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— Analysis —
 For music fans it used to be simple -- there was the radio and the record store. The evolution from 78s and 45s to LPs, eight-track tapes, cassettes and compact discs did little to disrupt the ritual of tuning in to the local station and, if a song caught the ear, trooping down to some dusty shop with a quirky sales clerk to buy a recording. Over the past decade, everything has changed. Perhaps no media segment has been as buffeted by the Internet, mobile and other technologies as the music industry. Where choice once was limited, consumers today have many options, whether buying songs or albums in multiple formats; getting music for free in exchange for watching advertising; listening to streaming music over computers, phones and other devices; subscribing to vast libraries of songs or to individual artists; and sharing songs with whomever they please. -- See the entire 9.15 Tech Confidential Special Report --
As a result of these shifts, a business once controlled by a handful of
big record labels is increasingly ceding power to small technology
companies, many backed by venture capitalists eager to cash in on what
they perceive as a changing of the guard. Even relative newcomers such
as Apple Inc.'s iTunes store, launched seemingly eons ago in
2003, are having to shift gears as newer companies capitalize on the
falling costs of producing, distributing and publicizing music.
The revolution in how music is packaged, distributed and consumed has had a parallel, if less tangible, effect on music as a cultural artifact. Widespread pirating is not only driving the price of music toward zero, but also altering the very meaning of "owning" a song for consumers, artists and music companies alike. Musical taste, too, is fragmenting. Freed from the requirement of buying an entire album to get the two good tracks it contains, consumers are turning increasingly promiscuous in their listening habits. That is forcing artists to get creative in how they connect with fans, which is changing how music is marketed. To many fans, especially younger ones, music is no longer a standalone entertainment form so much as part of a multitasking experience involving the Internet, video games, films and other channels. How did we get here? In the short, turbulent, history of digital music, the two companies that wrought the biggest changes, opening the door for a new generation of companies, are a computer hardware maker and a failed startup. Cupertino, Calif.-based Apple effectively atomized the music business by allowing single-song purchases from its iTunes store in an effort to spur sales of the company's portable iPod players. Meanwhile, defunct file-swapping service Napster Inc. ushered in the era of music piracy, forever altering consumers' notions of what music should cost. (Napster liquidated in bankruptcy court after a 2002 court order to stop trafficking in copyrighted material.) "The labels have let [Apple CEO] Steve Jobs have the industry," says Ajay Chopra, a general partner with Waltham, Mass., VC firm Trinity Ventures. "When I'm evaluating opportunities, I ask myself, 'What is Steve Jobs going to do?' And if I can't answer that, I don't move forward. Apple is determined to be big in the music business." Indeed, earlier this year iTunes eclipsed Wal-Mart Stores Inc. of Bentonville, Ark., as the top seller of music, physical or digital, in the U.S. Yet Apple's dominance as a retailer may soon begin to erode as rival online music stores, on-demand streaming services, subscription services and other offerings gain market share, causing customers to rethink the merits of paying 99 cents for a song that is incompatible with most non-Apple hardware. Already, within its first year of operation, Seattle-based Amazon.com Inc.'s MP3 store has grown into the fourth-largest music retailer in the U.S., after iTunes, Wal-Mart and Best Buy Co. of Richfield, Minn. Unlike most music sold on iTunes, Amazon's song files are free of "digital rights management," or DRM, software, which restricts usage of a file beyond a pre-set number of devices or other reproductions. Also entering the fray is social networking giant MySpace Inc. The News Corp. unit is preparing to launch a retail store, also free of DRM, that will be integrated with its music-heavy profile pages. Three of the four major labels -- Universal Music Group, Warner Music Group Corp. and Sony BMG Music Entertainment, all of New York -- hold equity in the MySpace Music joint venture. Many Internet startups trying to undercut these established players are focusing on price. Online retailer Amie Street Inc. of New York, backed by an investment from Amazon, uses a flexible model under which songs are initially free and escalate in price as demand for them increases. Meanwhile, other venture-backed services are touting free, ad-supported music, although usually with a catch. SpiralFrog Inc. of New York, which has raised $30 million from hedge funds including Moore Capital Management LLC and Stagg Capital Group LLC, both of New York, lets visitors download DRM-restricted songs from an ad-heavy Web site.
