Selling Music in the 21st Century

Scarcity, Theft, and Evolution in a Digital World
Obsolescence of Reality
The dawning of the information age has heralded a revolution in consumer power. Producers were once sluggish, opaque, monolithic entities governed only by self-interest, successfully proffering cheaply produced goods at the highest prices consumers could swallow. “Build it, and they will come” was the prevailing creed adhered to by major firms during the era of producer-centric economics. Times have certainly changed. Viable global competition, consumer-centric development and marketing, and above all else, the proliferation of internet access have withered away the fundamental cornerstones of the buyer-seller landscape. Newspapers, magazines, and television networks are now well aware of the “Pandora’s box” nature of the internet. In the 1990’s, all began providing limited web content, curiously testing the waters in an emerging, alien format. Not surprisingly, consumers liked accessing content for free, acclimated to the format, and came to expect it (and even prefer it). Today, free web content is the genie that won’t go back in the bottle. The New York Times, Los Angeles Times, and Washington Post, among other major newspapers, have been forced to cut jobs to accommodate their burgeoning web operations.1 Over the same period, physical print media sales have plummeted, leaving these once dominant media institutions facing a future supported entirely by internet ad revenue. Network broadcaster NBC went through great pains to eliminate the unauthorized sharing of its video content on second-hand sites like You Tube, but now offers viewing of its entire program catalog online for free.
While all surviving firms have been forced to cull inefficiencies and reorganize themselves into leaner, more agile, web-present entities, it is perhaps the record industry that has been the hardest hit by this shift from the physical to the virtual marketplace. Physical album sales continue to drop, with scant reason to believe they will recover. Prominent record labels have endured a shocking succession of artist purges, mergers, and near-collapses. Things don’t look good for retail music providers, either. Just last year, behemoth music retailer Virgin Megastores collapsed amid mounting pressure from, among other things, virtual music markets.2 Circuit City looks poised to fail in the near future. Visionary entrepreneur Mike Dreese, CEO of Newbury Comics, Inc, recently spoke bluntly of the impending doom faced by his own retail locations: “Brick and mortar will be completely gone, irrelevant, in ten years… maybe five.” The world is going digital, and there is no turning back. In this virtual world, buying music is as simple as downloading a “series of 1’s and 0’s” to your hard-drive. You never see it, you never touch it. Reality is obsolete.
The Absence of Scarcity
Imagine you could buy a good once and never have to replenish it. The good could be infinitely multiplied and sent all over the world with the click of a single button. As long as one consumer on earth was willing to buy the product, it would be instantly available to all who desired it, for free. What would this strange transactional model mean to consumers? Simply put, ultimate leverage over, and even freedom from, producers. What would this model mean for producers? Simply put, irrelevance. A viable market cannot exist where consumers have the ability to satisfy their own demand for free.
A digital file does not occupy space in the physical world, and this makes it unique from all other commodities. Neither supply nor demand are influenced by its production costs or scarcity. While an artist may figuratively sell “one million units” on iTunes, in truth what he or she is actually doing is selling one unit, one million times. Each unit sold is identical, costs nothing to produce, and can exist in multiple locations at the same time. This seeming violation of the laws of physics is another distinguishing characteristic of immaterial commodities. You can’t buy a gallon of gasoline, copy it, and simultaneously fuel every car on earth, forever. With digital music, this feat can be performed with the click of a single button. If physical commodity markets were to behave in this way, no one would ever make any money. In the absence of scarcity and production cost, oil would not be viable commodity. It would be a free and infinite public good. Hence, I believe digital music is ultimately doomed to become a free and infinite public good.
