The New Economics of the Music Industry - Essay Example

The New Economics of the Music Industry I. Introduction The technological boom has ushered countless innovations in almost all the sectors in the global economy. These advances have facilitated the spillover of positive and negative externalities in various industries facilitating the emergence of new trends that disrupt and refine the current economic equilibrium. Along with other sectors, the global music industry had been significantly altered by this technological boom notably, the internet and associated technologies. These innovations have revolutionized the market structure and value chain of the music industry through the alteration of the intermediation processes. These new technologies allowed the faster mobility of goods from the artist to the costumers as other processes in the value chain are eradicated. Aside from these obvious developments, technological changes have many other considerable implications for the music industry. This paper will look at the technological changes which became significant drivers in the structure and performance of the industry and their economic implications. The first portion will give a brief profile of the industry and present the traditional value chain and market structure. Next, it will tackle the trends in the industry along with the current technologies affecting it. It will then present the changes within the industry ushered by technological advancements and analyze the economic implications of these changes. It will conclude with a summary of its findings and recommendations. II. Music Industry: A Brief Overview The music industry is one of the largest players in the entertainment sector in fact, it is regarded as one of the "most important and complex" industries. The global music industry was able to shore in $32.1 billion in revenue during 2004 with the United States accounting for the largest share at $561.6 million [1].Other countries which contributed significant portions to the aggregate sales are Japan, United Kingdom, Germany and France [2]. The traditional music industry is essentially ologopolistic in nature as it is dominated by five large recording and distribution companies which capture more than 80% of the global market share (Figure 1). Also regarded as Big Five, these companies are Sony/BMG, UMG, EMI, Polygram, and Warner. Having a strong foothold on the entire music industry, these companies command high level of bargaining power among other important players as they have are involved in all the processes in the value chain. Figure 1. Market Share of the Big Five (2001) Source: Hannaford, 2005 However, the dominance of these companies is largely felt in America and Europe while the Asia Pacific market is mainly controlled by independents [3]. In this region independent record labels hold almost 40% of the entire market share. In this case, we can see a duopolistic competition where the Big Five abound together with a local competitive fringe. III. Traditional Market Structure Record label plays various roles in the operation of the music industry. It can be noted that these companies are almost always present in the entire traditional value chain. The value chain of the music industry begins with the acquisition of content which typically involves the contract signing between artists and the company to formalize the production of an album. The record label will then start the production of the album by allocating fund in order to cover the costs of providing a producer and engineers or subcontracting with an artist's own team. After the record is produced, discs are manufactured which is typically simultaneous with the launching of aggressive marketing efforts to promote the album [4]. Distribution of the album is usually done by the marketing arm of the record label. Artists heavily rely in the name and reputation of the label for their releases to succeed. The strong marketing muscle of the company has a large influence for different media in the promotion of an artist's music. Record label and music retailers often collaborate in bringing the product to the consumers [5]. Figure 1. Value Chain of the Music Industry Source: Schutze, 1994 The traditional supply chain of the music industry has a very essential economic feature in relation to risks. It can be noted that in the entire course of album production, all the financial risks are shouldered by the record label. Starting from allocating fund to finance the cost of recording to the traditional royalty bonus given to the artist at the beginning of the contract, record label shells out cash as initial investment. Huge expenses for promotion are also solely covered by record labels. Record labels are able to assume all this risks with the prospect of profits derived from the sale of albums. IV. Technological Trends in the Music Industry As stated above, the interrelatedness of economic variables in the global market facilitates the spillover of externalities from one sector to another. The main driver of change in the music industry is technological advancement. It can be noted that the past decade has ushered innovations in the industry, notably MP3, P2P, streaming