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«Kate Totaro An honors thesis submitted in partial fulfillment of the requirements for the degree of Bachelor of Science Undergraduate College Leonard ...»

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Theory and Evidence

The Economic Utility of the Compact Disc

by

Kate Totaro

An honors thesis submitted in partial fulfillment

of the requirements for the degree of

Bachelor of Science

Undergraduate College

Leonard N. Stern School of Business

New York University

May 2006

Professor Marti G. Subrahmanyam Professor Samuel Craig

Faculty Adviser Thesis Advisor

TABLE OF CONTENTS

1.

Abstract

2. INTRODUCTION

3. THE DIGITAL WORLD

3.1 CURRENT STATE OF THE DIGITAL MARKET

3.2 ALTERNATIVE DIGITAL REVENUE STREAMS

3.2.1 P2P Regulation

3.2.2 The Mobile Phone Market

3.2.3 Streaming Music

3.2.4 Bundled Downloads

3.2.5 Timed Releases

3.2.6 Collective Licensing

3.2.7 Artist/Label Relations

3.2.8 E-labels

3.2.9 Conclusion on Digital Alternative Revenue Streams

4. PRIMARY RESEARCH

4.1 FOCUS GROUP

4.1.1 Overview

4.1.2 Procedure

4.1.3 Subjects

4.1.4 Results

4.1.5 Managerial Implications

4.1.6 Limitations

4.2 SURVEY

4.2.1 Overview

4.2.2 Conjecture/Prediction

4.2.3 Procedure

4.2.4 Subjects

4.2.5 Results

4.2.6 Managerial Implications

4.2.7 Limitations

5. THE FUTURE OF THE MUSIC INDUSTRY

5.1 THE FUTURE OF TANGIBLE MUSIC

5.2 THE FUTURE OF RETAIL SALES

5.3 CONCLUSION

6. ACKNOWLEDGMENTS

7. APPENDIX A: SURVEY REPLICA

8. WORKS CITED

1. ABSTRACT Despite the music industry’s historical format evolution—from vinyl to 8-track, 8-track

to cassette, and cassette to CD—today’s music world is facing a slightly different situation:

today’s replacement format (free and for purchase online digital music) is different than those replacements of the past, most notably, because it is not tangible. Unlike the switch from vinyl to 8-track, the transition from CD to online music is not comparable. In the first case, the purchaser can physically hold, feel, see their investment. However, with the digital revolution, the consumer is purchasing a right: a right to listen, a right to burn, a right to share. In my exploration, I aim to answer the following questions: Will tangible music remain relevant for today’s college aged consumers (the music industry’s most profitable audience)? If so, what utility do these consumers gain from tangible music as opposed its digital alternative? How will the interaction between digital and tangible music shape the future of the music industry?

Through primary research and industry exploration, I have identified a small but dedicated population of CD enthusiasts and a broader population of “sometimes-CD-purchasers” within the college aged demographic. Both of these populations’ demands are large enough to maintain a viable tangible music market. The utility that consumers gain from tangible music seems to stem from traits such as authenticity, collectability, displayability, safety (perceived permanence), and enhancements. While consumers will continue to demand tangible music, a relevant portion of future industry revenues will develop from the digital music realm, including mobile phone music, streaming music, bundled downloads, and singles downloads.

2. INTRODUCTION

–  –  –

Let’s take a time warp through the evolution of music: music began as a form of aural communication passed through bodies and instruments, was revolutionized when standardized notation was developed, giving people access to a transcendent form of music, then was reinvented again when recording technology broke down the previous barriers of space and time, turning music into a personal commodity. As is obvious, the music industry is no stranger to innovation. Just speaking to recording technology alone, from vinyl, to 8-track, cassette, and compact disc, the industry has continually evolved to adapt to new technology. And, as can be inferred, the future of music will depend on the industry’s ability to embrace and control this.

Despite the historical format evolution, today’s music world is facing a slightly different situation: today’s replacement format, digital music1, is different than those replacements of the past, most notably, because it is not tangible. Unlike the switch from vinyl to 8-track, the transition from CD to online music is not comparable. In the first case, purchasers can physically hold, feel, see their investment. However, with the digital revolution, the consumer is purchasing a right: a right to listen, a right to burn, a right to share. In my exploration, I investigate if and how much college aged students (the music industry’s most profitable audience) value of tangible music (i.e. the CD2) over that of free or for-purchase digital music.

When I use the term “digital music”, I am referring to downloadable music. Although CDs utilize a digital format, it has become common practice to use “digital music” to refer to music available online either for free or forpurchase.

“CD” and “tangible music” are also used interchangeably.





Additionally, I will investigate what the impact of the digital revolution will be on the industry, both short-term and long-term. Is digital music simply another form of advertising similar to radio play and music videos? Will consumer access to music replace ownership of music? What will the business structure of the industry look like in the future? Are CDs going to remain on the shelves or does online music spell the demise of retail music stores?

I predict that the student survey will reveal a small yet dedicated population of CD enthusiasts as well as a broader population of “sometimes-CD-purchasers”. Both of these populations’ demand will be large enough to maintain a viable tangible music market. I also predict that the industry will be drastically impacted by the ever-increasing access to free or very inexpensive music. While the CD will remain the primary driver of revenues, digital access will take multiple forms, catering to ever evolving consumer demand. Additionally, with this overhaul will come a reevaluation of artist relations and the role of current music labels.

While this project will aim to answer big questions, the scope of the study is obviously limited. Because of time and access to resources I will focus my studies on college aged students.

