This is the second in a series of blogs. It is also the working draft of the Introduction to the Second Edition of my book, the Future of the Music Business to be published next spring.

The Suffering of Major Labels

The impact of digital technologies on the major companies has been disastrous.  In 1999 income from recorded music was nearly $15 billion dollars in the U.S. alone. By the end of 2006 that income shrunk to an astonishing $11.5 billion -- and this included digital sales. In other words, digital downloads, interactive streaming subscription services and mobile delivery have not made up for the huge decline in CD sales. World wide losses are comparable. Income has dropped in every year except one since 1999. Two majors merged, Sony and BMG, resulting in thousands of lay offs and scores of dropped artists. Warner was sold to private investors and in 2007 EMI was sold off.   Many famous labels have been shuttered including Arista and Elektra. And in 2007 the largest retail chain, Tower Records went out of business.

Perfect Storm

In large part the labels cannot be blamed for their woes. The CD was introduced before the Internet and PC became widely popular. CDs are unprotected digital copies of master recordings. The labels could not have known that they in effect were selling perfect copies of their masters. When the PC and the Internet become popular it was easy to rip all those CDs and upload perfect copies to everyone in the world. So it has been very difficult for the labels to compete with the web, which in effect is a perfect copying and distribution machine.

But another often overlooked reason for the plight of the labels is that “free music” is not free at all. You need to pay for a computer to get all that free music, and unless you want to wait forever you need a broadband connection to get it swiftly. So you are paying a lot to the electronics business and the Internet service providers (ISPs) for so called “free music.” In addition if you want portability you are going to buy blank optical discs, and MP 3 players – probably an iPod. Apple has sold more than 100 million of them. So a fortune of money is paid for so-called free music – but the money is going into other pockets than those of the labels. This has given the electronics business and the ISPs every incentive to encourage people to acquire “free” music. The electronics industry has steadfastly refused to place code in their machines that would prevent sharing free content. And the ISPs have successfully insulated themselves from liability through pushing for legislation that prevents them from being responsible for people sharing music through their networks.

Bad Choices

Because the record companies could not deter the electronics business or the ISPs from facilitating free music, they targeted the peer to peer services such as Napster and then Grokster and Kazaa. Although they were able to shut these services down through lawsuits, other P2P services such as Limewire and BitTorrent replaced them. In the U.S. the labels’ trade organization, the Recording Industry Association of America (“RIAA”) also launched over an estimated 30,000 lawsuits against the labels’ own customers for sharing music through P2P services. But these suits have not stemmed the tide of free music. In fact, the number of files traded on P2P has not declined and more and more people have been driven to sharing music with their friends in private groups in order to avoid lawsuits. In fact, there is more music sharing through private networks and CD burning now than on P2P networks, and this activity is almost impossible to monitor or legally attack.

Bad DRM

The labels have exacerbated their ordeal by being extremely slow to create new business models that provide an attractive reasonably priced alternative to free. Instead they have insisted in coding authorized music with forms of digital rights management (“DRM”) that result in selling a product that is less attractive than free. DRM refers to access control technologies used by copyright holders to limit usage of digital content or devices. Advocates argue that DRM is necessary for copyright holders to prevent unauthorized duplication of their work to ensure continued revenue streams. But the forms of DRM that the labels have employed have led to a serious problem: a lack of “interoperability.”   Interoperability refers to the ability of different devices, particularly MP3 players, to play music from various on-line music services or stores.

There is no doubt that some form of DRM is necessary to sell music on-line. Without it, you could not set a price for downloading. Without it, you could not have a service such as Rhapsody which allows you to play any music you wish so long as you pay a small monthly fee.  In other words DRM supplies a “lock” that you need to sell or license music. But the overly intrusive DRM that the big labels and Steve Jobs have insisted on has severely stunted the growth of the authorized digital music business. Jobs has used his own DRM called FairPlay in iTunes and refuses to license FairPlay to other legit services. The result is that songs purchased from iTunes will not play in any digital player except iPods.  What is worse, iPods are infested with the same DRM so that it is not possible to play any music from another legitimate digital service on an iPod. The other legit services have also used forms of DRM, usually made by Microsoft, that are incompatible with the iPod.  This has caused confusion and frustration and turned people off to legit digital music. After all, free MP3 files will play on any player including the iPod. So does it make send to pay good money for a product if I can get it for BETTER QUALITY for free?

Next Installment: It is Possible to Compete with Free