Of course, exploiting this intrinsically infinite pool of supply requires consumer access to the world wide web. Digital commodities cannot be proffered en masse if there does not exist a corresponding digital marketplace, or central, virtual location at which to sell them. Thus, online sellers of digital music depend heavily on the continued growth and proliferation of consumer internet access, for therein lies the only access to their market. In what would appear to be a promising sign for online music providers, internet usage continues to grow explosively, after expanding its reach by two fold annually throughout much of the 1990’s.(3) Unfortunately, it is inevitable that a growing percentage of new internet users will someday learn to illegally download copyrighted music. As virtual consumerism widens, so does virtual theft. The problem: once internet access has topped-out and every potential music consumer has been reached, the market will cease to grow, while the percentage of consumers knowledgeable enough to engage in theft will continue to rise. Legitimate online music sellers will lose market share to more omnipresent points of illegal download, following the logic of the “broken windows theory” of criminology that suggests that as unpunished petty crime becomes more visible, otherwise law abiding citizens are likely to commit more of it.(4) Somewhat paradoxically, the closer the digital music market comes to its full sales potential, the closer it comes to annihilation. In young, tech-savvy, trendsetting urban environments like Hong Kong, illegal downloading is “no longer a niche behavior, but a mainstream one…” according to TNS Market Research Director Steven Yap, citing a study that found over 80% of consumers aged 15 – 26 engaging in intellectual property theft.(5)
Rational Theft
The ramifications of intellectual property piracy cannot be overemphasized. In the early days of online file swapping, it was postulated that a misplaced sense of being “ripped off over the years” by “greedy record labels” was fueling young slackers into exuberant, lawless looting. This argument was strengthened by a palpable public animosity directed toward long-successful artists like Metallica, who were made out to be crybabies and whiners hell-bent on destroying the universally popular Napster.(6) However, this convenient contextualization painfully oversimplifies the issue of anonymous theft. While lawsuits did eventually set a much-needed legal precedent against illegal digital downloads, they did not exact any action against the perpetrators, whose numbers have easily grown by the millions.(7) Today, internet users continue to operate in a sphere of relative anonymity, especially in the realm of file sharing. As the overall volume of illegal sharing increases, the risk of legal action per download decreases. Downloading communities are becoming larger and more anonymous, dashing any hopes of regulation.
The impetus to steal a good lies not in some misplaced, nebulous vindictiveness, but in the most basic of economic principles: rational self-interest. Theft is by far the most efficient means of acquisition. The reason physical theft isn’t more prevalent in rule-of-law societies is that it is often accompanied by significant negative consequences.(8) Theft and graft are perfectly normal occurrences in nations with underdeveloped legal systems, and their prevalence is not the result of lower national IQ, inferior moral systems, or for that matter any measurable difference in human nature. Cheating is simply the most conducive act to survival. Ceteris paribus, it is the most rational solution to any single-iteration confrontation.(9) A fundamental principle of game theory states that the default strategy of any rational player (namely, one that is concerned with maximizing utility gained per transaction) is defection, not cooperation, in the absence of probable retribution.(10) Lack of regulation allows for pure competition, and pure competition awards primal impulses. A market that merely provides a central location for the unregulated theft of its goods will not remain a market for long. Anonymous and unpunished, theft is limited solely by scarcity, for when there is nothing left to steal, theft ceases. What happens when supply of a good is in fact infinite, as is the case with units of digital music? Presumably, the only remaining factor governing theft of a good is in fact the thief’s own appetite for the good. Now apply those principles to the “market” for stolen music. The implications are grim.
Digital audio technology quickly transformed the once scarce commodity of recorded music into an infinite resource; one able to be duplicated ad infinitum. The subsequent proliferation of internet file sharing transformed the hitherto limited and innocuous practice of intellectual property theft (physical copies of cassettes, CD’s) into a worldwide epidemic. A file need only be purchased once and DRM-expunged before it can spawn a secondary “market” in which supply is infinite and equilibrium price zero. There is simply nothing more rational or utilitarian than gaining something for nothing. Economically speaking, the only rational future is an increase in theft.