technologies and the internet which in turn gave way for new and innovative trends. Digital Technology and Music The digitization of music has begun in the introduction of CD format [6]. However, innovations brought more technologically advanced products in the market one of which is MP3. The advent of MP3 has significantly affected the method of obtaining music. MP3 is short for Moving Pictures Experts Group, Audio layer III and is a compression format which shrinks audio files. Typically, compressed files result to a poorer sound quality yet the employment of MP3 enables users to shrink audio files with insignificant effect in audio performance [7]. Through the use of MP3 technology, digital music takes up only one-twelfth of the original space for a track, making it very viable for internet download. Since the size of the file is lessened, downloading is more efficient as time required is also reduced. Peer to Peer Architecture Peer-to-Peer (P2P) is a network that "relies on the computing power and bandwidth of the participants in the network rather than concentrating it in a relatively few servers [8]." This technology is widely used for sharing content files which contains audio, video, data or anything in digital format. It is also used to transmit realtime data such as telephony traffic. This type of network architecture has triggered the introduction of music file sharing. Music File Sharing Perhaps the most noteworthy revolution in the music technology is the conception of online music services which allows music file sharing among customers through the use of peer to peer network architecture. This radical breakthrough began in 1999 when Shawn Fanning released the first original Napster. His discovery was the fruit of his quest in finding an easier method of searching music other than using IRC or Lycos. Napster became the first popular peer-to-peer file sharing system which specialized exclusively in music in MP3 format. This technology allowed music lovers to easily swap MP3 music files with each other for free which eventually lead to the music industry's accusations of massive copyright violations. The clamor of record labels lead to the shut down of the whole Napster network in 2001. However, Napster has begun its operation using a new business which allocates subscription fee for its service users [9]. Streaming Technologies The rapid advancement of technology has also facilitated the creation of streaming technologies which enables the user to view or hear digitized content in the same time that it is being downloaded from an Extranet or Internet. This technology allows information to be readily accessed in real time as the file is being transferred from another location. Unlike the typical downloading process where the content is first downloaded before the file can be accessed, streaming technology allows the "remnants" of the file to be discarded while it is being used. Therefore, this technology saves tremendous amounts of both time and disk space adding to total efficiency of a consumer [10]. Streaming technology has allowed consumers to download music from the internet without being constrained by the track's size. This technology is much more advanced than MP3 as it does not merely economize on disk space but eradicated the disk space requirement altogether. Napster has began an era of online file sharing services which was later adopted by other networks like Gnutella, which is a free and open protocol service. On the other hand, commercial online services were offered by iTunes and Rhapsody. III. Impact of Technological Development in the Music Industry Since the music industry is highly responsive to the changes in the economic system, technological advancements have strongly influenced its performance. The internet technology has facilitated the creation of new business models for the acquisition and distribution of music. Traditionally, music products are distributed in music shops, malls and record bars. However, the advent of the internet technology has allowed music products to be marketed online. Marketing of albums are now possible not only in physical retail stores but on the virtual music shops online. This technology has eradicated the geographical boundaries within continents and facilitated the free mobility of music products from country to country. Brick and mortar strategies are now complemented or even replaced by online business models. Music products in physical format are currently available in E-bay, JWPepper.com, and Ciao!co.uk. This reduces the cost of operation incurred by distribution channels as well as boosts the convenience and efficiency of the customer through time and effort savings. A consumer anywhere in the globe can now buy his favorite album online and have it delivered at his doorstep with just a mouse click. He can also easily download the album he has purchased online. Technological changes have also changed the structure of the industry's revenue. Music in physical format such as CDs, VCDs, and DVDs continue to contribute smaller shares in the total global revenue while digital sales continue to skyrocket. It is notable that the total number of tracks purchased online