MP3: Death of the Music Intermediaries?[Fool on the Hill] April 3, 2000

An Investment Opinion

MP3: Death of the Music Intermediaries?

By Yi-Hsin Chang (TMF Puck)
April 3, 2000

I have written about MP3 before, but I had not realized the full impact the Internet likely will have on the record industry until I recently attended a talk by Chuck D of Public Enemy, who, as you might imagine, is very vocal and well-versed on the subject. I left the lecture thinking one thing: "The major music intermediaries -- record labels, music stores, radio stations -- are dead."

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 an MP3 file using the same modem.

MP3 is not the only audio format being used on the Internet. The space is burgeoning with creative activity, and new technologies are constantly emerging.

In my previous commentary about MP3, I mentioned that MP3 (and, I should add, technologies like it) liberates music artists and their fans from record studios and music retailing outlets. I liked Chuck D's take on MP3: "This is the emancipation proclamation."

I learned a great deal more about the record business from Chuck D. For example, only 7% of rap groups get signed by the major labels. The other 93% are left to wallow in obscurity. In all likelihood, we are missing out on some great talent as a result of the majors' fairly arbitrary selection process.

With technologies like MP3, artists can bypass the major labels and reach their audience directly at a pretty low cost. No longer do artists have to conform to studio requirements or compromise their artistic vision just to have their music heard. In fact, they can cater directly to their customers, the music listeners, without relying on all the intermediaries from record studios to radio stations to music stores. Artists can get instant feedback on the music they create.

The most interesting thing Chuck D made me realize was that all the talk of piracy on the Internet from the mouths of major studio executives is not about protecting the artist, but rather protecting the labels' bottom line. As Chuck D explained, "To protect artists would mean joint ventures," not deals that give artists a miniscule 5% of net profits.

Chuck D argued that "bootlegging" -- a favorite derogatory word of the major labels -- should just be called "sharing." If you think about it, the record labels have been giving away music for quite some time. For starters, they send roughly 5,000 pieces free to DJs, of which only 10% actually get used. You know how you buy a CD and you really like only two of the songs? Well, as Chuck D explained, you pay for those two songs, and the rest are free.

Essentially, the old way of doing business in the music industry is fading. The pie is growing, but more and more musicians will be able to get their hands on a piece of it. Meanwhile, artists and fans alike will increasingly turn away from the traditional sources of music. Why listen to a local radio station when you can log on to the Internet from your car and play the music of your choice off of a website?

What does this all mean for investors? Stay away from the music intermediaries. We're talking very short half-lives here. Sure, the major record labels, music stores, and radio stations likely will be around in one form or another, but expect more consolidation and a much smaller presence. The era of the big labels is over. The Internet is transforming the music business and putting more power in the hands of individual artists and fans. That's bad news for the intermediaries.