requiring a keen sense of pop culture, prudent consumer management, and financial support to succeed.

Action items for brick-and-mortar retailers include:

• Encoding a wide variety of songs in widely accepted industry standards and selling these songs via the Net;
• Offering facilities in stores for compiling songs onto albums and charging a premium for these services; and
• Turning physical retail stores into social gathering places with appropriate ambience for music lovers.

With this new music distribution paradigm, online retailers such as RollingStone.com, Amazon.com, CDNow.com, and MP3.com may assume some traditional roles of brick- and-mortar retailers. Such online retailers have established a strong presence in the music industry through aggressive promotion and a track record in fulfilling Internet orders. Besides selling CDs via the Net, online retailers can take the lead in offering consumers their choice of music in digital form. After settling its legal issues, MP3.com has relaunched its "Instant Listening Service." This service allows users to have online versions of CDs they purchased. From an account on MP3.com, they can access their music files anytime, anywhere.

Since online retailers have the expertise and facilities to distribute music files over the Net at minimal costs, they can adopt a competitive pricing strategy. To facilitate delivery of music files, online retailers can place servers at strategic places around the world to serve their consumer bases. For example, servers holding Asian songs can be placed in Asian cities where demands for such songs are high. Online retailers can also allow consumers to sample songs by making these songs playable from Web sites in live streaming format such as Real Audio (with limited playable period). In order to succeed, online retailers must make sure their Web sites (their only sales channel) are accessible at any given time. They need to invest adequately in computer and network equipment to handle Net traffic at peak periods. Alternatively, online retailers can team up with companies offering content delivery services globally, with a high-performance network instead of the usual best-effort network.

Online retailers tend to have extensive consumer databases. To better serve consumers, these retailers can use data-mining techniques to chart consumer purchase patterns and understand buyer preferences. Consumer behavior (browsing and purchasing patterns) at the Web sites can be captured in cookies and stored in databases. Consumer profiles can be created. This knowledge can be translated into increased sales through focused marketing efforts. For example, fans of a particular genre of music can be introduced to other artists of similar genre automatically (perhaps via email). Amazon.com has taken the lead by using this practice. Many consumers were initially attracted to Amazon.com not because of the good deals or the wide selection of music but because of its personal attention to users. Amazon.com’s Web site remembers the identities and interests of its consumers. In sum, online retailers can do well by employing a dual strategy of consumer intimacy (knowing consumer preferences) and convenient delivery (facilitating orders).

Action items for online retailers include:

• Offering selection of and distributing songs in digital form, and adopting a competitive pricing strategy; and
• Leveraging extensive consumer databases to examine consumer purchase patterns and engaging in focused marketing efforts.

Traditionally, record labels play key roles in the music creation and distribution process. They scan the environment, discovering promising artists with latent talents and enter into contracts with these artists. They manage the music production process by marrying artists with the right mix of coworkers (producers, songwriters, and musicians), handling legal aspects of music creation, packaging artists for marketing purposes, and distributing music (songs on CD or other media) through brick-and-mortar retailers. The increased visibility of the Net in the music industry may rattle the pole position of record labels.

For a long time, record labels have given brick-and-mortar retailers full responsibility of distributing music to consumers. But with rising prominence of online retailers, record labels must work with these emerging retailers or become online retailers themselves. Three of the five major record labels (EMI, Sony, and Universal) have begun offering downloads of music. Other major record labels and several independent labels (for example, Zomba and TVT) have announced similar plans. Major record labels have also teamed up with online companies (MusicNet and Duet) to deliver music online. MusicNet is similar to Napster except for one main difference: the songs expire after a time period if the subscription is not renewed. Duet uses streaming but there are doubts about the popularity of this approach. However, both approaches do not allow consumers to listen to music anytime, anywhere, and anyhow (on whatever device, online or offline). Warner, BMG, EMI, and other labels have entered agreements with MP3.com, MusicBank, and other companies to offer consumers the ability to store their music wherever they are and whenever they want through the currently legitimized Instant Listening Service. Since both types of retailers have their own unique competencies, record labels can attain maximal benefits by distributing music simultaneously through both types of retailers. With the online model, the increased costs in marketing are likely to be offset by savings in manufacturing and distribution costs. Moreover, by moving downstream toward consumers, these record labels can learn more about consumer preferences.

