How The Internet Will Make The Record Labels Evaporate

There is currently a great controversy over distribution of music on the internet. Kids are sharing MP3s, the RIAA is suing Napster, and the sound bites are flying

Copying is fair use
Copying is theft
Music wants to be free
Napster users buy more CDs
Music companies make too much money
Music companies will make more money with internet distribution
Musicians can't make money with internet distribution
Musicians will make more money with internet distribution

Some of these are true; some are false, but none of them are useful in understanding what is happening or predicting what will happen. To expose the underlying structure of the situation, I'll begin with another sound bite that is gaining currency

Isn't this just like the VCR copying case?

Video Cassette Recorders (VCRs) appeared in the late 1970's, allowing consumers to tape TV shows off the air. The movie industry, fearing that widespread copying of movies would lead to a loss of box office revenue, sued the VCR manufacturers. They lost: the U.S. Supreme Court ruled that time-shift viewing is fair use and home recording is legal. Since then, the movie industry has prospered by distributing moves on video cassette.

Superficially, the situation of record labels with respect to the internet seems similar to the situation of movie studios with respect to VCRs. The internet makes it easy to copy and share music, just as VCRs made it easy to copy and share movies. Reasoning by analogy, some have suggested that record labels can prosper by embracing the internet, just as movie studios prospered by embracing VCRs.

In fact, these two situations are completely different. The crucial difference is

movie studios make movies
record labels don't make records

VCRs created new distribution channels for movies, allowing movie studios to establish new price points for their product and expand their market under the demand curve. Aggregate revenue increased, as well as the number and variety of movies produced.

Monopoly rents

Record labels can't adopt this strategy, because their underlying business model is different. Record labels don't make records: musicians make records. Record labels are sales and marketing engines. They have got control of the primary distribution channel for music (sales of CDs at retail) and they use that control to extract monopoly rents from musicians (for their sales and marketing services) and from consumers (for the CDs).

The internet blows this business model out of the water, on three counts

The internet is a distribution channel, and the record labels cannot control it. Right now, the internet is stronger on delivery than on payment, but that could change.
The internet allows musicians to market their own product. They don't need record labels to find customers.
The internet allows consumers to find music that they want to buy—a kind of inverse marketing. This is so novel that we don't even have a word for it, but it is just as much a threat to the record labels.

In short, the record labels make money by getting between buyers and sellers; the internet allows buyers and sellers to deal directly with each other. If the internet becomes a viable distribution channel for music, then the record labels become superfluous: they evaporate.

On this analysis, we see that calls for the record labels to "embrace the internet" are futile. Record labels can embrace the internet the way a soldier throws himself on a hand grenade, and they know it. Prediction: the record labels will do everything they can to delay and obstruct the distribution of music over the internet. They may do this in the vain hope that they can actually stop it, or simply in a pragmatic effort to keep the gravy train running as long as possible.

But what about the musicians?

Besides the RIAA, a few musicians, such as Metallica and Aimee Mann, also object to the distribution of music over the internet. They fear

loss of artistic control
loss of revenue from CD sales

Issues of artistic control are complex, and I won't try to address them here. However, the analysis above suggests that musicians should make more money with internet distribution, not less. Why then do they fear it?

A little investigation resolves the question. The musicians who object to internet distribution own their own labels. This means that they are getting the same deal—the same monopoly rents—as the major record labels; it also means that they stand to lose those rents if internet distribution of music becomes prevalent. Naturally, they are opposed to it. By speaking out against internet distribution of music, these musicians function as shills for the record labels.

The case of Aimee Mann is instructive in another way. Her record label comprises two persons: herself and her manager. It appears that only two things are required to become a record label

the business acumen to work the distribution channel
sufficient name recognition to do your own marketing

With the internet, everyone can work the distribution channel, and everyone can do their own marketing. With the internet, everyone can be their own record label.

How it is

The major record labels use their control of the market not just to extract monopoly rents, but to mold the market for their own profit and convenience. This manifests in various ways

Producing a CD has large fixed costs and small variable costs. To maximize profits, record labels promote a small number of top-selling acts.
There is more creative talent in the world than the labels need to run their business. They take what they need and leave the rest.
To appeal to the broadest possible audience, record labels aim for a homogenized, middle-of-the-road sound. Their product is relentlessly mediocre.
To maintain control over the product, record labels assemble some of their biggest acts from component pieces: composers, session men, front men, producers. While this doubtless makes the production of music more orderly and businesslike, it probably doesn't do much for its artistic interest or integrity.
The market is polarized: a handful of musicians make millions, while the vast majority are shut out entirely.

How it could be

If distribution of music over the internet becomes prevalent, the world could be a very different place

The record labels evaporate—like puddles in the sun.
Thousands and thousands of composers distribute music over the internet. Musical styles and variety explode.
Consumers search the internet for music. The problem isn't finding music—it's everywhere. The problem is finding music that you like. People trade acts, titles and URLs with their friends.
Fans put up fan sites and review music. These sites are important to the success of acts.
Retailers burn CDs on demand. CD stores look like 1-hour photo developers: storefront, equipment, no inventory.
A successful act is one with a small, loyal following.
The market depolarizes. Instead of a few acts making huge sums of money, there are many acts making modest sums.
Mass culture demands super-stars. There will always be a few acts with millions of fans.

What is success?

Record labels count success in dollars.
Musical acts today count success in gold records.

What if we counted success by the number of songs written and heard by at least one person?

	People writing songs, that voices never shared...
		—Paul Simon

Notes

monopoly rents: The recording industry is actually an oligopoly: the 5 largest distributors control approximately 85% of the market. They maintain monopoly prices on the consumer side by, for example, conspiring to fix prices. Courtney Love has a lucid and detailed account of how they work the game on the producer side.
word for it: We could perhaps subsume it under the term surf, which refers generally to the activity of searching for information on the internet.
function as shills: They are actually not shills. There are both structural and ethical differences in their behavior.
creative talent: If one person in 1000 can compose music, then there are 300,000 potential composers in the United States alone. Even large retail outlets carry only a few thousand musical acts.
polarized: It probably follows a zipf distribution.

Steven W. McDougall / resume / swmcd@theworld.com / 2000 Aug 06