Research Paper for the ITS Conference Helsinki, August 2003 By Tung Q. Nguyen-Khac


...........................................................2 Rethinking the Status Quo 15 15 Online Music Downloads with the Apple approach 5 6 Conclusion .....................2 2 The Situation 3 Objectives........1 4..once a dynamic growth market......................15 4................................... Approach and Scope 3 5 Overview of the Music Industry – Development and Structure.............2 Digital Technologies – the main driving forces for the change within the Music industry 10 Change in the industry’s value chain 13 4 Solutions from outside ..............................10 3............. now in consolidation The Big Five: an Oligopoly within the Music industry 6 3 The Music Industry in a Strategic Dilemma ......1 3................2 The music market.............................17 References ...................................Table of Contents 1 Introduction ...........5 2............................................................1 2.........................................................................................................................................3 1.........................................................18 II .....................1 1...........

especially the marketing. the multi-utilization and the distribution of content into question. coming from the technological side and not thinking in a one-sided manner. 1. with professional journal w&v in August 2003. Currently experts name to main reasons to explain the music industry’s situation: the high technology standard to date and wrong strategy concepts by the music industry. 3 . CEO of Universal Music Germany. A connected questions is in how far a sustainable and survivable business model can be established within the music industry in the future. Factually it has not faced up to the challenges and is now in a transition period where the old business model is only functioning to a limited extent and where a new one – such as online distribution – does not function at all. Technological progress increasingly calls previously existing structures and processes within the music economy. the article starts with a description of the historic development. All this has made the industry very vulnerable as market entry barriers are lower than ever before. are increasingly taking over positions that threaten music companies and they are even capable of re-shaping the industry. this article will not be able to settle this claim. 1 For example in an interview with Tim Renner.2 Objectives. So far the music industry has not found the right answers to its current problems. Therewith it describes the recent emotional state of an industry that still used to celebrate itself in the Nineties. Approach and Scope The topic of this article is more prevailing than ever and is still in a fast ongoing process. For this reason it is the objective of the author to give a short and practice-oriented overview over the issue.1 Introduction 1. the structure and recent trends in the music industry as a first step. 1 One cannot ignore the fact that the industry has taken either taken half hearted or wrong measures to cope with the fast-paced technological development. This is followed by a description of possible causes underlying the current status quo of the music economy as well as by an analysis of potential developmental scenarios. Strangers to the industry.1 The Situation „The music industry in a vale of tears – German market breaking in – turnover of sound storage media is dropping by more than 16 per cent“ reports daily newspaper “Die Welt” in an article on the occasion of the popkomm 2003. which could arise out of the latest developments on the technology side. In order to convey a first basic understanding of the topic. Due to rapid developments and the limited scope.

Copyrights and Digital Rights Management) the paper can only touch many issues but certainly will leave some open questions.The article has an interdisciplinary nature but focuses on economic aspects. Therefore and because of the complexity of certain fields (e. 4 .g.

once a dynamic growth market. These convenience motivated consumers to buy not only their new music on CD but also to convert their traditional record archive into a CD archive. According to the German Phonographic Association3 the size of the German music market had to face a decline of roughly 25 percent. it is understandable that the music industry is in a rather bad mood.1 The music market.2 Overview of the Music Industry – Development and Structure 2. July 2003. meanwhile the world’s third largest music market. 2 3 Figures. the U. With an industry turnover of about rund 32 billion US-Dollar in 20022 the music business is even larger than the book of movie industry. recently published by the International Federation of the Phonographic Industry. With the increasing maturity the industry growth slowed down to 14 percent and since about three years a trend reversal is obvious: a shrinking music market with significant turnover losses.6 billion Euro. the music industry still had revenues of about 2. Based on that from 1990 until 1995. Germany too.. July 2003 5 . Piracy Report of the International Federation of the Phonographic Industry. is affected by this trend. while in 2002 the turnover was only about 1.3 billion officially sold CD albums. CDs are almost indestructible and the playing of CDs on a home stereo equipment was much more comfortable than a cassette or record.3 %. Comparing this figure with 2. had a dynamic growth of roughly 60 percent. now in consolidation The music industry today is a multi billion business. A real quantum leap was reached when the CD became a mass product because music as digital data on CD enabled the users a new listening experience. In 2002 alone. Half a decade ago. industry revenues dropped by further 11. Just a glimpse at recent figures illustrates the current dilemma of the music industry and thus which challenges it is facing. Music was not focused solely on Vinyl and with the introduction of the Walkman in the early 80s music entered the transportable age.97 billion Euro. The International Federation of the Phonographic Industry estimates that about one billion illegal CD-copies were circulating in 2002.S. in 1997. Drivers of growth were mainly technological innovations The introduction of cassettes in the mid 60s gave the industry a new sales perspective. the largest music market in the word.

