Tomo Hosoi, Joseph Kim, Dennis Stainken, and Felipe Caro
Over the last fifteen years, the music industry has made a rapid transformation through the advancements of digital technology and the Internet. At the turn of the century, Napster gave consumers a P2P tool to exchange digitally compressed files. A few years later, Apple created the iTunes Music Store service to complement the highly successful iPod music player and bring digital downloads to the mainstream. More recently, Spotify and other on-demand digital streaming radio services have offered new ways of listening to music. Through this rapid change in consumer behavior, physical media lost its place to its digital counterpart in the US music industry.
U.S. Revenue from vinyl record sales peaked at $3.5B in 1977, while CDs contributed the most to industry-wide revenue with a peak of $14.5B, or 91% of annual revenue, in 1999. After this high, there was a notable decline due to digital piracy until only the past few years. The available revenue pie has reduced by over 60% from that time, now with only $6.97B U.S. music industry revenue reported in 2014. Digital revenue made up 64% of this total with 37% coming from digital downloads and 27% from digital streaming.
Record labels played a dominant role in the pre-digital recording industry. They added great value to the entire supply chain, most significantly in providing artists with access to recording equipment, operational support for physical format manufacturing (vinyl, 8-tracks, cassette, CD, etc.), branding and marketing, and access to sales channels. In this era, it was common perception that successful artists were born through record label contracts. Record labels were able to take in approximately 30% of CD revenues, which was the highest of any player in the supply chain.
Today this traditional business model has been challenged by the digital revolution. Artists (and even small niche artists) are now able to easily produce digital recordings from home computers and self-promote to a global audience through digital channels such as Facebook and Youtube. Brick-and-mortar CD stores became virtually non-existent over the last decade, as we saw with Tower Records filing for bankruptcy in 2004. This disintermediation has shifted the value away from record labels and physical manufacturers toward consumers, small/niche artists and new technology providers.
With the much smaller industry revenue pie, there is even more scrutiny on how the pie is split among the existing players. Interestingly, record labels still claim the largest piece at over 50% of the share, despite their changing value to the supply chain. Some reasons for this phenomenon could be the existing contracts with the artists and the licensing/royalty business model that involve the record label as the performance rights holder for the recording. Much of this misalignment can be attributed to the industry-wide problem of information asymmetry in usage and royalty reporting. For example, it is possible that an artist or record label may not have full disclosure to the actual listening rates from the digital streaming music service. Kobalt Music Group is one company that attempts to resolve this information asymmetry problem through the supply chain. Kobalt offers artists, songwriters and publishers transparency to copyright administration and usage tracking through their proprietary portal, and also aids them through comprehensive label and publishing services for of their works.
As digital music stores and streaming services aim to carve out a larger portion of the industry and differentiate themselves from one another, further disintermediation is expected. We have seen this evolution in digital video streaming as Netflix, an on-demand internet video streaming service began to distribute exclusive content (e.g. House of Cards) in 2013. Apple recently launched their new on-demand music streaming service, Apple Music. There is further speculation of Apple eventually moving toward distribution of original content through the establishment of a new record label with exclusivity on major artists. However, some industry insiders argue that if the iTunes store did not cause Apple to make this move with music downloads, there's no reason to expect that happening now with digital streaming.
As the recorded music supply chain evolves it's unclear how record labels can respond to the disintermediation created by the digital revolution. It seems unlikely that traditional labels can regain the relevance they enjoyed in the pre-digital era and remain as strong without finding new ways of adding value in the supply chain. On the other hand, new channel players must show that they have what it takes to create a superstar artist, as record labels once did, rather than simply provide distribution.