The Tale of an Extinct Business Model

Sixty-five million years ago, a massive meteorite smashed into the Yucatan peninsula. That was the end of the dinosaurs.

The Internet is doing the same thing to a few dinosaur-like business models. I sure hope you're not heavily invested in any of them, because they are taking a few million tons of molten rock upside the head right now. With the old fogies swept out of the way, consumers and businesses alike will then enjoy the flourishing fauna of new-age publishing models that will replace the old ones.

Meet one ancient dinosaur
The music industry at large, such as major labels like Warner Music (NYSE: WMG  ) and Sony (NYSE: SNE  ) BMG, still expects me to mosey on over to a local retailer to buy a physical CD when I want to hear a song. And if Sony's history is any indication, it'd also like to stop me from moving that precious, precious "content" (a word that most artists probably hate) to MP3 players, home-burned CDs, or mix tapes. Heck, it'd probably stop me from grabbing my guitar and playing along, if it only could. After all, I haven't paid for any of those privileges, have I?

Online downloads are anathema to this school of thought. Sell one unprotected copy of a song, and the 'Net will soon be crawling with illicit copies. CD ripping presents the exact same dilemma.

... and an avalanche of cuddly mammals
But the cat is way out of the bag -- digital downloads of various kinds have opened up a whole new vista of music distribution strategies and tactics. If the old-line music industry won't adapt to this new reality -- and early indications tell me that it isn't exactly open to the idea -- it had better get ready for extinction. Here's a sampling of the new tools at the intrepid artist's disposal today:

  • Legal downloads. Convince that dusty old record label to allow your music on Apple's (Nasdaq: AAPL  ) iTunes, Amazon's (Nasdaq: AMZN  ) MP3 store, and other convenient digital sales outlets. If people are going to download or rip your songs anyway, why not get a cut of the sales?
  • Music games. The Rock Band download version of Motley Crue's "Saints of Los Angeles" outsold the iTunes release of the same song by nearly five-to-one in the week it was released. Aerosmith made more money from its Guitar Hero: Aerosmith title last summer than from its last two albums. Are Viacom's (NYSE: VIA  ) MTV Games, Electronic Arts (Nasdaq: ERTS  ) , and Activision Blizzard (Nasdaq: ATVI  ) replacing Sony and Warner in the music world?
  • Radiohead famously bypassed labels altogether and handed out In Rainbows straight from the band's home page. Pay as little or as much as you want. Nobody knows how much money the band made that way, but the CD release still topped charts around the world a couple of months later.
  • Veteran alternative rockers R.E.M. went really alternative with their latest CD Accelerate, putting audio streams of the whole album on their official site in the weeks before the release. The album then charted at No. 2 in the U.S. This was the band's best chart performance in more than a decade, despite the presumably hurtful free online streams. Let's agree that free downloads can be an effective marketing tool.

Not a hoser, for sure
Canadian record label Nettwerk, with acts like Barenaked Ladies and Sarah McLachlan among its clients, seems to "get it" and is monetizing the new, digital environment. "It took the lawyers years to get their heads around [the Internet business model] because they just didn't believe in it," CEO Terry McBride recently told a PBS reporter. "It's taken time, but now the managers are looking at a very steady cash flow, and the artists aren't fighting for their creative freedom but actually using their imagination -- and those are two very different things."

To me, McBride sounds like an early rodent, set to take over when the dinosaurs draw their last collective breath. Nettwerk is already wiggling its long, furry tail in defiance and looking for a few soul mates. Don't worry, eh? They're coming.

Until Nettwerk goes public or one of the tradable guys figures out this new paradigm, I advise shying away from music producing stocks altogether. Take two of these instead, and call back in a couple of years.

Further Foolishness:

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Fool contributor Anders Bylund holds no position in any of the companies discussed here. He wants to start a band, write a novel, and watch both endeavors shoot to the top of their respective charts. Dreams are still free. You can check out Anders' holdings or a concise bio if you like, and The Motley Fool is investors writing for investors.


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Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On December 26, 2008, at 9:56 PM, kurayami wrote:

    The constant vitriol from the Motley Fool editorial contributors toward the recorded music industry is extraordinary. It often says more about an axe-grinding agenda than about the subject at hand.

    Stockholders of Live Nation, Warner Music, Time Warner, Sony etc are interested in balanced viewpoints, especially with some vision of where media is headed in these turbulent times. Recent Fool articles have lauded Live Nation, but they have yet to achieve a sustainable profitable business model and ironically many record labels remain more profitable than Live Nation. The beating (down 75% in two months) LYV investors have taken may worsen. Film studios have watched the record labels' travails closely over the past decade and have felt their own revenue streams come under marked pressure in 2008. Will they follow? Where is there growth potential and/or money to be made in this space?

    Of course many older big-name artists have a plethora of new options, now that they already have an audience built during the previous era. They're even leaving many established managers, including Avril Lavigne leaving Nettwerk, which you compliment in this article. How will new artists build their careers? The top download charts (both paid and P2P) show a troubling lack of new artists -- in fact, the Top 10 varies little from even 15 years ago. Companies that figure out how to provide value to new artists as they launch their careers, and then figure out how to get paid something for their efforts, should be the subject of investor attention.

    The idea that we all support giving away all intellectual property and changing our IP laws, because "this is what the 'consumer' wants" (quoted from your linked "They're Coming" article above) and instead support the limited business model of touring/merchandising (still a fraction of the total music market, despite the fall of CD sales), just doesn't make business sense. Are you aware that one of the biggest expenses for record companies in the 80s and 90s was artist tour support? And where does this end? We would all love free software, free films... should investors sell all these stocks assuming they are the next wave of this "consumer" revolution? Shipping piracy in the Gulf of Aden has grown to the point of an unstoppable new reality, despite the clear illegality... by your way of thinking, should shipping investors give these Somalian "customers" what they want, change our "outdated" laws and settle for promotional value? That would make sense, if it made money... unfortunately, none of these suggestions to date have born any real profit.

    As to the future of music in the US, you mention Apple above. They have pursued a classic business school strategy of selling a complement (music) as cheaply as possible to maximize the margin of their main product, the iPod. They make no money on iTunes, and make no bones about it.

    And you mention games, suggesting that they will be the future means of developing artist careers, supplanting music labels. Yet the only examples you cite are of established artists, in which the deals behave more like merchandizing opportunities for artists who already have top brand names. How will this work for new artists? Where is the value to investors if these future artists have little commercial value? Will games companies partner with artists and share in artists' supposed touring revenue? Without new development, there is no future wave as the current artists age in their careers.

    To take a meaningful look into the future of American entertainment, look at China for music, and Korea for films. Cheap near-universal access to broadband in Korea has caused the local film studios to fold -- they cannot produce nor distribute films in Korea and make enough money to stay in business. China's domestic music market was a shadow of its tiny Taiwanese neighbor for decades, due to rampant piracy and a consequent lack of funding. Despite China's whopping 100-fold population advantage over Taiwan, Taiwanese artists dominated in the mainland, building their recorded music careers in Taiwan and then touring in China. Meanwhile, Japan's strict enforcement of IP has led its domestic music and film industries to thrive, with Japanese films now selling more in total than foreign, and the music industry growing since 2003.

    As an investor and a reader, I would love to hear more real analysis of these trends and ideas on what investor opportunities we may see in entertainment, opportunities to achieve growing and sustainable profit.

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