A Rational Plan to Save the Recording Industry

 
From: Dave Goldberg
Sent: Thursday, July 31, 2014 8:58 AM
To: Lynton, Michael [mailto:__________@spe.sony.com]
Subject: Re: Music strategy-confidential
Michael,

As we discussed Saturday, I thought I would send you a longer email with my thoughts about the strategy, what the risks are with it and the reasons it hasn’t been done to date. I obviously don’t have access to any internal data but I think Sony is close enough to WMG or EMI (where I have seen the data) to make reasonable assumptions.
 
If you still want to discuss this after you digest this, I am happy to find a time to come down to talk about it more. I think this amount of reinvention has rarely been done inside a public media company and it would be tough for Sony as a company to stomach the complaints from artists, employees and related parties (RIAA budget would be slashed, as an example). We would have to really decide if it was possible if you agreed with my thesis. I would also want to do a lot of actual work prior to implementing to validate the data behind the assumptions and understand the sequencing. I think it is a two-three year project to shrink the company down to the end state with a lot of noise in that period.
 
Best,
Dave
Core strategic assumptions:
 
Music is becoming a purely digital product. A digital-only recorded music company will be a much more profitable one after one-off restructuring costs.  It will have lower revenue and higher margins.  Its revenue will be very stable and grow with the overall digital music market growth.  It will be a much more valuable company with its revenue base solidly coming from subscription and ad revenue.  It will be valued like music publishing companies or cable channels, not like recorded music companies today.  Margins for recorded music should eventually be above 40% on that lower but growing revenue base.
 
Catalog provides 50% of the revenue and 200% of the profits of recorded music.  This has generally been the case for the other recorded music companies when the analysis was correctly done.  The correct analysis requires including reissues, live albums, greatest hits releases in catalog.  Catalog needs to be defined much more broadly to include all music that hasn't been created in the last 2 years - EMI used to call the Beatles releases “new music” even though they clearly weren't under a new album contract.  

In addition, streaming revenues tend to be more heavily weighted to catalog. Pandora and Spotify are probably 65% catalog under this definition. Licensing and synch revenue are mostly catalog as well. Therefore, if Sony Recorded Music (ex-Japan) is doing $250MM in EBITDA today, catalog is probably generating approximately $500 MM and the new release business, which is 98% of the headcount, is losing $250MM per year. The catalog is also primarily generating this revenue off “deep” catalog that is at least 5 years old or older. The great classics of pop music are stable earners, much like the consistent songs that generate most of the music publishing revenues.
 
With catalog providing the base profits, new releases need to be cut back dramatically to the point where the new business either breaks even or loses a small amount of money (justified by the long term catalog income stream of those songs). Thus, if the new release business is oriented towards building new deep catalog, it changes the entire process from trying to pick big hits to safely getting some good music out that has longevity. This will bias new releases to genres like rock and country that typically have had strong catalog. These also happen to be the genres that don’t have expensive producers so more music can be created for the same A&R dollars. 
 
The record company needs to act like a music publisher for new releases - putting up very little money but not trying to hold artists for long contract periods or to keep as much of the revenue.  Advances would be $50k with a 40% revenue share after the advance.  Losses in new releases are generally driven by expensive fixed headcount and built-in marketing costs for new releases that don’t pay off.  The new release business budget, employees and capital need to be ring-fenced from the catalog so that it stands on its own with a Lifetime Value assessment of the capital deployed.  Most fixed headcount in new releases will need to be eliminated, artists will need to be paid quickly and transparently, deals will need to be simple and fair and catalog replenishment is the only goal of the new release business. 
 
Artist contracts that have large fixed marketing costs will need to be restructured or sold off as there will no longer be headcount to do the work.  New releases will be tested on consumers before added money is spent to ensure that it isn’t wasted.  In short, the new release business will become like an independent label.  Publishing and recorded music A&R should be combined to ensure that all recorded music releases had a combined publishing deal and that you can capture the publishing value from the catalog you create.  Not all new publishing writers would be on recorded music contracts but all new recorded music contracts should be combined with publishing.
 
Physical distribution is going away - it doesn’t need to be eliminated prematurely but it needs to follow digital and not drive it.  The record company will want to milk the physical CD business but not worry about supporting retailers with credit to make quarterly numbers.  Jamming product into the channel needs to be eliminated and the digital business needs to be the priority.
 