with “few” being everything between one firm to many firms. EMI Music had a share of 12 %. Sony Music’s share was 14. Together the „Big Five“ hold a 4 An oligopoly is defined as “few” sellers operating in the market. 2.and software in the consumer market need to be mentioned.8 %.5 -4. In 2002. There are two aspects that have mainly contributed to the redevelopment of particular fields in the media economy or that will make them redefine themselves.9 %.6 -3.5 -4 -6 -8 -10 -12 -14 -12.6 % and Warner Music reached 11.7 -12.German Music Market is shrinking since the late 90s New storage solutions and download technologies are also hitting the German market 0 1998 -2 -2. which has reached more than 50 percent of the relevant population groups in highly developed countries. the fast-paced technological development of the IT industry in regard to transmission possibilities of digital information has exerted a massive influence on all media industries. Apart from some segments of the publishing industry. the market shares of these five majors were as follows: Bertelsmann Music Group (BMG) reached about 9. the music industry has been largely affected for more than three years now.1 1999 2000 2001 2002 Source: International Federation of the Phonographic Industry During the last decade. Most notably.2 The Big Five: an Oligopoly within the Music industry Considering its structure the music industry can be described as an oligopoly4 because the five biggest music companies control about three quarters of the world-wide music market. but also the sharp drop in prices for highly advanced hard.8 %. the increasing penetration of the internet. Universal Music Group had a share of 24. 6 .

6% World market shares 2002 Data in per cent Others 26. BMG achieves between 50 and 60 % of its turnover in the USA. Elvis Presley and Miss Elliot.8% EMI 12% BMG 9.9% Source: International Federation of the Phonographic Industry EMI Music EMI Music is part of the EMI Group.share of 73.g.1 % and left a residual part of 26. when it had to take over the small label Zomba Records in 2001 for an approximated 2. Today BMG runs more than 200 labels in 54 countries and just recently it was in the news again. Bertelsmann not only bought a huge backlist catalogue. The familyowned Bertelsmann started its music activities in the late Seventies when planned and targeted acquisitions for the music segment by the then music-responsible manager Monti Lüftner created an external growth. Britney Spears. The Big Five of the Music Industry An oligopoly that shares three quarters of the market turnover Universal Music 24.9% Sony Music 14. independent music companies. By taking over Arista Records in 1979 and RCA Victor in 1986.7 mill.9 % to several thousands of small. the „Big Five“ are described in regard to their company structure and their historic development. Europe and Germany are BMG’s second most important market. Bertelsmann Music Group The Bertelsmann Music Group. Gramaophone Company and Parlophone joined to 7 .8% Warner Music 11. In the following. EMI Music began with the merger of three labels in the United Kingdom in 1930. that has its head quarters in the tranquil German city Gütersloh. Colombia Graphophone. Key Artists are e. USD due to an obligation arising out of a put option. but also succeeded in entering the world’s biggest music market. belongs to the media company group Bertelsmann. Today. which is globally known as BMG.

create Electric and Musical Industries Ltd which was later named EMI Ltd. Today. music and movies. The Sony Group operates in four key industries: electronics. With these three labels. in 1998. Key Artists are e. The Group is operating in 45 countries and has licensing and distribution agreements in further 26 territories. formerly a natural resources company came into trouble when its former CEO Messier tried to transform the former state company into an entertainment and telecommunication company starting in the late 90ies.000 copyrights and has the most interesting music catalogue of the music industry. Vivendi was recently in take over talks with 20th Century Fox and Apple. 8 . Chrysalis Records in 1989 and Virgin Records in 1992 EMI. Warner Music started when Warner Brothers purchased Atlantic Records in 1967 and was extended with the Acquisition of Elektra Music in 1970. Warner Music Group Warner Music is owned by AOL Time Warner which was formed through the merger of AOL Inc. In both cases the European Commission gave no permission for the European market. EMI has a global market share of about 12 percent and was recently in serious merger talks with BMG and Warner Music which finally failed. Vivendi. games. The key business units of Sony Music are Sony Music Publishing and Colombia Records. Overall the company manages 65 labels. Universal Music is on sale. The Sony Corporation entered into the music business when it took over CBS Records from CBS in 1988 for 2 Billion US-Dollars. other labels are Epic Records and C2 Records. The Groups owns more than 800. With the acquisition of Capital Records in 1956. Universal Music Group Universal Music Group is currently owned by the French Vivendi Group. Furthermore The EMI Group owns 43 percent of HMV Media Group. EMI’s Key artist are Robbie Williams and Kylie Minogue. a music retail chain.V. Thanks to large acquisitions Vivendi showed impressive external growth on the one side but increased its debts position to an unhealthy level on the other side. since Vivendi needs to reduce its liabilities. Michael Jackson and Bruce Springsteen. 23 music publishing companies and several manufacturing facilities. The rapper Eminem who just recently won 2 Grammy awards is a Universal artist. Music became a leading player in the recording business. and Time Warner in 2001. Sony Music Entertainment Sony Music Entertainment is owned by the Japanese Sony Corporation which has a high reputation for its excellent consumer electronics products.g. Universal Music Group was formerly owned by the Canadian Seagram Company which entered into the music business through the acquisition of MCA in 1994 and Polygram N. on the German side Herbert Grönemeyer.

