Digital Matters - Issue 39

"That explosion you just heard is the music business."

It's last winter, and Steve Volk is sitting at a table at Harry's, a restaurant just around the corner from the New York Stock Exchange. He's an unassuming man. He's also chairman and CEO of DataPlay Inc., a digital-media company based in Boulder, Colorado.

Before Volk's swordfish dinner arrives, he pulls out a grab bag of memory cards. One is big and clunky, has 8 MB of memory, and costs $200 to manufacture. The next one is sleeker, has less memory, and costs more to produce. On and on it goes as he makes his way through the bag.

Then Volk pulls out the DataPlay Disc. It's the size of a quarter, has 500 MB of memory, is recordable, and works across every platform imaginable. The DataPlay Disc costs roughly $5.

Volk believes that DataPlay will soon make disks that have 2 GB of memory and should cost about the same as its current disks. You'd be well advised not to bet against him. So, in a couple of years, we won't be buying CDs, diskettes, or flash-memory cards -- we'll be buying those little DataPlay memory quarters (or something smaller). Those little disks will store it all: text, digital photographs, music, voice mail. And any adapters that you might need will be built into your PDA, cell-phone, or OnStar system.

Okay, now put that technology together with peer-to-peer computing, which is all the rage in the Silicon Valley venture world these days. Peer-to-peer computing is like Napster, but without the middleman. My computer talks directly to your computer, which talks directly to someone else's computer, and so on down the line. Peer-to-peer computing enables networked computers to eliminate the need for a server. Collectively, those computers are the server.

An open-source application known as Gnuttela is a sort of poster child of peer-to-peer computing. Gnuttela allows you to link your computer tofriends'computers -- exponentially, across all six degrees of separation. Collectively, you become one another's server.

Now, add a dash of wireless-Web technology (so that you can connect to whatever server you choose, no matter where you are). Blend all of that together, and you get the end of the recording industry (and, eventually, the end of the creative-arts industry in general) as we know it. That explosion you just heard is the music business. And for some reason, as is so often the case, industry executives seem intent on pushing the detonator button themselves.

That's not a surprise. Everyone knows by now that digital technology deconstructs traditional business structures and traditional business strategies. Look at what systems like TiVo and ReplayTV do to advertising-based broadcast television. Both systems pretty much erase the advertising. And look at what eBay has done to classified advertising. Look at what Amazon.com has done to the book business. (A good book on how digital technologies deconstruct traditional business structures and strategies is Blown to Bits: How the New Economics of Information Transforms Strategy [Harvard Business School Press, 1999], by Philip Evans and Thomas S. Wurster.)

What is surprising is how the major "record" companies (and some musical artists) have decided to respond to that challenge. They sued Napster and got a federal district court to shut down the Internet company (at least temporarily; stay tuned for further developments). They've enlisted various artists and musical groups to bring their own lawsuits against Napster. They're menacing new-economy recording companies like FreedomZone.com. They're actually raising prices on new products. They would even sue the creators of Gnuttela if they could figure out how to argue the case ("Goddamn it, your honor, those people out there on the Internet are connecting to one another!"). In short, record companies and many recording artists are burying their heads very deep in the sand.

Of course, that strategy isn't going to work for long. This is not to say that companies like Sony, Virgin, and Warner will go out of business tomorrow. For the moment, their businesses are booming. The Internet is connecting them to a much wider audience than before, and people are buying more CDs than they ever have. This is known as the "media effect": Every time a new medium comes on the scene, it enhances the usage of existing media. But eventually, that string runs out. According to Don Tapscott, author of Growing Up Digital: The Rise of the Net Generation, baby boomers watched 24 hours of TV per week when they were growing up -- echo boomers watch 16 hours of TV per week. Each generation has its own media.

Over time, artists are going to figure out that digital technology enables them to connect directly with their fans, that the middleman can be cut out, and that all the work done by the middleman can be jobbed out at a much lower cost.

A traditional music-business organization like Sony, Virgin, or Warner is a mishmash of competencies that, taken as a group, once added up to a competitive advantage (and, in many ways, still do). In a fully digital world, however, individual companies will do each piece of work -- at every stage of the process -- better than Sony, Virgin, or Warner does.