through downloads mounted to 200 million or ten folds from 2003 to 2004. This is even surpassed by the large figures recorded in 2005 as digital sales during the first and second quarter more than double the sales recorded in the entire 2004 [11]. Also, the influx of new communication gadgets like cellular phones has created a totally new subsector in the music industry. Currently, music is not solely consumed and recorded on traditional equipment like MP3 players but mobile phones. According to the most recent statistics, the mobile subsector is becoming an important market for the music industry as it accounts for the massive revenue generated which is somehow offsetting the losses incurred from the steady decline of the industry's total sales. We can see that revenue in this segment continue to mount as more and more consumers demand for this music service [12]. Technological boom has also altered the structure of the traditional music industry. Aside from the significant change in the distribution process and business model employed by record labels, the new technology has also considerable reduced the power concentrated in the hands of recording companies. This is aided by the use of more advanced technologies like online music sharing through the employment of P2P network systems. The impact of the aforementioned technologies can never be overstated. The creation of online music sharing services like Napster has allowed consumers to download their favorite tracks online for free or for a minimal fee. This led to the restructuring of the entire music industry as the importance of record label and other distribution firms in the entire supply chain is reduced or even eradicated. As stated above, the supply chain of the music industry was highly regulated by record labels through their strong financial and marketing muscle. However, this strong influence in eliminated as users can now function as distributors and users. File sharing allows individuals to obtain copies of their favorite tracks for free or with minimal subscription fee without meddling with record labels. Power, nowadays is in the hands of individuals who has access to online sharing services like Napster, iTunes and Rhapsody [13]. The significant functions which are traditionally carried out by distributors are now performed by the end user themselves. This is aggravated by the fact that the internet technology is not hindered by geographical locations making this a huge problem not just in a specific market but in the entire global music market. This has special implications for supply chain of the industry. In the traditional value chain, production and distribution is shouldered by record labels that in turn bear all the risk in the venture. We can also see that these companies also serve as an intermediary between artists and consumers. However, new technologies have integrated distribution and consumption in the hands of consumers giving them with a higher leverage. It is also apparent that record labels are displaced in the supply chain, posting the possibility of bringing artists and consumers together without their aid. IV. Industry Issues According to a report by the International Film and Phonographic Industry (IFPI), the year 2004 is the best performing year in global music sale since the past five years. It can be recalled that since 1999, global music sales has been escalating. Global sales in 2004 remained flat relative to the previous year at $33.6 billion [14]. The large and continuous decline in sales caused uproar in the industry especially among record labels worldwide. The decline in global music sales is highly attributed to the massive online and physical piracy. Another factor considered is the widespread commercial piracy and illegal file sharing which depressed the sales of music products [15]. Record labels are currently pushing lawsuits to the sectors involved in commercial piracy and illegal file sharing [16]. An example of these is the lawsuit filed against Napster in 1999 to prohibit the sharing of copyrighted material online which resulted to the shut down of the network and its eventual operation as a commercial online music provider. For them, these technologies have contributed to the bane of the music industry as consumers are encouraged to download music online therefore decreasing the demand for the products that they offer. They are currently intensifying their thrusts in the protection of the copyright of music materials. File sharing which allows consumers to download music for free is considered as a violation of the copyright law, which has protected the record labels from unauthorized copying, usage, and distribution of albums. File sharing is considered a form of piracy and theft where the rightful owner of the track is not paid for consumption. To stop the steady trend of illegal usage of recordings, the Recording Industry Association of America (RIAA) together with numerous intellectual property and commerce organizations such as the World Intellectual Property Organization (WIPO), United States Council for International Business (USCIB) and the International Chamber of Commerce (ICC) have become active in promoting the establishment