Today experts believe that the Commission is likely to go a different way due to the recent market developments. Just recently AOL Time Warner and Bertelsmann officially announced that they are in exclusive merger talks to merge their music business and Vivendi Universal is reported to be in merger talks with General Electrics NBC. 9 . It is conceivable that the market in a phase of consolidation. whigh owns CD. the music industry has to fight with many problems and a shrinking market. CDROM and videocassette manufacturing facilities. affiliates and non affiliated licensees. The British EMI Music was already in detailed merger negotiations with first BMG and then with Warner Music. Current developments within the music industry Despite the oligoplistic structure and an impressing market power. WEA Manufacturing. In both cases the European Commission has refused to approve because of antitrust issues. In addition it owns Warner / Chappel Music Publishing. The music unit of AOL Time Warner operates in 68 countries through various subsidiaries.Warner/Elektra/Atlantic Distribution was formed which was later simply called WEA Distribution.

Broadband. private consumers – for a decent investment . To transfer an MP3 file across a computer network.g. use a program to convert the data to MP3 format. Furthermore. it was still too expensive for the private user to buy the hardware that is necessary for writing. Only their combination and their concurring effects led to the development of the current status quo. The parallel evolution of four distinct technologies is driving the change within the industry. Gnutella. The greater the bandwith. Player formats of digital data. Memory card formats. private consumers are able to process a large amount of digital data (required by digitalized songs) and to save them on CDs and large hard drive capacities. The end 10 . to market and to distribute digital music data.5 This strongly influences the possibility to create. In combination with the compression format MP3 a faster transmission of a large amount of digital data is possible. Compression technology. Another relevant factor is the increasing internet penetration in industrialized countries as well as improving possibilities to transmit a larger range of bandwidths. Internet. About ten years ago. Today. While a typical CD normally takes hours to download.3 The Music Industry in a Strategic Dilemma 3. the faster the file can be transferred. PC and processor hardware. similar to other fields of the media industry. Reasons: The increasing and accelerating degree of maturity of hardware (combined with parallel designed user software). all one has to do is take a CD. it becomes obvious that. Still. The development of digital technologies have created a number of new business opportunities and effected the music industry at large.g. networks like Napster. with the help of today’s fast PC processors. copying and saving music files on CDs.have the technological capabilities to do that. in the following the focus lies in the description of exogenous factors. progress in industrial production and associated economies of scale. 5 MP 3 is a data compression standard that compresses music without degrading the audio quality. These are ß ß ß ß Software Development for Consumers: e. MP3 files do have all relevant data for the human ear. There is a proven loss of quality but this is not crucial since Humans can only hear about eight percent of the sound that is recorded on a CD.g. Mobile Telecommunication Peer-to-Peer and Network Technology: e. transfer the data to a hard drive and send the file to another user through the network.g. an MP3 version can be downloaded 10-12 times more quickly. PDAs Access and Transportation Technology: e. there are a variety of exogenous and endogenous factors affecting the music industry. Kazaa The technological influence factors in the consumer market need to be mentioned first. Encryption and security solutions Hardware: e.1 Digital Technologies – the main driving forces for the change within the Music industry Analyzing the reasons for this development.