U.K.-based We7 Ltd., which has drawn funding from British musician Peter Gabriel, along with VC firms Eden Ventures and Spark Ventures plc,
both of London, offers free songs that contain short advertisements
that vanish after a few weeks. We7 recently added songs from a third
major label, while SpiralFrog signed up only two of the four majors,
meaning that finding free songs can still be something of a wild "Just over 50% of our user searches are satisfied," acknowledges SpiralFrog founding chairman Joe Mohen. "I think a year from now, you'll see that the paid model is for MP3s and the free model is ours, with DRM." Nashville's NoiseTrade, a bootstrapped startup, provides a way for artists to give away music in exchange for the e-mail addresses of prospective new fans, while angel investor-backed TrueAnthem Corp. of San Francisco connects brand advertisers with musicians, who introduce tunes with short, personalized ads. Consumers less inclined to possess a virtual copy of a song also have more options. That includes subscribing to libraries of music content and Web sites that allow streaming songs on demand and limited downloading. Publicly traded RealNetworks Inc. of Seattle has emerged as a clear leader among such products with its Rhapsody service, while the existing Napster, which purchased its trademark from the original bankrupt startup, has lost subscribers and remains far from profitable. Both companies offer several tiered plans, ranging from roughly $10 to $15 per month, that provide access to millions of songs from all four major labels, as well as "tethered downloads," or DRM-restricted files that expire once a customer cancels his subscription. The market for free music "streamed" on a Web site is more complex,
with some startups relying on subscription services to supply songs
through their own user interfaces. Most streaming services are married
to some other Web utility, whether a social networking site, music
discovery service or With investment from VC firms Sequoia Capital and Morgenthaler Ventures, both of Menlo Park, Calif., as well as from Universal Music and Warner, social music site Imeem Inc. of San Francisco has built the fastest-growing free streaming service. All four major labels now supply music to Imeem, which lets users play songs on demand. Imeem's growth highlights the pressure on "old music" companies, like other old media firms, to change with the times. And the legal battles between upstart music firms and incumbents have been no less intense than the fights in other quadrants of the media industry, such as the ongoing court dispute between Google Inc. and Viacom Inc. over the search giant's use of protected video on YouTube. Warner sued Imeem in 2007 over alleged copyright infringement, only to later buy a stake in the startup after settling the case. "Sometimes a lawsuit is foreplay to a licensing deal," says Norwest Venture Partners principal Tim Chang of startups' path to legitimacy in the age of free music. "They infringe so that users get what they want and advertisers pay attention, scale so that you have some leverage against labels, get sued and then settle." Yet while the labels are sometimes investors in these startups, they are unlikely to take the plunge and buy them outright. An Internet music service typically needs to license music from at least three of the four major labels to satisfy consumers, Chang says, making media companies looking to branch into the Web music sector the more likely acquirers. The biggest exit to date for a venture-funded online music startup was for Imeem rival Last.fm Ltd. The company, which offers a personalized Internet radio service based on a user's taste, along with on-demand streams, raised $5 million from a lone investor, Index Ventures of London, in 2006, at an undisclosed valuation. Just one year later, CBS Corp. paid $280 million to buy Last.fm. Like other streaming-music sites, Last.fm has yet to prove it can
generate enough revenue to cover the cost of paying royalties to the
major labels that supply its music. And relations with the labels have
been nettlesome. Warner pulled its songs from the on-demand area of the
site this spring, apparently to renegotiate the terms of Bruce Benson, a senior managing director at FTI Consulting Inc. of New York, notes that the penny-per-stream standard in the industry requires a streaming music site to generate a cost per thousand impression, or CPM, rate of at least $10 simply to repay content owners. "You'd need a $15 CPM to cover your own needs, and the numbers I've been seeing haven't come close to that," he says. As Benson suggests, the digital-music business is entering a phase common to many emerging high-tech sectors. The land rush of startups that follows any significant technological shift, such as file sharing, is already starting to thin out as winners stake their claims and losers get consolidated, if they're lucky, or simply disappear. For example, Last.fm rival Pandora Media Inc. faces a fight for survival despite having attracted prominent venture investors and a slew of good publicity. The Oakland, Calif., startup employs music experts to create a recommendation "engine" for Internet radio. But an upcoming regulatory change that will result in a doubling of streaming royalty rates for Web radio companies could spell the company's doom unless it elects to charge users a subscription fee or finds a way to add advertising that its audience will accept. Like Pandora and Last.fm, music discovery site iLike Inc. of Seattle has become popular, if not consistently profitable. One key to its success in attracting users has been its availability over Facebook Inc. of Palo Alto, Calif., through