of regulatory structure which will further boost the copyright protection of the holders. This led to the formulation of various legislations like the Digital Millennium Copyright Act [17]. Together with the downtrend in revenue, breach or infringement in copyright due to the developments posted by new technologies like P2P network architecture, online music sharing, and MP3 technology are the major issues faced by the industry. Industry players, especially record labels are wary that this can lead to the eventual downfall of the music industry. The drop in overall revenue due to free music downloads have brought huge profit losses to labels. Online music sharing is seen as a threat to the whole industry as this displaces the record labels in the value chain. These facts can lead to even lower demand for music products as consumers prefer to avail of free music offered by online music sharing services. V. The Music Industry in Economic Perspective After looking at the effects of technological innovations in the music industry and the issues brought about by these changes, we now turn at the economic implications of these technological changes and how these affects the different sectors involved in the music industry. Impact of Technological Changes in the Economy Economically speaking, improvement in technology is expected to bring about economic development. This is due to the fact that new technologies promote efficiency in the economic system as processes are aided by equipments which can lower the time and costs associated with production. In fact, basic economics tell us that an improvement in technology can cause the Production Possibility Frontier of a country to shift outward, enabling it to produce more quantities of certain commodities [18]. The improvement in transportation technology promoted efficiency by economizing on time and maximizing the convenience for a passenger. Likewise, the advancement in information technology boosted efficiency in communication by facilitating faster, more accurate, and effective communication. It is irrefutable that these technologies has significantly altered everyday processes and brought major changes in the global economy. Increase in Inter-regional Trade Technological innovations, especially the internet technology has greatly aided in the establishment of a global village. As the internet removed the geographical boundaries which limits trade, at the same time it also permits the free mobility of goods from country to country. The advent of the internet technology allows the physical and virtual transportation of music from one geographic location to another without any hassle. This therefore increases inter-regional trade among continents as consumers utilize the internet to purchase tracks that they want even if it is in another country. More Intense Rivalry Among Players The internet technology has no doubt intensified the competition among industry players, specifically for those involved in the marketing and distribution channels. As consumers can now readily access information about the music products sold online, they can easily compare prices charged by different retailers and take advantage of price differences. Due to this, retailers are forced to bring down their prices or add other features which will attract the consumers. Value adding has been a trend to compensate the consumers for higher prices. Consumers, in turn gained the power to choose among different alternatives which will maximize their utility by choosing the least priced products offered by distributors. Maximized Consumer Utility and Altered Supply Curve Peer-to-peer network architecture has cultivated the sprout of online music sharing services like Napster. Using the economic perspective, Napster has maximized the utility of music fans by providing them with less costly alternatives. Online commercial music sharing service providers are Napster, iTunes and Rhapsody. Basic economic theory tells us that consumer surplus is maximized by charging the least possible price to a product [19]. The change in business models has also altered the demand and supply curve faced by consumers and the music industry. The most common commercial service providers charge a fixed amount as subscription to cover all the musical downloads. These subscription fees are usually paid monthly. The traditional demand curve faced by consumers is downward sloping denoting their willingness to purchase a larger quantity of goods at lower prices. Supply curve is upward sloping denoting the producers' willingness to supply goods at higher prices. However, since the music industry is oligopolistic in nature, the price charged is not determined by the intersection of the demand and supply curves but whatever is assigned by the record labels. In the new market structure, however, consumers face a new supply curve. Since they only pay a fixed price regardless of the quantity they download, this is represented by a perfectly elastic supply curve which is a horizontal line on the level of subscription fee. This significantly increased the amount of consumer surplus which is represented by the larger area between the consumer's demand curve and the