The first popular File Sharing service was the illegal download platform Napster which was founded by the college student Shawn Fanning in 1999.Additionally.and software in the field of music. VAT) Number of songs downloaded from the internet in millions 2000 2001 2002 Source: International Federation of the Phonographic Industry It is mainly the rapidly-spreading Peer-to-Peer (P2P) or File Sharing Technology that has had a massive influence on the established industry structure over the last three years. represented by the Recording Industry usder can then listen to the music in MP3 form (using computer software). Within a year. transfer the MP3 to a portable MP3 player. from February 2000 until February 2001.and Software and mass storage capacities are devouring the music industry‘s turnover 36964 34649 32228 622 492 316 Worldwide turnover of sound storage media in mill. due to the increasing maturity of hard. in so far as instead of strategically build artists and formats. it has always focused on short-term profit maximization. the Napster community grew from 1. Fanning programmed a software that used a peer-to-peer architecture for users to exchange MP3 files freely without transaction costs other than the connection fee. or convert the MP3 music back onto a CD if he or she has access to a CD writer. Already at the end of 1999 the music industry. artists took the opportunity to influence the development and production of music content during the past ten years.6 million members. The Internet. The industry’s attitude acts as a further aggravating factor. 11 .1 million users to roughly 13. For creating and marketing music content a private person is not solely dependant on the big music corporate groups any longer. high sophisticated Hard. USD (retail prices incl. Although file sharing technology can be used for all kinds of digital data it was the massive illegal exchange of music files that made Napster so popular. The resulting CD can be played on conventional stereo equipment.

2002 Napster filed for bankruptcy..g. This is still illegal but in order to get the illegal use under control the music industry would have to bring every single member to court. Kazaa delivers the software but let the users exchange their music among themselves.7 The Filesharing Technology: from centralized to decentralized File Sharing File-swapping network P2P Network Internet Central Index Server Technology Shift/ Decentralisation Internet File transfer e. Bertelsmann took over the majority of Napster shares and tried to establish a legal peer-to-peer distribution model with the Napster brand but failed since it couldn’t come to an agreement with the other Majors. Morpheus. unpaid. i. Gnutella Network (Kazaa. After several hearings in spring 2001 Napster was forced to eliminate all copyrighted music files from its servers. Kazaa is still the most used file sharing platform with about in the world 230 million downloads of Kazaa’s software. According to information published on Kazaa’s website in July 2003. Napster has used a centralized file sharing model where users leave their files on a central server located somewhere in Boston and therefore legally available. rd 12 .Association of America (RIIA) brought Napster to court for copyright infringements. Although Napster lost in court and had to stop its service6 the technology has inspired many others to adopt the principle by programming a similar model. The Software company Roxio just recently bought the Napster name rights and aims to introduce a online music download model by the end of 2003. Although there were some first court rulings in 2003. The successors use a decentralized model where e..g. Napster Network e. spreading of music content. BearShare and most of all Kazaa are prominent successors of Napster and have boosted the illegal.) Source: Own Graphic 6 7 On June 3 .g. Bearshare. Limewire.e..

Hummerl.2 Change in the industry’s value chain According to Haes and Hummel. Johannes: Napster and the Economics of Music Distribution. traditionally distributed on physical way. Now. Joachim.3. “The traditional business model for distribution music is no longer the architecture bridging the creators. consumer behaviour has not changed. p. It had always been legal to copy a CD for private reasons (within sensible limits) and illegal to do it out of commercial rights. Still. has neither actively sought for solutions concerning rights in digital copies of music nor has it developed a new business concept beyond the traditional business model. “The actual property rights of music did not change. the sellers and the buyers. Music is an information good in a mass production market. But the music industry.”9 So.”8 The problem of the new digital architecture is to make a clear distinction between a legal copy made for private use and an illegal one that is offered to many other music consumers. 1 13 . 725 Zhang. People used to copy their music on cassettes and shared it with others but had a natural limitation to use and distribute their copies. the developments 8 9 Haes. p. Actually for many experts of the music industry the main critical issue if it comes to a discussion about new technologies and its consequences for the music industry is a legal one. pack & ship) Wholesale Retail Source: Durlacher Research According to Michael Zhang from the MIT. with the new technologies music files can be easily copied and distributed without physical limitation. People think that nobody is harmed by exchanging music. facing heavy sales und turnover losses. Michael: A Review of Economic Properties of Music Distribution. The Industy‘s traditional Value Chain Development (Artists & Repertoire) Production (Recording) Sales & Marketing (Publicity) Distribution (Pick.

The first one is whether online music retail will generate significant sales and on the long run might even replace offline sale. London. file sharing or subscription services of digital data.mentioned before. streaming and music destination sites. other like the manufacturing and distribution of music will increasingly be replaced by digital technologies like downloads. for the first time. a study published by Screen Digest Limited. They both allow and influence business models with regard to music creation and distribution like virtual record labels. Although several functions of the music industry’s value chain such as A&R11 marketing and promotion can be adapted and migrated to the internet. retail partners and consumers. the chance to control the marketing and distribution of their music. Vogel.10 The Internet and the new technologies offers music creators and performers the opportunity to take a more prominent role in the industry’s value chain than they could in the artists. One is centered on sales. the other on distribution. 2002 A&R: Artist & Repertoire st 14 . Prince. 10 11 Preiser. The second one is whether the industry can come up with a online distribution model that will be accepted – based on a working copyrights system . Armin: The Music in the 21 Century. For the Majors there are two crucial questions if it comes to rethink the distribution value chain. Jürgen. have a profound effect on the music industry because it completely changes the industry’s entire value chain. online radio. David Bowie and other artists have proven that the Internet gives them.