There are and will be state-of-the-art recording studios built specifically for just that purpose. There are and will be CD manufacturers, such as DataPlay, that make much more useful products. There are and will be promotion companies that do promotional campaigns much better than the corporate pr geeks in New York and Los Angeles. There are and will be video companies that make much more interesting music videos. And, of course, there is and will be that distribution channel known as the Internet, which can reach -- directly, in people's homes -- 1 billion customers worldwide.

The music business has long lived off the proposition that tours sell albums. That was grand news for recording companies, which historically have received much of the revenue that comes from album sales. What revenue they did not receive, they "recouped" from artists as costs related to marketing, advertising, or promotion. "Recoupables" are the music business's version of Hollywood accounting. Only after an album went double, triple, or quadruple platinum did an artist see any revenue. And even then, companies often claimed that additional revenue was needed to "recoup" previous marketing, advertising, or promotional expenses.

In the Digital Age, albums sell tours -- as well as promotional possibilities -- in which, happily enough, artists have traditionally made their money. No company is going to make big money by selling CDs, because digital technology transforms one copy into 1 million copies (now through Napster, but soon enough through countless peer-to-peer computing programs).

The only way to keep the traditional CD business going in the short term is to cut prices aggressively. That would buy time for the recording companies while they reinvent themselves as what Evans and Wurster call "navigators," and as what others call "infomediaries."

As in so many other categories, the greatest profits in an Internet-based music business will go to those companies that serve effectively as navigators through a world of unlimited choices. This change has already happened in financial services. Charles Schwab reinvented itself as a navigator of financial services, and it went from being a "discount broker" to being the most powerful financial-services brand in the United States. Merrill Lynch did not reinvent itself for the Internet, and it paid the price in terms of its market cap. The change has happened in retail as well. Amazon is probably the premier retail navigational service extant and is now worth $2 billion more (in terms of market cap) than Sears.

The future of the music business lies in helping people navigate a wide range of music choices, and in making those choices coherent. Companies like Sony, Virgin, and Warner would be well advised to take the money that they're spending on legal fees to sue companies like Napster and to invest that money in collaborative-filtering software and other navigational tools that help customers get the music that fits their tastes.

A larger opportunity is for companies like Creative Artists Agency and William Morris Agency to reinvent themselves as creative navigators. Talent companies have traditionally "cut deals" with major labels, studios, and advertisers; have taken a cut of the action; and have moved on to the next deal. With digital technology, they are now able to cut out record companies and to partner with other navigators to distribute, promote, and enhance the value of their client's product and brand. In a sense, they are well positioned to become recording companies, since they presumably have the best interests of their clients at heart. (The more money the artist makes, the better it is for the agent.)

That is why, in the great coming music-business shakeout, the prime acquisition targets will be the talent companies and the law firms that represent artistic talent. Traditional music companies own the catalogs and the master-recording disks. But the future value of the music business will be in the head of Bruce Springsteen or of Sheryl Crow or of some unknown-but-talented kid. Own the representative relationship with those artists, and you own the future. Partner with the best collaborative-filtering service, and you can take the music of Bruce or Sheryl or that kid -- and you can play it for almost any person who might be remotely interested in paying to listen. The rest is job work.

In other words, the model for the future of the music business is Tiger Woods. He essentially gives away the "album" -- his performance in various tournaments. Yes, he wins prize money (a lot of prize money, actually), because he's unusually good at what he does. But that money is a small percentage of his total income. He makes a killing in his partnerships -- with American Express, Nike, Titleist, and others. The company that handles all of those partnerships for Woods also makes a killing. Everyone else is essentially disintermediated from the deal.

It's a good thing that most of the money goes to Woods. He deserves it, just as Bruce Springsteen, Sheryl Crow, and thousands of other musical artists deserve the money that they make. They worked too hard for that money to see it get ripped off by some cheese-ball recording company.

Technology is now conspiring to make it more possible -- and, ultimately, more likely -- that great creative talent, or at least very popular creative talent, will finally be compensated adequately. Companies that enhance that value proposition will prosper. Companies that don't will be deconstructed.

John Ellis (jellis@fastcompany.com) is a writer and consultant based in New York.

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