supplier's horizontal supply curve. Increase in Distribution Efficiency It is irrefutable that the internet technology has deliberately increased the distribution efficiency in the music industry. As more and more suppliers are establishing their presence online, which does not require them to own or lease spaces for physical product distribution. All they have to do is own a domain name. This also saved them from huge costs of promotion as they are not compelled to heavily advertise their products. Time constraints have disappeared as online retailers cater to customers twenty four hours a day and seven days a week. This also means more customer service for online buyers. Less Producer Surplus for Record Labels As discussed earlier, the global music sales have been continuously declining since the past five years [20]. This decline in sales is heavily attributed to the decrease in the consumers' patronage of physical formats like CDs and VCDs. However, this is offset by the marked increase in consumer's preference to digital formats. The skyrocketing number of tracks downloaded online is a strong evidence for this. Producer surplus is reduced as consumers are finding cheaper alternatives for music consumption. This is further indicated by the lower revenues and profit losses incurred by labels. Nowadays, record companies are compelled to lower their prices to effectively compete with lower priced music products. It is notable that lower priced products are not only due to the growing commercial online music sharing companies but also due to illegal file sharing and physical and digital piracy. VI. Conclusion, Outlook, and Recommendation This paper has examined the developments brought about by the technological boom in the music industry. The technological advancements ushered in a host of new technologies which has modified not only the supply chain but the entire industry structure. These new technologies include the creation of CDs and MP3s which started the digitization of music, peer-to-peer network architecture, music file sharing and streaming technology. These new advances introduced pioneering changes in the global music industry. This paper tackled how the new technology restructured the value chain of the industry as distribution and consumption is integrated. The composition of global music sales has also changed as consumers' preference shift from music in physical format to digitized formats. The widespread use of cellular phones by various economic sectors also created a new market for the music industry. The wide acceptance for music file sharing also reduced the importance of record labels in the entire supply chain. The degree of power is shifted from the labels to the consumer who now acts as important channels for music products especially for digital formats. In the economic sense, technological revolution has important implications for the music industry. It has created a sector in a global village that surpasses geographical boundaries. It has increased inter-regional trade, promoted more intense competition among players, maximized consumer surplus and altered the supply curve, increased distribution efficiency and lessened the producer surplus incurred by record labels. The current technological breakthroughs and future developments will continue to shape the future of the music industry. It is projected that the music industry will continue to evolve as an online market which be supported by the continuous mount in digital sales. The increasing e-commerce in music industry will only bring about market efficiency as new technologies are exploited. This market efficiency will mainly be felt by music consumers who now have a higher power in terms of choosing the song that they want to hear and obtaining music from a cheaper source. Technology will further provide a way to deliver music more efficiently and carve out an uncharted market niche which can be profitable for business ventures. It is expected that digital distribution of music will flourish. The increase in global digital music sales relative to physical formats implies that customers highly value the convenience of shopping for music online. The relative ease and time savings derived from online music providers encourage buyers to increase their purchases. This further implies that though music fans value the social value of music derived from shopping at music stores and shops and value "genuine" goods, they are more inclined to purchase products which are more convenient and accessible to them. It should also be noted that downloading music online adds to the total utility of music fans as they can now choose only the tracks that the want and are not constrained in purchasing an artist's whole album. The production of music will be streamlined as the involvement of record labels is reduced. It has been documented in numerous economic articles that the "ease of digital distribution will mean that artists will no longer be confined to the rigid parameters of big record companies." This is especially true as artists now have the ability to produce and distribute albums with relatively lower expenses. A good example of this is the artist called Prince who has utilized