Internationally, most local repertoire will probably have to be eliminated.  The record company will want to sell off the local repertoire or spin out the local labels and focus on English language repertoire globally, unless there is some country that has managed to be profitable on its local repertoire (i.e.Japan).  This is a huge part of the cost base with very little value.  Digital distributors do not need local new release labels to work with as they are all regional or global players.  International local publishing repertoire will need to be evaluated but much of that cost and infrastructure shouldn’t continue either.
 
Digital licensing strategy needs to change dramatically.  The record company and the publishing company need to understand the economics and the ecosystem of the DSPs and work to help them grow profitably but also to ensure that there are multiple providers.  Pandora should be incentivized to build a subscription business, Spotify to enter the radio space, new entrants to have an advantage in the beginning and much more international access to digital content.  
 
The simplest way to start would be to offer Pandora, Spotify, Google, Amazon and others a new three year deal.  This would be a 10-15% premium over their expected payment for the 3 years but they would get unlimited use of the music during that period.  This would incent them to heavily invest in growing their user and revenue bases because they would see improved margins on each incremental sub.  Additionally, the record company would make licenses transparent and simple for all new entrants while removing the price setting constructs from on-demand subscription.  If Netflix wanted to pay 200 MM per year to give all of its 40MM subs a music subscription - that should be encouraged, not scoffed at.  The goal for digital is for subscription and ad based services to become the predominant means for people to access music.  These services need margin to attract capital to make the investment to grow their user bases.  This should help build more stable long-term revenue streams for both recorded music and publishing.
 
Publishing needs to extract itself from the tax of the PROs (ASCAP, BMI).  The technology is available today to enable direct licensing of public performances for radio and TV - if the costs of the PROs was shared equally between broadcasters and publishers, this could result in an incremental 7%-9% revenue increase to publishers on the same base of content.  In addition, record companies should be able to get a US performance right for analog radio by pushing hard to move as many listeners to digital radio as quickly as possible.
 
Headcount reductions will take time but after the restructuring period, it should be possible to run Recorded Music with a few hundred people and the same for publishing.  More investment will be needed in technology for royalties, reporting and licensing content and revenue will certainly come down on the recorded music side but the absolute and relative margin improvements should make up for it.
 
It should be easy to double margins without much change - Warner now has an 18% OIBDA margin on a lower revenue and publishing based compared to Sony’s 11%.  But the goal is to get to a 40% margin on the combined Sony Music business, albeit on lower revenue.  This should be a growth business that grows with the digital business and gets a substantial premium on its valuation because of the margin, the stability of the cash flow and the growth.  If the whole business had $587MM of OIBDA on $5.4 B of revenue last year, it should get to $1.6B of OIDBA on $4B of revenue in 3 years.  
 
This would be an almost 3X improvement in absolute earnings but would be a 4-5x increase in valuation because of the margins and the growth tied to digital.  The new business would be growing 10-20% annually with high margins.

Dave Goldberg is a former recording industry executive at Capitol Records (now part of Universal Music Group), and a co-founder behind early digital music venture LAUNCH, and an outspoken advocate of MP3 distribution while heading Yahoo Music. More recently, he headed SurveyMonkey and was married to Facebook COO Sheryl Sandberg. Goldberg died in a freak treadmill accident last year.

28 Responses

  1. DavidB

    A Rational Plan to Save the Publishing Industry:

    1. Don’t publish any new books.
    2. Live on the royalties from ‘catalog’.
    3. Fire most of your staff.

    Do you see what I did there? Technically, the ‘plan’ would probably increase profits for publishers (or record companies), assuming they had a sizeable catalog, but in the long run it would not be saving the industry, just postponing its demise.

    Reply
    • Build a Catalog with No New Releases... Genius!

      To funny. Do people actually take this seriously? How does he suggest you create FUTURE catalog revenues without investing in NEW titles so that there IS a catalog in the future… Wow, just wow.

      This isn’t a genius business model. But without labels investing to develop new artists, even publishers will find themselves in a downward spiral of the snake eating it’s own tail.

      Reply
  2. Rob F

    ignores the fact that catalogues are profitable and evergreen for record labels because they invested heavily in content creation and promotion. Profitability enjoyed on catalogue releases comes at the expense of short term gains. Also, it is fantasy to believe that they can offer 50K advances to superstars for a 40% royalty and they would just go along with it. Someone will fill the void with bigger advances.

    This is portfolio management, not the music business. The catalogue business is targeted at an aging consumer and the assumption that they can create new, valuable catalogue without significant investment is silly. It would actually be awesome if the majors went with this model. It may be the only way we see their influence diminish over time.

