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Music Industry 2.0

By Anders Bylund - Updated Apr 5, 2017 at 8:03PM

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How to invest in what looks like a deeply troubled sector. Hint: Think outside the CD case.

Change happens, and it hurts if you happen to make a living in an obsolete industry. The advent of electricity killed the kerosene lantern industry. Trains, planes, and automobiles reduced horse-and-carriage teams to a quaint niche market. And who needs an 8-track player or a 78-rpm turntable when we have CDs?

And that's where we leap out into the great, wide-open future of the music business.

Free Fallin'
We're standing at the crossroads of the traditional studio system and a new era of mostly digital free agents. CD sales are no longer the cash cows they once were. Physical media sales, where CDs stand for the lion's share, dropped 15% last year, and the trend is expected to continue. Wal-Mart (NYSE:WMT) is no longer the largest music retailer in the world, as Apple's (NASDAQ:AAPL) iTunes store claimed that honor back in April 2008.

The labels are understandably upset because their very successful business model is going the way of the dodo bird, the crossbow, or the hunter-gatherer social structure.

Yer So Bad
The record industry as we know it is buckling under pressure from digital downloads. Labels like Warner Music (NYSE:WMG) like to blame illegal file-sharing for much of their problems, continuing a Quixotic lawsuit crusade against the windmills of piracy. "Digital sales gains don't make up for the physical losses," they often complain. But that lament fails to account for the fact that consumers have broken free from the restrictions of the old album format. One-dollar single-song downloads have simply changed the way fans buy their music. Why download a whole album when you can just pick the good stuff and leave the yucky filler material behind?

The way to fight this battle is to start trusting the consumer a little. Apple's success proves that people are perfectly willing to pay a reasonable amount of money to fill their musical desires, as long as the shopping experience is easy and elegant. The company is selling iPods about as fast as it can make them, and iTunes sales follow suit.

Radiohead gave us another bit of evidence of the basic desire to pay fair price for music. Giving away its latest album in return for optional donations turned out to make a lot of money from the digital experiment -- and it still topped the charts with the physical release a couple of months later. Embracing the downloaders, then, might just grow the total market rather than cannibalize the old one.

As for the piracy problem, think of it as free advertising. Downloading a track for free is no different than using a cassette player to tape songs off the radio, only on a larger scale with more control over the process. Alternative rocker KT Tunstall says that "as long as people are hearing your music, no matter how, whether it's illegally or legally," she's happy to play a set in a new town where "people know about it and show up for the gig." Grateful Dead encouraged fans to tape live shows for years. Word of mouth is a powerful advertising tool, and enough fans care enough to keep the music profitable.

But until some major record label truly embraces this attitude, which hasn't happened yet, it's hard to invest in this trend. Apple is hardly a pure music play, and Napster's shares no longer trade thanks to Best Buy's (NYSE:BBY) purchase.

Time to Move On
It's a good thing we have video games. Guitar Hero and Rock Band have the distinct advantage of being hard to download, at least if you want the full gameplay experience. Activision Blizzard (NASDAQ:ATVI) and Viacom's (NYSE:VIA) MTV Games division have already graduated from selling a fun little rhythm game to leveraging the publishing potential of these platforms.

Aerosmith's Guitar Hero venture has sold about 2 million copies, or double platinum in album terms, despite being much more expensive than a regular CD. Metallica published its latest album as a downloadable set list for the game, and will release a more "greatest hits"-oriented game disc next year. Not to be outdone, Rock Band has a Beatles edition in the works and more than 500 songs available in total -- including whole albums by big-name bands like Judas Priest, the Pixies, Red Hot Chili Peppers, and Rush.

Downloadable content is a great idea. With the games already in place, distribution becomes a simple matter of laying down the note tracks for gamers and then pushing the result out to an attentive audience of adoring fans. That means low overhead and quick turnaround, making the band games a viable alternative platform for "greatest hits" compilations and the like.

And don't forget that we're in the early days of guitar gaming. Rock Band 5 may come with virtual music video modes and party playlists that'll let you hear songs as they were recorded without ever touching a plastic guitar.

The Waiting Is the Hardest Part
Forget the old line of music studios and their traditional sales channels. The future is digital and surprising and innovative, as it should be. Invest in the new breed of tastemakers and earthshakers, like Activision, Apple, or Rock Band distributor Electronic Arts (NASDAQ:ERTS).

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Stocks Mentioned

Activision Blizzard, Inc. Stock Quote
Activision Blizzard, Inc.
$77.16 (-1.09%) $0.85
Wal-Mart Stores, Inc. Stock Quote
Wal-Mart Stores, Inc.
$122.37 (-1.41%) $-1.75
Electronic Arts Inc. Stock Quote
Electronic Arts Inc.
$122.88 (-2.17%) $-2.72
Apple Inc. Stock Quote
Apple Inc.
$137.44 (-2.98%) $-4.22
Best Buy Co., Inc. Stock Quote
Best Buy Co., Inc.
$68.85 (-4.56%) $-3.29

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