Digital Music - A Really Tough Business

Due to my previous experience at Listen.com/RealNetworks, I seem to get a lot of business plans and questions about digital music.   When starting Donnerwood, we spent a lot of time looking at the music business, and we were simply not smart enough to discover a sustainable way to drive value in that sector.   

Why is that?  At the end of the day, you have what I call a "serial monopoly" of 4 suppliers (labels), meaning that it's more difficult to get reasonable music rights than it is negotiating with an oligopoly like OPEC since Eminem and Norah Jones are not substitutable, while crude oil from Mexico and Saudi Arabia is relatively substitutable.   This is not a knock on the labels - in fact I spend a lot of time defending labels who generally act according to what they believe their best interests are - it's simply a matter of leverage - a start up needs to have rights from all of the major labels (EMI, Sony/BMG, Universal, Warner) and most of the smaller ones in order to compete in the sector, and the lack of those rights generally cripples the business - therefore, there is essentially no negotiating leverage, which makes for very low margins.

To top it off, you need to pair those low margins/lack of leverage with an intensely competitive marketplace, with RealNetworks, Napster, Apple, Sony, Yahoo, Wal-Mart, MSN, and a host of others all marketing like wild, discounting the product (MSN's buy 1, get 5 free), and trying to cut exclusive content deals.  Only Apple has truly managed to show profits in the business, primarily through sales of related hardware, and finally, through an 80% market share of the download market, but it's must just be brutal for the others.

I think digital music will eventually be extremely profitable for the content providers, including publishers, but I struggle to find a business model for the middle man in this business, at least for any model which requires broad label rights.  And when you consider the joys of the mobile music sector, where you have both a concentrated supply chain AND a concentrated customer base (4 -6 carriers), you begin to see why I find that sector to just be a disaster in spite of the hype.

So we will most certainly not be in the digital music business here at Donnerwood, primarily due to our collective experience in it over the last 5-10 years, but I have no doubts that companies will continue to pour resources into it.

Comments

[Zac Shaw]

It may be that there is no sustainable business model for middle men in the music industry anymore because digital technology allows artists and listeners they exploit to create a new, more fair and profitable business model that creates a direct relationship of patronage between artist and listener. This could take many forms: tip jars, flat tax, subscription to special content, etc. That being said, your metaphor was particularly apt: we need less dependence on oil as well as less dependece on mega-stars like Eminem and Norah Jones). I believe the digital music industry's woes are based on an inability to transition from a market in which no artist sells 10 million records, but 10 million artists play each night. The future of music is in services such as MySpace Music, an extremely sucessful online community of 200,000 independent musicians that required no major label support and just sold for over half a billion to News Corp. No doubt the service will get lost in corporate beauracracy, but social networking is exactly what will make online music stores like Napster and Rhapsody obsolete. Bottom line: the idea that music will be free terrorizes the industry, but it is what the artist and listener are crying out for. The real new music industry is when my music spreads virally from three people to 3,000 because it's freely available, and 300 of those people pay to see my show, and 30 of them by T-shirts. I just made $1,500 in one night. The industry is not involved beyond the people I paid to record my music, book the venue and make my shirts. The artist and listener is happy. Precisely why there is more live music than ever and companies like MerchDirect, MerchNow and JakPrints are flourishing. There is a future music industry, but it's not a future of miropayments and subscription fees. It's a future of file sharing, lots of live shows, companies specializing in filtering the vast array of MP3s, videos, podcasts, etc. It's a better than the present, where artists are impoverished and listeners don't even seem to like music anymore. The new music industry sells the services of artists to listeners and the service of listeners to artists. It's a mutual relationship, no need for middlemen. We should be happy about that.

[mikeb]

Sean,
I can't agree with you more. The time I spent at The Harry Fox Agency and RealNetworks taught me a similar lesson.

Gaming, however, is explosive -- you've made an excellent choice. I always wondered why Real didn't poor more resources into developing its gaming portfolio...

Best of luck!

[Anton Gourman]

Hi Sean,

I am currently working with digital media rights issues in Brussels and your analysis is right on the spot.

However, it's not only an issue of licensing from the big five, there are also issues of collecting rights which right now prevent digital media providers from competing successfully.

Luckily, that is about to change, at least in Europe. There is new legislation on the way that might change the way licensing and collecting rights are handled which could in the end help out the small and middle-sized providers. (At least I hope it will).
I think it will also allow new types of services to spring forward; in my oppinion this has been the biggest weakness of the big ones. Instead of adapting new technology they tried to close the digital technology funnel with a bunch of CDs..

I hope that small industry stakeholders will soon have a much better negotiating position, I feel it will move the music industry forward from where it is trudging around today.