Of course, the relationship between record labels and artists will change. Traditionally, artists are dependent on record labels for music creation and especially for music distribution. Now the Net makes it possible for artists to handle parts of the music creation and distribution process. To earn a bigger share of the sales proceedings, established artists can marry up with coworkers and distribute their songs over the Net, independently of record labels. To make up for the possible departure of established artists, record labels must compete with each other in their search for new talent, to whom the services of record labels will be most valuable. With intense competition, it is prudent for record labels to concentrate on their core competency of music creation. This way, record labels can remain truly relevant and valuable to both established and new artists.

Realizing their lack of technological expertise, record labels are striving to form alliances with Internet and media companies to encode music in secure standards so as to battle piracy [3]. For example, the RIAA has undertaken the Secure Digital Music Initiative (SDMI) [9], together with record labels, with the objective of developing secure standards for music files so they can be distributed over the Net without being subjected to piracy abuse.

Action items for record labels include:

• Distributing songs to consumers through traditional and emerging retail avenues;
• Becoming online retailers and distributing songs with a concept of anytime, anywhere, and anyhow;
• Focusing on core competency of music creation and proactively searching for talented new artists; and
• Strengthening strategic alliances with Internet and media companies to develop secure standards for encoding music files without sacrificing portability.

Established artists such as Sting, Wycelf Jean, and Laura Fyji may break free from the restraining confines of record labels and deliver their own music to consumers via the Net. With their many years of experience in the music industry, these artists no longer need to rely on record labels. Some artists are already raising their own visibility via the Net. For example, David Bowie has a Web Site to reach out to fans and sell songs to consumers (www.davidbowie.com). Some artists are distributing their song samples through their own Web sites at minimal costs. Other artists have left their record labels to self-promote and distribute their music via the Net. Besides artistic freedom, these artists stand to gain a large share of the sales proceedings.

For new artists, however, the emerging scenario is an interesting conundrum. The ease of accessing the Net and the quality of MP3 files allow new artists to provide consumers with unprecedented amounts of song samples. Soon, consumers will be faced with a glut of choices for songs and artists. When this happens, new artists will face tough competition in their efforts to get adequate attention on the Net. These new artists can turn to record labels, which can assist them in getting attention through intense marketing efforts. Record labels can also facilitate the music creation and distribution process for these new artists.

While the Net can bring about disintermediation, it may also result in reintermediation, where new companies move in to fill the void left by record labels in the new music distribution paradigm. Such companies include traditional marketing companies (Ogilvy & Mather is just one) and Internet marketing companies (DoubleClick.com is one example). Other companies (for example, Artistdirect.com) attempt to play the roles of record labels but in a new Internet context. Artistdirect.com manages Web sites for over 50 artists and groups, including big names like the Rolling Stones and Aerosmith. With the new music distribution paradigm, artists can look to such new companies when seeking professional management.

Action items for artists include:

• Promoting and distributing via the Net for better financial benefits (for established artists);
• Turning to record labels to receive support for publicity creation, music creation, and music distribution (for new artists); and
• Looking to new value-adding partners when doing music distribution through the Net (for all artists).

Consumers will be the biggest winners with the new music distribution paradigm. Key players in the music industry will compete with each other to deliver high-quality music in convenient or other preferred ways to consumers. The fierce competition and the Net’s minimal delivery costs will drive down song prices. Some key players may even offer songs for free to attract more consumers to their Web sites and instead generate revenue from advertisements. For example, EverAd (an New York-based advertising company) is testing a system of embedding advertisements into the free music that it offers to visitors of its Web site. When a song is played, a series of advertisements will appear and remain until the song is finished playing. New business models that are centered on consumers and driven by their needs will emerge.