    Reply
  3. Paul Resnikoff
    Paul Resnikoff

    I read a story recently of how longtime recording industry executive (and current Capitol Music Group Chairman/CEO) Steve Barnett ripped down all the platinum plaques and pictures of all the storied mega-artists of yesteryear, like the Beatles, from the hallways of Capitol Records. The reason, according to the report, was that Barnett feels that this represents the past, the glory days that are holding the company back from effectively bull-charging into the future and releasing the superstars of tomorrow.

    Goldberg’s version cuts against that romantic change narrative, because it states that there isn’t a new, fresh frontier to be created. It’s all about maximizing the past! And, minimizing the heavy expenditures that it takes to prop up modern-day stars like Pitbull, Katy Perry, and Selena Gomez.

    Now here’s one big problem with that plan: it isn’t sexy! That’s like publishing, the dry side of the business that nobody cares about, it’s like working at ASCAP or something. Guys like Steve Barnett and Lucian Grainge want something sexier!

    Yes, they’re losing, but never underestimate the lure of a sexy business, and how it dramatically skews business planning. It may be a big part of the story here.

    Reply
    • Troglite

      Great point! Never underestimate the influence of the human ego over our choices and actions.

      Reply
    • Rob F

      yes, and if major record labels stop giving out big advances to sign new talent, someone else will step into the breach, likely those from less sexy industries who want to hang out with rock stars. Oil billionaires and russian oligarchs, etc. It happened in film financing and it will happen in music.

      Reply
      • Paul Resnikoff
        Paul Resnikoff

        Well then, let them do it! That might support Goldberg’s point, which is that the huge costs associated with breaking new acts isn’t worth it for an actual business. For an oligarch fun-time vanity distraction? Definitely.

        Reply
      • Troglite

        @RobF. I think you’re getting to the heart of the matter. Frankly, I’ve heard different versions of this sales pitch more times than I care to admit. Its a standard part of Silicon Valley culture. It seems that whenever a company hires an expensive expert as a consultant to advise them how to transform their legacy brick and mortar business into a modern digital leader many of these themes appear. As an aside, its funny how when its your own business they call it “transformation” but when its someone else’s business its “disruption”.

        Examples:
        * Monetize your digital assets, even if it requires undervaluing them.
        * Push risk onto smaller start-up businesses that you can buy if their efforts are successful
        * Ignore the nuances of the business because from the Valley’s perspective, its really all the same (just digital content assets to be used to attract larger audiences and new opportunities for venture capital). If questioned, accuse them of resisting the inevitable advance of technical innovation.
        * Bravado without repercussions. The consultants always get paid, whether the strategy works or not.

        For me, what makes Goldberg’s message challenging is that some of it has merit while much of it exhibits hubris and ignorance.

        Changing the way that risk is managed is highly relevant. With smaller margins and declining revenue, this change seems mandatory for anyone working at a major label. Its not a matter of if risk can be reduced, its a matter of how.

        We’ve already seen some of these changes. For example, as a percentage of the business, A&R investments are already much lower than they traditionally have been… and that’s being facilitated by allowing other parties to play a larger role in finding new talent (YouTube, self-releases, indies, etc). When you think about it, its really not that bizarre to propose that attracting and supporting the largest established artists requires a substantially different business model than breaking a new artist.

        Reply
    • Faza (TCM

      No, Paul. The real problem with this plan is that it is the equivalent of halting production, getting rid of anyone who isn’t strictly necessary and gradually selling of existing stocks and plant.

      Will that boost your profits in the short term? Sure! Except it isn’t anything other than an extended folding of your company.

      Let’s not kid ourselves: catalogue loses value over time. Every major label has a lot of it and the golden years aren’t that far back in the past, but it’s definitely a diminishing returns strategy. Anyone in a culture industry has to evolve along with the culture or get left behind. How’s Capitol’s catalogue from the 40s doing these days, I wonder?

      Catalogue is a money-maker – in the digital age, especially – because once you’ve established value, you can continue milking it at zero to no cost. How do you establish value? By spending a crapton of money on artist development and marketing. Is a lot of this money wasted? Yep. Do we know which part, in advance? Nope. What we do know, however, is without it you don’t get catalogue. At best, you might get a five-minute hit that will be forgotten by the end of the year – as any number of YouTube “sensations” demonstrates.

      Let’s not beat about the bush: unless you are at least generating enough current hits to replace the diminishing value of your catalogue, your company is dying.

      Reply
      • Paul Resnikoff
        Paul Resnikoff

        Halting catalog is one thing, but what about deploying your resources to develop more innovative ways to release that catalog, monetize it, and monitor its sales? Goldberg isn’t saying halt new production or artist development, but he is questioning by such a gigantic, draining percentage of major labels’ resources are being devoted to artists like Selena Gomez and Rihanna. In the immediate, Goldberg is advocating trimming that down to the extreme, and focus on cheaper-to-develop artists.

