Fool.com: MP3 Revolution (Fool On the Hill) August 30, 1999

FOOL ON THE HILL
An Investment Opinion

MP3 Revolution

By Yi-Hsin Chang (TMF Puck)
8/31/99

There's a revolution going on in the music industry, and it's happening right here on the Web. I'm not talking about ordering CDs online from the likes of Amazon.com or CDnow, which simply shift an old world business to a new world medium. I'm talking about music direct sellers, a new way of doing business that cuts out the middlemen -- in this case, record studios and retailers. I'm talking about a potential category killer.

That's how MP3 is revolutionizing the music industry. MP3 stands for "Motion Picture Experts Group-1, Audio Layer 3." The technology compresses high-quality audio files to a more manageable size -- roughly 1/12 their original size -- thereby reducing the time it takes to download what is near-CD quality music. So a song that takes more than 40 minutes to download in a CD format using a 56K modem would take less than four minutes to download as a MP3 file using the same modem.

Up until now, the major record studios -- Seagram's (NYSE: VO) Universal Music Group, Bertelsmann's BMG division, Sony Corp.'s (NYSE: SNE) music entertainment unit, EMI Group, and Time Warner's (NYSE: TWX) music division -- have raised a ruckus about MP3 only as it relates to pirating. They are concerned that consumers can illegally and all too easily download copyrighted material from the plethora of websites out there without paying the record companies a single cent.

Late last year, the Recording Industry Association of America (RIAA) announced the Secure Digital Music Initiative (SDMI), an effort to work with the technology community to create an open architecture for digital music security by this fall. In July, the group published its first voluntary, open standard for new portable devices.

At the same time, the major studios also have gotten in on online music retailing. Most notably, Columbia House, the music and video club direct marketer equally owned by Sony and Time Warner, recently announced a merger with one-time music e-tailing leader CDnow (Nasdaq: CDNW). In addition, rivals Universal Music and BMG, which together control 44% of the U.S. market, joined hands to launch a new online music store called getmusic.com.

Ironically, aside from the piracy issue, the major studios have downplayed MP3 as a potential threat to their very existence. Think of Dell Computer and the way it has revolutionized the computer industry. The success of selling PCs directly to consumers without going through traditional retailers such as CompUSA or Radio Shack forever changed the PC business and hurt the profitability of retailers as well as computer makers such as Compaq that didn't make the transition fast enough.

MP3 liberates music artists -- and their fans -- from record studios and even music stores. Artists can record their own music and sell it directly to consumers online using MP3 technology. This way artists can make more than just a buck or so off the sale of a CD, the norm under the system controlled by record labels. Artists who choose to set up their own independent online stores -- say a PuffDaddy.com or Madonna.com -- can simply outsource the fulfillment services and pocket an even greater profit than selling their music through an existing music-download website.

Unlike the case of PC direct sellers, artists selling music online don't have to worry about manufacturing. Sure, they still have to record the music in a quality sound studio, but they don't have to work out the details of actually pressing CDs, nor do they have to be concerned with distributing the CDs to retailers throughout the world.

Plus, as direct sellers, artists can dictate when they will release new music and how often; they are no longer beholden to studios' schedules. Not only do artists achieve economic freedom, they also attain true artistic freedom.

Even new, up-and-coming artists will be able to sell their music to consumers, to build an audience from scratch. They won't need record companies to subsidize their rise to stardom. They'll be able to do it themselves.

Music fans also stand to benefit from MP3. First of all, music costs will go down as the costs of producing, marketing, and distributing music drops. Also, the interactive nature of the Web will allow artists to get direct feedback from consumers, thereby facilitating releases and remixes in response to customer demand.

This week's Barron's features an article titled "Swan Song," saying that the Internet will kill some of the recording industry's old ways of doing business. While I agree, the article doesn't go far enough. The $40-billion-a-year global music business will not just be changed by MP3; it will be completely transformed.

As the Barron's article states, online music is already bigger than sex at least in one sense: Last April, the Internet site Searchterms.com reported that "MP3" has surpassed "sex" as the most popular term used in Web searches. ("MP3" denotes music files the same way ".txt" and ".doc" denote text files.)

The ascendancy of MP3 should not be viewed the same way as the introduction of previous new music formats such as cassettes or CDs. MP3 is not just a new format; it's an entirely new way of doing business. It takes power from the hands of the major record studios and puts it in the hands of artists and fans. Now, that's truly revolutionary.