Is the music industry dying?

An anecdote in a recent Economist perfectly summed up the problems facing the major music labels. After EMI, the smallest of the Big Four, invited a teen focus group to its London headquarters in 2006, it wanted to give the teens something for their time. The response is worth quoting in full.

At the end of the session the EMI bosses thanked them for their comments and told them to help themselves to a big pile of CDs sitting on a table. But none of the teens took any of the CDs, even though they were free. "That was the moment we realised the game was completely up," says a person who was there.

Given the years of declining revenues at the major labels and the constant stream of stories in the mainstream press about music's decline, you'd be forgiven for thinking that the music industry's pallbearers are already lined up and waiting in the hallway. But music isn't on its deathbed yet; in fact, people are listening to more artists than ever before, on more white earbuds than ever before, in more places than ever before. They're just not paying as much.

Don't put all the blame on file-swapping, either, or chalk the problems up to an inability to "compete with free." Digital music sales soared in 2007, and in fact, the total number of "units" moved during the year increased over 2006. eMusic, the number two music download service in the US behind iTunes, doubled its own projections for the Christmas season, pushed out 10 million tracks in the month of December, and added 50,000 new paying customers in the last six months.

And all of this happened without the four major labels even offering DRM-free tracks online. Now that Sony BMG has finally capitulated, 2008 is poised to be the year digital goes so mainstream that even your parents use it.

All that good news means that music is alive and well—but it doesn't mean that things are rosy at the major labels. Let's run the numbers from 2007, then do a case study on eMusic's recent results to see just what kind of success can be had in the digital download world by competing with free.

Major label blues

Revenues at the four major labels (Warner, EMI, Sony BMG, and Universal) have been on a slow decline throughout the decade. From 2002-2006, the majors' revenue declined by 11 percent even as movies held steady at the box office and video games grew. Despite the downturn, the chart below makes clear just how large the major label music business truly is.



Data sources: RIAA, MPAA, The NPD Group

Things have gotten bad enough that the labels themselves are demanding change even from their trade groups. EMI has recently been pushing both the IFPI and RIAA to restructure their operations, for instance, and all four labels have tried to adjust to a new world by dropping DRM and launching innovative programs like "Comes With Music."

Is the downturn due to people not paying for music, though? Hardly; it's due in large part to people not paying for CDs.

Again, looking at data from 2002-2006, we can see that CD sales have seen sharp decreases in all but one year, with 2006 having the sharpest drop of the bunch (2007 may have been worse).



Data source: RIAA

But unit sales have actually been rising over the last few years, with 2007 being another strong year. Reuters recently reported that overall unit sales rose 14 percent in 2007, with digital sales jumping by 45 percent.



Data sources: RIAA, Nielsen Soundscan

What's happening is obvious; consumers are making far more purchases than ever before, but are often choosing to grab only selected tracks rather than complete albums. The album may not be dying in a general way, but it has certainly lost its importance as the primary way that buyers in the digital era get their music. Bands with a track record of putting out uneven albums won't be able to milk that strategy for massive profits anymore, nor will any labels that nurture such acts.

That has translated into a grim situation at the major labels. Warner Music's stock price is down more than 70 percent from its IPO price in 2005. EMI, recently acquired by private equity firm Terra Nova, was appalled by some aspects of the business it had acquired. In a recent interview with the Financial Times, new EMI boss Guy Hands asked rhetorically, "Can you imagine what would happen if most consumer industries over-shipped by 20 per cent? Can you imagine any consumer industry having 10 per cent of employees as middle management? Can you imagine only 6 per cent of staff in production?" Things are so bad that EMI has been spending $50 million a year just to destroy CDs it couldn't sell, and has announced plans to lay off as many as 2,000 employees.

The situation is reminiscent of a Tim O'Reilly essay from 2002 in which he pointed out that "File-sharing networks don't threaten book, music, or film publishing. They threaten existing publishers." The same holds true of music. As long as the demand is present, there are huge opportunities to make money by giving consumers what they want—but that's no guarantee that existing business models will continue to support companies.

It's often said that it's hard to compete with free, and that may be true for some segments of the population. (Are college kids ever really going to cough up much cash?) But for most adults who don't get off on breaking the law or on stiffing artists, it's easy enough to compete with free. Make something that's faster, more reliable, with better metadata and album art, and a huge DRM-free selection. Throw in charts, some editorial staff, and some community features, and money is there to be made.

Even as the majors have found their revenues declining, indie-focused companies like eMusic are growing rapidly. Ars talked to eMusic CEO David Pakman to get some insight into how his company fared in 2007.