Hopefully, this glimpse into the industry will spur further contemplation for the future of both digital and tangible music.

In the remainder of this paper I will first describe and analyze the industry and its outlook for the future of music. With the background laid, I will then discuss my study of college-aged students and their attitudes towards music consumption and the utility of tangible music. Finally, I will compile my research and study findings to form my own prediction for the future of the music industry and, more specifically, the future of the compact disc.

3. THE DIGITAL WORLD

–  –  –

As EMI Chairman, Eric Nicoli points out, good music is no longer enough. In order to survive and be heard in this new atmosphere of music consumption, in which the number of regular music downloaders is growing at a rate of over 100 percent annually (Kusek, 2005, p.101), labels and artists need to adapt appropriately. If not approached correctly, the digital market could severely harm the overall music business; however, if optimized, the digital market could catapult the success of the whole industry through increased consumer exposure and access. So, the fundamental and pressing question becomes: How can and will the potential of digital music be optimized for the industry?

Interestingly, an analogy of the current atmosphere of music consumption can be made with many other entertainment industry sectors, including the film and pornography industries.

In the film industry, the 1980s were the inflection point. During that time, the advent of the VHS tape was predicted to kill the movie business; however, in hindsight, VHS actually grew the film industry, offering customers different options for experiencing content, and now the home video market makes up an astonishing portion of film revenues.

The pornography industry also parallels the music industry in that it was blindsided by the potential of online content. The internet effectively broke the distribution monopoly that moguls like Hefner and Flynt enjoyed in the pornography industry. It provided opportunities for new entrepreneurs to challenge the traditional system and establish multiple sources of revenue.

In fact, the internet helped to increase the pornography industry’s overall revenue ten-fold.

While traditional music labels—just like traditional pornography media—will still have a role with the advent of digital content, their impact will be hugely diminished if they are not able to harness the potential of the online medium. As David Kusek states in his book, The Future of Music: Manifesto for the Digital Revolution, “Both the entrenched porn kings and the music kings failed to see the potential of the Internet for new business models, and were caught entirely off guard by what happened” (Kusek, 2005, p.75). And, as Dan Bricklin quips in his article on the same topic, “Record companies complain about the consolidation of radio station ownership and the cost of paying off radio stations to play their music so we can listen for ‘free’ and figure out what we’d like to buy. At the same time they are trying to kill a goose that is laying a golden egg by fighting digital music rather than […] understanding and joining it” (Bricklin, 2005, p.6).

While the music industry initially reacted poorly—like their entertainment industry counterparts—to the introduction of new products, they still have time to correct their mistakes and take the digital medium further.

3.1 CURRENT STATE OF THE DIGITAL MARKET

–  –  –

Let’s consider some statistics. In 2005 alone, about 420 million tracks were downloaded globally (or approximately 6.4 million a week), up more than 20% from 2004. When combined with mobile phone downloads, these two new distribution channels brought in an estimated $1.1billion in global sales in 2005, tripling the value from 2004. And, there is expected further growth in 2006 (IFPI, 2006, p.3). Just in the U.S., estimates indicate that downloads and subscriptions (not including mobile phone content) will be a $1 billion plus business by 2007 (BBC, “The Digital Music Revolution”, 2004). Additionally, by the end of this year, there will be over 43 million broadband households in the U.S. and an almost equal number of digital audio players in the market (Macklin, 2004, p.2).

–  –  –

As Figure 1 above indicates, broadband has reached deep penetration, with 43 million lines in the U.S. alone, and downloads are skyrocketing, single track downloads seeing a 147% increase from 2004. In fact, 2005 was the first year that sales of these singles began to regularly offset the decline in full album sales (Leeds, "When All the…”, 2006).

3.2 ALTERNATIVE DIGITAL REVENUE STREAMS

–  –  –

By this point in the evolution of the digital market, the industry has realized that the internet and digital music offer unprecedented opportunities that need to be optimized for the industry to recover. As Kusek states, downloadable music has given the music industry a “turbocharged version of tape-swapping,” (Kusek, 2005, p.42). It has given them an opportunity to promote more music than ever (unlimited shelf-space) at minimal expenses, almost circumventing (or perhaps supplementing) Clear Channel stifled radio airplay and MTV monopolized video play, allowing something fresh to penetrate the market. The internet has

created an avenue to additional sources of revenue for the music industry. As Kusek states:

Finally, there is a way to reach a huge audience nearly for free with whatever music you have to offer. As the saying goes, the rising tide will float all boats. Those who try and stop it will be washed overboard in the floodwaters, never to be seen again. Those who learn to ride the rising waters and navigate the flowing current will be carried onto a better world where artists and fans of music can connect more fluidly (Kusek, 2005, p.105).

The future for the industry holds a lot of possibilities, but many potential downfalls as well.

Those that learn to embrace and harness the new technology optimally will be shaping the music of the future, but those who do not adapt will be left asking, “What went wrong?” When industries are forced to face extremely painful and sometimes counterintuitive changes, established companies often whither away, leaving room for more agile entrepreneurs.

There are various strategies on how to optimize digital music. Many of these strategies are explored below. And while one may standout to lead the market in the future, I believe that it is a combination of a few of these strategies that will optimize the new digital market for music.

The strategies I will explore are:

–  –  –

Ultimately, the company that can offer “as much music, in as many ways, to as many consumers via as many formats and distribution channels as possible [legally]” will set the bar for the digital music revolution (IFPI, 2006, p.3).

–  –  –

Two thousand and five was a landmark year in the industry’s fight against P2P networks;



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