are partly self-inflicted.1 Rethinking the Status Quo Interestingly. 1. the problems that the music industry has to deal with today. to date they have not been accepted by consumers and therefore are unsuccessful. There have been numerous attempts in co-operation to establish competing download platforms. Disregarding single independent labels on the national level. Consequently. the industry was late to realize the imminent danger of increased internet usage and the high advanced PC equipment in private homes. the industry did not manage to create a sustainable business model focused on the new media and technologies. In the past these Majors dominated a music market that was characterized by increasing turnover and high profit margins. Universal Music and EMI. The developments described above. The question is whether the music economy needs to reinvent itself.2 Online Music Downloads with the Apple approach There is perhaps one example that could pave the way for the industry: In 2003 a company from an unrelated industry. Will the CD stay the music medium No. In booming years. The problem has become virulent for the music industry. Warner Music. which can be exchanged in large quantities via internet? Will enough money be circulating in a reshaped music economy to keep the conventional “Star System” alive? 4. such as the lack in sustainability in the creation of artists and their development. succeeded with a new product: PC producer Apple known for its personal computers for users in the creative sector. the number of the relevant music companies is lucid: BMG. given that huge amounts of MP3s can be saved on current hard drives which are getting smaller and smaller and increasingly handy? Will the music industry be able to earn money with a format that you cannot touch. Yet. However. it has neglected to fight against structural problems. Moreover. presented its new “I-Tunes Music Store”: For 15 .4 Solutions from outside 4. require the industry to rethink their processes in the fields of artist management (A&R) marketing and distribution. However. with stable revenues. since the national and the international music industry have more or less the structure of an oligopoly. the music industry has not been able to find acceptable solutions for this development so far. the right answers still need to be found. This is surprising. in a way a nobody. Sony Music.

Sony Music. From today’s point of view. BMG and EMI. The name of this new music web catalogue: Phonoline. Warner Music. Phonoline is rather a compromise than a thoroughly designed marketing system designed for the needs of the consumer. prepare a common download platform which is supposed to be launched at the end of this year. With more than two million paid downloads within two weeks after its introduction.g. What was the success formula? Difficult to say after this short period but Steve Jobs. succeeded in long-lasting and difficult negotiations to convince all Majors to make their content available on this platform. convincing successes. together with Deutsche Telekom as technology partner. Currently there are only about 200. In Germany the big Majors Universal Music. CEO of Apple. the consumer will have to conclude a contract with Sony. In contrast to its competitors. As all companies set their prices irrespective of each other.the first time a working music download model based on the internet. the “apple from an unrelated industry” provided a new impetus in a market characterised by lethargy. Yet. 16 . there is no stringency for the offer. With the introduction of the “i-Tunes Music Store” pressure on the music industry has risen. Apple had a higher turnover than the competing download platforms of the Majors (e. For playing a song by Jennifer Lopez for instance. Phonoline is just a bunch of offers by the participating companies. with extended usage and license terms (unlimited usability on several media) and a successful PR Promotion. If a consumer decides to download a song by Christina Aguilera (who is under contract at a BMG label) they buy the song under the terms and conditions of the respective Bertelsmann subsidiary.000 songs available on Apple’s platform. During this short period. The platform will be based on an electronic distributional system that has already been existing for years and which will be operated jointly by the record labels. The question whether this offer will be successful and accepted from the market is still open. in combination with an easily comprehensible and attractive price model (99 cent per download). Musicnet and Pressplay) in their whole first year of operation. I-Tunes Music Store has demonstrated some first.

Madonna or Eminem who still succeed in selling millions of copies of their albums. but on the other hand it was also the album that sold most copies in the USA. Nena. there are artists such as Herbert Grönemeyer. despite the threat deriving from new technologies. should not hold back the industry to face a further challenge: the long-termed building-up of artists and their further development. A challenge to be won? 17 .5 Conclusion A first slight hope? At least the music industry can make out a ray of hope at the dark horizon and got some hints on their seek for a solution. This. however. After all. Robbie Williams. The music industry has realised its dilemma and is forced to develop and implement quick-acting counter measures and strategies. On the one hand Eminem’s album “The Eminem Show” was the album with the most downloads in 2002.

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