An Inessential Empire
It is perhaps a stroke of unimaginable bad fortune that the record industry’s painful metamorphosis from “brick and mortar” to “point and click” comes concurrent to the greatest global economic downturn in 80 years. Consumer spending is drying up at an alarming rate, and demand for inessentials, luxury items, and products available elsewhere for less will plummet in kind. More money will be spent on inferior goods, and illegal behavior such as theft will rise.(11) Coupled with the evaporation of employment, disposable income, and consumer credit, a sudden incentive to engage in risky behavior could prove to be a destructive powder keg for online music sellers. The graph below (Figure 1x) illustrates the alarming downturn in US album sales per capita that occurred in the years before the current economic turmoil. An extended recessionary period will only serve to exacerbate the slide in physical sales.
(12)
As consumers adapt to more spartan lifestyles, recorded music will become a less integral component of their consumption bundles. However, if demand for popular music remains as strong as it has for musical instruments (described by NAMM as a “uniquely durable” market(13), a discrepancy will develop between quantity demanded and quantity supplied. While this discrepancy would normally correct itself through the laws of supply and demand, record labels will be exceptionally loath to surrender any more profit than they already have. Adding to the burden of the current drop in CD sales, the “real price” of recorded music has already fallen considerably over the last decade, while the cost of producing it has risen.(14) Previous attempts to stimulate an increase in consumer demand by lowering prices have not produced impressive results. Even the entrance of low price mass merchants like Wal-Mart, Target, and Meijer (who’ve contributed to a decrease in average retail prices considerably) to the music market has not produced a noticeable positive change in consumer demand. The cognitively dissonant pairing of increased affordability and decreased demand is observable by comparing the aforementioned graph (Figure 1x) with the graph below.(15)
It is worth noting that US GDP per capita has risen steadily for the last 60 years, beginning with the end of the second world war, and accelerating confidently throughout the 1990’s. Americans are, relatively speaking, very wealthy. It is not surprising that this economic growth (what some economists have termed a “wealth bubble”) did heretofore provide a solid platform from which a myriad of luxury and inessential goods industries were able to launch and thrive. The US has become defined by its consumerism. Unfortunately, many of its past excesses will not be possible in the foreseeable future. As consumer spending dries up, it will become increasingly clear whether or not a good is truly valued by its consumers. Rightfully nervous record labels await the verdict.
Music functioned solely as a cultural expression for thousands of years before it was sterilized, copyrighted, and mass-produced as an accessory to the prefabricated rock star. There exists no law of nature stating that the “music business” will forever support an infinite legion of Ferrari-driving MBAs in Beverly Hills. If the record industry cannot quickly regain some basic control over the proliferation of its own product, then a stark revaluation and reorganization are in store. It’s quite possible the salad days of this inessential empire are over.
Inevitable Evolution
While it is not easy to predict the future of an industry in flux, it is becoming abundantly clear the record industry cannot continue to exist in its present form. For more than a decade, major record labels have been defined by, above all else, shortsightedness and intransigence. If they intend to survive for another decade, that must change. Fifteen years ago, mp3 technology was a little-known technological phenomenon, a perplexing artifact to music consumers and an irrelevant distraction fit to be ignored by opulent record label executives. Today, it is the preeminent medium for music consumption, and has spawned a highly unorthodox, highly exploitable virtual marketplace. While this burgeoning market may never make up for the revenues lost in the collapse of the Compact Disc, its successes may provide the industry with a few valuable lessons.