this technology. However, some artists would still want to be associated with record labels as these can provide them with greater publicity and larger amount of talent fee [21]. This has large implications for record labels as they will be competing head on with their talents in music production and marketing. The impact of more digital distribution and file sharing is expected to trigger stiffer competition among record labels. Tougher competition will shake off players which are not capable of competing head-on with dominant players. This will possibly reduce the number of players in the industry and consolidation, merger, or acquisition can take place. However, the larger companies will mean that music companies can regain the control of the distribution of their product online. The further stricter enforcement of copyright laws, and improved rights management and encryption technologies will also mean that more royalties be channeled to the rightful owners of the tracks [22]. To battle with players who distribute online, record labels may also want to either digitally distribute their catalogs themselves, particularly older libraries for the after-market, or pool resources and invest in online companies that do it for them. This is also seen as a profitable move for music companies to take advantage of buyers' shifting music preferences. Labels are expected to pursue partnerships with different companies to enable secure distribution, financial transaction administration and data management. Royalty agreements will also likely be restructured, giving artists a larger share of the pie to encourage them to stay with the music companies. Notes 1. "Global Music Retail Sales Including Digital, Flat in 2004," 22 March 2005, < http://www.ifpi.org/site-content/press/20050322.html> (02 Nov. 2005) 2. Ibid. 3. "Music's Brighter Future," The Economist.com, 28 Oct. 2004, The Economist. < http://www.economist.com/business/displayStory.cfmstory_id=3329169> (02 Nov. 2005) 4. Adam Sosinsky , "Are Streaming Technologies a Threat of the Music Industry," 2000, < http://pages.stern.nyu.edu/sjournal/articles_00/streaming_technologies.pdf> (02 Nov. 2005) 5. Ibid. 6. Kevin Zhu, Bryan MacQuarrie, "The Economics of Digital Bundling: The Impacts of Digitization and Bundling on the Music Industry," 2003, Graduate School of Management UC Irvine. < http://web.gsm.uci.edu/kzhu/PDFfiles/Papers_Abstract/CACM_DigitalBundling_p264 zhu_published.pdf> (02 Nov. 2005) 7. "MP3," Wikipedia--The Free Encyclopedia, 01 Nov. 2005, < http://en.wikipedia.org/wiki/MP3> (02 Nov. 2005) 8. "Peer-to-Peer," Wikipedia--The Free Encyclopedia, 01 Nov. 2005, < http://en.wikipedia.org/wiki/P2p> (02 Nov. 2005) 9. "Napster," Wikipedia--The Free Encyclopedia, 01 Nov. 2005, < http://en.wikipedia.org/wiki/Napster> (02 Nov. 2005) 10. Sonsinsky, "Are Streaming Technologies a Threat to the Music Industry" 11. Global Music Retail Sales Including Digital Flat in 2004 12. Ibid. 13. Mark Fox, "E-commerce Business Models for the Music Industry," June 2004, Look Smart Solutions. 14. Global Music Retail Sales Including Digital Flat in 2004 15. Ibid. 16. Chris Gaither, "Group sues 261 over Music Sharing," The Boston Globe, 9 Sept. 2003 (02 Nov. 2005) 17. Sonsinsky, "Are Streaming Technologies a Threat to the Music Industry" 18. Campbell McConnel, Stanley Brue, "Economics. Priciples, Problems, and Policies," (New York:McGraw-Hill) 2002. 19. Ibid 22-23 20. Global Music Retail Sales Including Digital Flat in 2004 21. Sonsinsky, "Are Streaming Technologies a Threat to the Music Industry" 22. Ibid. References Dolfsman, Wilfred. "How Will the Music Industry Weather the Globalization Storm." 18 Apr 2000. (02 Nov. 2005) Hannaford, Steve. "Industry Brief: Music Recording 1." 28 June 2003. Steve Hannaford. < http://www.oligopolywatch.com/2003/06/28.html> (02 Nov. 2005) Fox, Mark. "E-commerce Business Models for the Music Industry." June 2004 (02 Nov. 2005) Gaither, Chris. "Group sues 261 over Music Sharing." Globe Newspaper Company. (02 Nov. 2005) "Global Music Retail Sales Including Digital, Flat in 2004." 22 March 2005. < http://www.ifpi.org/site-content/press/20050322.html> (02 Nov. 2005) "Napster." Wikipedia--The Free Encyclopedia. 01 Nov. 2005. < http://en.wikipedia.org/wiki/Napster> (02 Nov. 2005) McConnel, Campbell, Stanley Brue. "Economics. Priciples, Problems, and Policies." New York: McGraw-Hill, 2002. "Music's Brighter Future." 28 Oct. 2004. The Economist. < http://www.economist.com/business/displayStory.cfmstory_id=3329169> (02 Nov. 2005) "MP3." Wikipedia--The Free Encyclopedia. 01 Nov. 2005. < http://en.wikipedia.org/wiki/MP3> (02 Nov. 2005) "Peer-to-Peer." Wikipedia--The Free Encyclopedia. 01 Nov. 2005. < http://en.wikipedia.org/wiki/P2p> (02 Nov. 2005) Sosinsky, Adam. "Are Streaming Technologies a Threat of the Music Industry." 2000. New York University. < http://pages.stern.nyu.edu/sjournal/articles_00/streaming_technologies.pdf> (02 Nov. 2005) Zhu, Kevin, Bryan MacQuarrie. "The Economics of Digital Bundling: The Impacts of Digitization and Bundling on the Music Industry." 2003. < http://web.gsm.uci.edu/kzhu/PDFfiles/Papers_Abstract/CACM_DigitalBundling_p264 zhu_published.pdf> (02 Nov. 2005) Read More