Hitting For Average: Why the Major Labels Will Go Down Swinging

by John Davidson
30 January 2006

In my last post, I talked about the need for the music business to revolutionize. But that’s not so insightful, is it? CD sales have essentially been falling for years, and that can’t last without consequences. Identifying the problem is easy, you say. What about solutions?

Actually, identifying the problem is often the most difficult part, mostly because of complexities in the market. There are actually many reasons for declining CD sales, and we’ve heard them all before (piracy, peer-to-peer theft, competition from video games, fracturing markets, prices are too high, etc.) and from that assortment of issues we’ve seen an equal number of responses. We’ve seen the industry sue fans, lobby for more digital copyrights, lower prices, more pervasive marketing efforts, and so on.

My position is that the industry is on the cusp of significant structural change, and that that change is being seen throughout the entertainment business wherever digital distribution is robust. And that’s an area where newspapers, magazines, film, television, and music have never faced competition.

Typically, as markets and industries grow, there is a shakeout period where certain companies dominate and either destroy or swallow their competitors. They do this in a variety of ways, but typically vertical growth is a common strategy. In the music business, record labels did this buy not only developing artists and recording their music, but also by obtaining distribution channels, manufacturing assets, etc. Their interests veered from simple artist development (finding and recording hit songs) to a business that had complex interests. Think about the conflict of interest when a company is selling a huge number of products that all compete against each other, and not just in the racks for teenager’s wallets. Priorities are also made in distribution, promotion, recording, producing, etc. The larger and more vertical a corporation gets, the more difficult it is to manage the process and stable. The homerun mentality prevails when each of these elements require significant, non-discretionary assets (cashflow).

The major labels have grown so much that they are now fairly inflexible to the vast changes in the marketplace. They can try to hit for average (lots of small hits instead of swinging for the fences on every at bat) but their business model wasn’t designed for that. Yes, they are trying to change their bad habits but decades in, they have two great problems: a shareholder one and a cultural one. Shareholder demand is impatient and cannot be ignored, which has resulted in layoffs and asset sales. So where major labels once had other competitive advantages in the marketplace because of their size, they are now weakened considerably because of it. Culturally, major labels face an even larger hurdle since their staffing and facilities were developed under much different conditions. These companies need their legal teams, they need their accounting departments, they need expensive executives to oversee their corporations. And beyond the labels, much of the supporting industry (radio, retail) is faced with similar pressure.

All this is why the independents continue to gain more market share at the expense of the big guys. Much lower recording costs, much lower distro costs, much lower marketing costs, and a much more connected network of fans is flatting the market in ways that big companies almost certainly cannot adequately adapt to. If digital rights management (DRM) was figured out and record companies could cut out the manufacturing/distribution cost of physical CDs, it would flatten the market even more. The fact that the vast majority of music purchases are CDs actually helps the big companies, because it sustains their competitive advantage in distribution. When digital distribution becomes the standard, you’ll see massive fallout among the majors.

Hitting for average is already happening in the independent label world. Actually, most of the little guys who have lasted more than five years have always done it that way. They’ve always worshipped at the altar of the customer, they’ve actively built intimate relationships with fans and mailing lists and creative marketing and frugal budgets. They’ve never had million dollar bonuses. And now, with their key expenses coming down (recording, distro, marketing), they are in a position to exploit them in the marketplace. Thus, it’s not a question of how to play Moneyball. It’s a question of doing it or not.

Filed under business music industry