The consumer holds all the power. Gone are the days of producer price dictation and towering profit margins. Record labels must observe and emulate lean, agile businesses that have weathered similar paradigm shifts. Pragmatism must rule the day, as a willingness to engage in organizational experimentation will undoubtedly be necessary to maintain basic solvency. While I believe intellectual property theft will ultimately render obsolete points of legal download like Apple’s iTunes Store, I sincerely applaud Apple CEO Steve Jobs, who long ago chose practicality over hesitation, sagely cornering the market for mp3 players and reaping the temporary (and immense) rewards of ingenuity. Record label executives could use a refresher course in ingenuity. The “market” for illegally downloaded music has already ballooned to 20 times the size of the market for legal downloads(16), and the mature next step is not to keep ignoring the problem, but to look for potential upsides. Tracking the volume and preferences of the illegal market may yield valuable insights, and help determine which artists are gaining in popularity, a statistic that can aid record labels in their future efforts to reorganize and transition to more diversified contractual practices.(17)
Subscription services may provide another source of income and complimentary market research. Nokia recently announced a new built-in subscription service called “Comes with Music” in a bid to compete with Apple’s iTunes Store.(18) I believe its merit to be largely short-term. Ultimately, Nokia is absorbing the risk of a price hike in a global recession, while providing the starving labels with effective subsidies; mere stopgap revenues incapable of replacing falling CD sales. While “Smart Phones” continue to grow in popularity, on November 14th, 2008, Nokia made public a considerable fourth quarter sales shortcoming, and projected doubts about its future sales potential.(19) Sooner or later, record labels will be forced to undertake more drastic action.
This action may have already arrived in the form of the much-discussed “360 Deal”, a broad new contractual model that helps artist financiers diversify their earnings. However, mega-promoter Live Nation has already staked its claim as the prime beneficiary of this model. By scheduling its artists’ tours almost entirely in its ubiquitous collection of outdoor sheds, Live Nation stands to squeeze enormous revenues out of the new earnings model in a way no other company can. Once again, the record labels may be left on the outside looking in. The only thing that is absolutely certain is that the music industry is in for another decade of upheaval. Former giants will probably continue to fall. Survivors will continue to consolidate. Unorthodox bonds will be forged between the flagging “mechanical” and thriving “live” wings of the industry. The landscape of the industry’s future will not resemble its landscape today, but the sooner a model can be settled upon, the better.

By Alex Beram

1. Perez-Pena, Richard. “New York Times Plans to Cut 100 Newsroom Jobs.” New York Times 14 Feb. 2008.
2. Gibson, Owen. “Nevermind the high street: Branson Sells his Virgin Megastores.” The Guardian 18 Sept. 2007.
3. Coffman, K. G., and A. M. Odlyzko. “The Size and Growth Rate of the Internet.” AT&T Labs – Research revised (1998): 1-25.
4. Anon. “Criminology: Can the Can.” The Economist 20 Nov. 2008.
5. Anon. “US illegal downloads on the rise.” News.bbc.co.uk. 16 Jan. 2004. BBC. 20 Nov. 2008 .
6. Wire Report. “Metallica hails Napster decision as music downloads continue.” CNN.com. 13 Feb. 2001. CNN. .
7. Ibid (as note 5)
8. Axelrod, Robert. The Evolution of Cooperation. New York, NY: Basic Books, 1985.
9. Ibid
10. Ibid
11. Taylor, Cliff. “Thieving soars with recession.” Nzherald. 28 Sept. 2008. New Zealand Herald. 20 Nov. 2008 .
12. Liebowitz, Stan J. The Industrial Organization of Digital Goods and Electronic Markets. Cambridge, MA: MIT P, 2005.
13. Wilson, Ken Wilson, Erin Block, Betty Heywood, Megan Nelson, Christian Furst, and Laurie Gibson. NAMM 2008 Report. PublicationNo. 1. National Association of Music Merchants. 2008 ed. NAMM. Pgs. 5-7.
14. Alhadeff, Peter. “The Value of Music and the Trappings of the Marketplace, 1990-2005.” Global Business & Economics Anthology (2006): 13-16.
15. NPD Group. NPD Music. “CD Price Declines Are Accelerating.” Press release. 23 June 2004. NPD. 20 Nov. 2008 .
16. Anon. “Piracy: Look for the Silver Lining.” The Economist 17 June 2008.
17. Ibid
18. Murph, Darren. “Nokia’s Comes With Music gets scrutinized, sounds good so far.” Engadget. 16 Oct. 2008. Engadget.
Nov. 2008.
19. Anon. “The battle for the smart-phone’s soul.” The Economist 20 Nov. 2008.

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