which more than half of its 30 million users connect to the service. Through a partnership with Rhapsody, iLike allows users to stream as many as 25 songs per month and download selected others for free while examining their friends' tastes and recommendations. The startup has raised $15.8 million in two rounds of funding from former Time Warner Inc. executive and MTV co-founder Bob Pittman, star venture capitalist Vinod Khosla, and the Ticketmaster unit of IAC/InterActiveCorp of New York. "There's a natural propensity for social networking and music to go together," says MySpace founder Brad Greenspan, who left the social network in 2003. "When you're surfing people's profiles and everything starts to look the same, the only way to differentiate among them is their individualization. And if you add an image of an artist on a site, you will bring in people who want to be close to that musician's energy, whether by blogging, chatting, befriending or following them." Drawing on such desires, music-blogging hub MOG Inc. of Berkeley, Calif., wants to tap into fans' efforts to spread the word about their favorite artists. Universal and Sony BMG joined the Angels' Forum of Palo Alto in putting $6 million into the startup, which compiles the musings of volunteer bloggers writing on given musicians and bands. MOG, which also offers on-demand music, represents a one-stop version of the musical blogosphere, where songs are commonly shared without compensation for content owners. Also harnessing the power of the blogosphere are music-focused search engines such as the bootstrapped Hype Machine Inc. of New York and angel-backed Seeqpod Inc. of Emeryville, Calif., which index thousands of music blogs where MP3s often reside for a few weeks so users can sample them. Another area where Internet startups are encroaching on the record labels' turf is marketing. Launched this summer, Los Angeles-based Topspin Media Inc. enables artists and fans to communicate directly, offering a sort of customer management technology package for musicians that allows sales of songs, albums and merchandise. Under one subscription option offered through the company, a fan can pay a flat fee for a musician's entire recorded output over the coming year -- income a musician might otherwise have to share with a label. Venture investors are on board, with Topspin having raised funding from Redpoint Ventures of Menlo Park and Foundry Group of Boulder, Colo. "By turning the music world from low margin to high margin from a musician's perspective, we believe that a middle class of artists can make a living," says Topspin chief executive Ian Rogers, who previously led the music division of Sunnyvale, Calif.-based Yahoo! Inc. "We've moved from a world of limited distribution channels to a world where consumers are empowered with unlimited choice, which makes marketing that much more important." Technology also benefited the labels. Production costs for music have fallen rapidly over the past decade or so, when Digidesign Inc. of San Francisco introduced recording software that made home recording, editing, and mixing inexpensive and easy. The replacement of physical media such as CDs with online music files has cut distribution costs accordingly. But rampant music piracy continues to dwarf legitimate sales, cutting label revenues by as much as half since the mid-1990s. Meanwhile, work that had long been the province of music companies has been gradually appropriated by newer, fleeter Internet companies or, as with marketing, "disaggregated" out of existence. Other competitors also have emerged. LiveNation Inc. of New York, a publicly traded live music promotion company spun out of Clear Channel Communications Inc. in 2005, has signed top acts, including U2 and Madonna, and has sweetened its deals by letting artists maintain ownership of their material. The labels' uncertain future hinges, finally, on what roles they will retain and which they will abandon. "There was a cash register between the record label and the customer," Eric Garland, CEO of Los Angeles media measurement firm Big Champagne, told a conference audience in the spring. "Now there's a tip jar." If so, what will the business look like? A dying era of superstar acts may give way to a music scene carved into myriad niches, with proliferating media channels creating room for more voices -- the "middle class" of artists, as Rogers puts it. Artists and fans will operate in closer proximity, with more tools in place to help them connect. How, then, will music derive its commercial value, and where should investors place their bets? The future is likely to include more sponsorship and patronage. Imagine liquor companies, fast-food joints and other advertisers paying the band of the moment for rights to its music before it's recorded rather than after it hits the charts. Alternatively, rich benefactors -- or legions of fans -- could support artists in exchange for early access to a new album or even a shout-out in the liner notes. Tie-ins with other media such as video games will also create opportunities: People may not buy the album for $15, but they'll pay $39.99 for the "Guitar Hero" version. The old ways, reinvigorated by technology, are made new again. Comments | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
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Lars Ulrich, drummer and co-founder of Metallica, started a crusade against Napster and became one of the most popular opponents of P2P platforms. If he only knew this before he started fighting Napster, to become one of the most hated personalities in the entertainment industry, major record companies might not be in such a bad shape today.