Action item for consumers include:

• Exploring alternative music distribution channels available to them and purchasing songs through their preferred channel; and
• Getting music anywhere, anytime, and anyhow.

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The Piracy Issue

Piracy remains a nettlesome issue despite efforts by RIAA to clamp down on illegal music distribution Web sites. The advent of portable MP3 players and similar technologies exacerbates the situation by encouraging piracy and copyright infringements [7]. But on the other hand, the prevalence of technologies supporting specific industry standards also facilitates development of the new music distribution paradigm. With the need for widely accepted industry standards, the piracy issue can be alleviated through secure standards, legislation, and education.

RIAA started SDMI as a forum to bring together parties that can contribute toward development of secure standards for distribution of music in digital form. To be effective, guidelines put forth by this body of participants must be adhered to universally with the cooperation of key players in the music industry. One way to alleviate the piracy issue is to promote the use of watermarking when encoding digital music [3]. Watermarking is a process of embedding concealed identification and tracking information directly into encoded digital music. This solution can be complemented by implementing playback devices that recognize and play only legal MP3 files. As an example, the Serial Copy Management System has been used to encode original music with security information and playback devices built around this system that can differentiate legal from illegal music. Although such security features are not impregnable, these may suffice to discourage consumers from illegally obtaining music. If the music industry makes the effort to encode songs only in widely accepted secure standards, fewer opportunities for piracy will be available. Only with such concerted efforts can the thorny issue of piracy be controlled.

With regards to legislation, the Digital Millennium Copyright Act (DMCA) [7] was passed into law in 1998 to address legality issues in the music industry. The issues covered in DMCA include defining penalties for piracy of original music, setting the context of copyright infringements, and establishing rules for Web-casting technologies. Having such legal infrastructure is vital for effective control of piracy activities, enabled in part by advanced technologies. DMCA is applicable to music licensing organizations, Web-casters, Web-casting recipients, artists, record labels, and retailers. Such a law should be extended to other parties, such as manufacturers of portable playback devices, to encourage them to manufacture devices compliant only to secure standards. Besides the U.S., other countries can contribute to the music industry by enacting similar laws.

Education can complement secure standards and legislation. Some students are currently using college servers to establish their own music Web sites and make unauthorized copies of original music. The Internet and MP3 facilitate the proliferation of these activities, despite policies in many colleges that forbid such activities. Because the Net is a relatively new technological frontier, there is widespread misconception about what is legal in the context of music distribution via the Net. Many college students believe their illegal music Web sites can benefit artists by functioning as a promotional vehicle. Others are simply unaware that it is neither ethical nor legal to create such Web sites. Education is clearly necessary to help college students and others understand how their actions are potentially detrimental to the music industry.

Complete elimination of piracy is a utopian idea; there will always be a demand for pirated music, and rewards for piracy are simply too tempting. But with appropriate measures (secure standards, legislation, and education), the piracy issue can be alleviated. For example, appropriate measures have helped to reduce software piracy in Asia, where it was most rampant. A study showed the software piracy rate in Asia decreased from 64% in 1995 to 49% in 1998. Worldwide, the software piracy rate has fallen to 38% in 1998, the first time it has gone below 40% [2].

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Conclusion

Lawsuits filed against Internet companies serves to underscore the impact the Net has on the music industry. However, lawsuits are not the best approach for record labels to deal with emerging technologies. Lawsuits are ephemeral and serve only as a delay tactic for record labels to catch up with emerging technologies. While the issue of contention in lawsuits is often the protection of copyright materials, the real concern for record labels may be the ceding of monopoly power in the distribution of music.

The Internet is bringing new key players and business models into the music industry. Technological advancements and emergence of industry standards is accelerating such changes. Some key players in the music industry have readily embraced the Net, hoping to reap first-mover benefits. Others have been cautious about jumping on the Internet bandwagon.

Consumers will be the biggest winners amidst intense competition. All other key players in the music industry must concentrate on their core competencies and reexamine their value propositions so as to remain truly valuable and relevant to consumers. What remains to be seen is whether brick-and-mortar retailers or online retailers (if any) will prevail.

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