Record labels' digital strategy -- do nothing

A customer checks out Music Store with Apple iTunes at an Apple store in Tokyo in this August 25, 2006 file photo. Record labels need the digital music market to take off.

By Antony Bruno

LOS ANGELES (Billboard) - Record labels need the digital music market to take off. So why aren't they helping it any?

Physical CD sales have been in decline for the last five years, and according to various estimates are expected to fall another 15%-20% again this year. And while digital revenue is on the rise, it is not yet reversing the trend. Sony BMG global digital business president Thomas Hesse says that if physical revenue drops by 15%, digital revenue must rise by 60% to compensate. This year, he expects net revenue to fall.

So what are labels doing other than licensing their music to digital services that they hope will become successful? According to many service providers and industry analysts, the answer is -- nothing.

"There's no plan, no sense of direction," one digital retailer executive says. "They're just hoping somebody is going to figure all this out for them."

To date, that somebody has been Apple -- its iTunes store commands 70% of all digital music sales and the iPod around 80% of all digital music devices. Yet, record labels are the first to point out that Apple can't reverse their falling fortunes on its own. They need more services selling more music to more people. And although labels have tried to support potential competitors to iTunes, such as Microsoft's Zune bid, these services are merely limping along.

The reason, operators of such services and digital music industry analysts say, is the music industry is not taking an active-enough role. "They're not directly hurting services," one former digital service provider says, "but they're not directly helping either."

MARKETING

Record labels are marketing and promotion machines, and could flex that muscle to help drive more users to digital outlets. Yet most of their advertising directs buyers to either big-box CD retailers or iTunes.

Even some label execs think this needs to change.

"(We need to) take more responsibility for driving awareness and consumption from our own ad dollars and impressions rather than relying on others to do it for us," Universal Music Mobile GM Rio Caraeff says. "We're not doing enough in my opinion. Most of our marketing goes toward selling CDs."

As digital revenue contributes more to labels' bottom lines, he says, that will change.

SLICING THE PIE

Of course, digital service providers could spend much more of their own marketing dollars if they didn't have to pay labels and publishers so much in licensing fees. This is an old argument, but one that isn't going away anytime soon.

Gabriel Levy, VP of labels relations at Rhapsody, says satellite radio providers were able to amass millions of subscribers in a relatively short period of time because they didn't have to pay the same licensing rates that subscription music services do, and as such were able to devote more money to advertising.

And that's just the existing services. A host of new technologies and business models are waiting to license music to go public, but are left waiting in the wings as labels work to evaluate the risk potential rather than the business opportunity.

"The people in charge of these deals are very risk-averse," Music Choice CEO David Del Beccaro says. "They're a bunch of lawyers."

Label sources say that they make deals as quickly as they can and prioritize their efforts based on which deals will result in the most immediate revenue. But even industry insiders agree that, for the long term, the dealmaking process needs to be addressed.

"If we don't retrofit our business to accommodate, we're going to miss out," says Richard Blackstone, senior adviser to the chairman for Warner Music Group.

INTEROPERABILITY

Perhaps the greatest obstacle to the digital market's growth, though, is that music acquired from any "legal" service other than iTunes won't work with the iPod.

Apple famously encouraged the labels to sell without DRM (digital rights management) to solve the problem, while labels put the onus on Apple to license its FairPlay DRM system to other retailers.

"This is a technical problem with a technical solution," says Thomas Gewecke, senior VP of Sony BMG's Digital Business Group. "The only people that have a problem with it are technology companies who benefit from the situation being closed."

Yet if labels are serious about forcing Apple to open up its technology, some question why they don't just pull their music from iTunes until Apple complies. "If you don't like the way (Apple) is protecting your property, take it away," dares Jon Potter, executive director of the Digital Media Assn.

Most digital music services are run by executives hailing from either the software or consumer electronics world, where it is not uncommon for the major companies involved to jointly set the technological standards and other rules governing the sale and distribution of their products. The music industry, by contrast, so far seems satisfied to simply license its content and let the technology industry figure out the rest--a source of increasing frustration among those in the digital space.

How the music industry responds should prove an interesting barometer for how far along the convergence of digital and music has come, and how much further it has to go.

Reuters/Billboard