        I think there’s another piece to this that needs to be developed. After all, this isn’t a fully-developed plan, it’s an email that leaked out. Ultimately, it seems that a radically different strategy could be deployed around new artist development — in fact, that strategy could involve letting others do the heavy, resource-intensive work of finding stars and ‘kick-starting’ them into some level of traction.

        That could come from an indie, an artist’s parents, a management agency, etc., with the major coming in when the artist is more ‘baked’ and market tested. You could argue something like that happened with Mackelmore, though I admittedly haven’t looked into the fine-tuned details of that case study. May be an interesting starting point here, though.

        Reply
    • Name2

      Re: Barnett

      Deep, profound shame can make people violent, too.

      Just sayin’.

      Reply
    • Mite Be

      Too bad noone today can write a decent song to save their lives, and african americans are mostly stuck in the rut that is hippity hoppity, uh rip rap rippity doo doo.

      Meanwhile, millenial caucasians imitate Seals and Crofts and Simon and Garfunkel and the Band, except extremely laughably and poorly, and with almost no actual vocal talent, except that Hozier guy stuck singing the same song a billion times, because he won’t write another good one.

      Yeah, tear down those great Capitol plationum reoords and put up Mumford instead. Peeyooska!

      Reply
  4. Me2

    4. Get rid of costly contracts requiring promotion.
    5. Quit dealing with local labels.
    6. Anything older than 2 years is catalog.
    7. But even the new stuff is all about on catalog, We don’t need no stinkin’ hits.
    8. So we’ll focus new releases on Rock and Country, where the producers are cheap.
    9. Oh and make sure we get the publishing too.

    Reply
  5. Name2

    How long are we supposed to be cutting these poo-eaters their checks?

    Didn’t Bill Clinton end “welfare as we know it”?

    Reply
  6. Josh

    Goldberg’s assumptions are a key indicator why the industry needs “saving”.

    Reply
  7. T. Cooke

    “Media Executive Wife Stages Treadmill Accident to Murder Depressed Husband in Mexico.” I’m sure that’s not true, but reading his pitch is really depressing. I don’t mean to offend anyone.

    Reply
  8. Name2

    Catalog now! Catalog forever!

    (“Dee Dee, cancel my lunch tomorrow and tell Congress we need copyright extended another 100 years. kthxbai.”)

    Reply
  9. Eclipse

    The bit that gets me is that they want to move all consumption of music to ad-based subscription services. Deals over ad space equals more money for the label and nothing for the artist. The labels are figuring out how to make big money again…artist development and artist royalties are expenses and as usual, low on the list of priorities.

    Reply
  10. Spoken X Digital Media Group

    There is nothing sexier than great margins . A digital only product is a ones & 0’s inevitable–destiny. Stop thinking ‘ Music Industry ‘ and start talking about ‘ My software Catalogue Program ‘ : They have a trillion valuation of consumer electronics gadgets out there. Both musical and literary entertainment software is the greater percent driven force that made those gadget–devices relevant. With that being said , I think it’s time for a proper total revenue percentage shot gun wedding to take place . . .

    Reply
  11. Versus

    First, get rid of all those demanding musicians. Unwashed hippies, the lot of them, and hypocrites, supposed to be all about free love and art, but always saying “show me the money”.

    Reply
  12. Thedenmaster

    I can’t wait till the big labels go down.
    Once the old men die so will classic rock. It will be a glorious day for all mankind.

    Reply
  13. Tim Wood

    +1 to Mite Be. +100 about the derivative millenials, lol!

    Lot of good economic ideas in this one, but it seems to require clairvoyance as to what tunes will yield significant catalog money over time, and without big marketing money first. Not too many Clive Davises and David Geffens walking the streets….

    Reply
  14. Yroglite

    What if there was an open, transparent marketplace for catalog sales? What might that look like and how could it impact revenue for the participants?

    I could see an indie selling their catalog for an artist that has broken out so they can take a profit and reinvest in developing a new set of artists.

    I could see majors selling off catalog for works that failed to acheive their expectationa as a write-off. Others could still find value in licensing and distributing these works for specialized purposes.

    I could see individual artists who have achieved a moderate level of success on their own selling a catalog to an indie as a way to fund their next project without relying on crowd funding or taking on debt.

    I could see an auction model helping the marketplace optimize the price for these catalogs.

    Reply

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