April 13, 2012

There are similarities between the strategic challenges faced by the dial-up ISP industry (which for the purpose of this post i will treat as just one company: AOL) and the recorded music industry. Both industries were recently sitting on some of the most lucrative businesses the world has ever known. Both industries also happened to peak at the same time: the late 90s. At peak, AOL had 35 million subscribers, each paying a monthly fee. At peak, the music industry was grossing $20B annually from CDs. Times were good.

The usual straw man argument leveled against the music industry is that there was a systemic failure to boldly embrace radical new technology-based business models. The industry “missed the boat”.

By way of contrast, AOL has been consistently making bold moves towards a new business model. AOL management was and is fully aware that the legacy “access” business will continue to decrease every year, one day reaching zero. Agressive moves have been made. Bebo was bought. Tim Armstrong was explicitly hired to come in and use what’s left of this dying cash cow to build a next generation advertising business. The Huffington Post was bought. Patch has had a great deal of money plowed into it. In the best way it knows how, AOL has been swinging for the fences.

The aforementioned bold moves seem to have inspired more criticism than praise from investors & press. Why? Because these strategic moves could easily fail. The jury is still out.

On the other hand, we can contrast AOL’s moves with what the music industry has been doing to save itself. With a few exceptions, the music industry relies upon licensing relationships to participate in new business models, rather than the direct creation and marketing of products to consumers.

The implicit philosophy of music industry licensing is: every deal is wired for success. The garden variety music licensing deal is generally constructed in a way that would make a Goldman Sachs partner smile.

Minimums payments, upfront payments, greater-of calculations between 3 different variables… it’s all there. There is also no shortage of innovation towards the creation of exotic business terms. For example I once heard that the labels now ask for (and get) “non-dilutable” equity in startups.

When you think about it, Beyond Oblivion is the case study for the most successful music licensing deal ever done. Why? Beyond Oblivion paid out a great deal of up-front money to work out licensing deals, then promptly shut down. Since the service never launched, none of the alleged non-refundable payments were related to the usage of music, so no money would then be paid out to artists. Sounds like breakage to me.

Some have said that the labels want Spotify to fail, but I personally don’t agree. If the deals were constructed properly, the labels should have no real preference whether or not Spotify fails. If every deal is wired, it doesn’t matter how successful any individual license-holder is. All that matters is that there are more deals to be done, and that there are constantly new licensees willing to pony up the cash.

Under this business philosophy, the music industry cares as much about which music service “wins” as ExxonMobil cares which gas station chain wins. It just doesn’t matter… as long as the money continues to roll in.

To recap, the AOL strategy to save themselves from a dying legacy business has been to make longshot bets. These longshot bets keep the risk/rewards on management’s shoulders. The music industry strategy has been to utilize financial engineering in order to push product & execution risk off as far away from their core business as possible.

Which strategy is better? I suppose it depends on what outcome you are optimizing for.

294 Kudos