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Guess Who's Making a Comeback? Record Labels.

As difficult as it is to find anything uplifting about the recorded music industry these days, I have recently turned bullish.

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Being a record label executive isn’t as cool (or fun) as it used to be. Ever since worldwide sales peaked at $38 billion in 1999, the industry for recorded music has contracted to less than half of that ($15 billion in 2014).

It’s not just sales — even profitability has found new lows. According to Ernst & Young (and as published in Billboard magazine), music has the lowest margin (and margin growth) within the broader media and entertainment sector. Today’s profit margin of ~10 percent is a far cry from the reported 20 percent as little as 15 years ago.

Various factors contribute to this collapse. Piracy and the unbundling of albums into individual tracks are just two of them. In general, the industry suffered from inertia to embrace digital when it first came to the scene in the late ’90s; too much money was at stake to experiment with this new format.

Identifying, dissecting and discussing each point of failure is irrelevant; it can’t be undone (but if you wish, I elaborated on some of this in a related article previously published on TechCrunch). As difficult as it is to find anything uplifting about the recorded music industry these days, I have recently turned bullish. And that’s what this article is about — how the music stars are beginning to align.

For starters, there has been significant consolidation in the industry. The major five have become the major three (Universal, Sony BMG and Warner), and the thousands of smaller indie labels have smartly teamed up (Merlin, The Orchard, etc.). With supplier concentration comes market power and appetite for brinkmanship. For example, music execs have made it very clear that the days of free music for Spotify and YouTube may soon be over (watch Lucian Grainge at Code/Media). It requires confidence to take such a stance against the (respectively) No. 1 music-subscription and music-video distributor.

Second, better playlisting will significantly enhance the $10-a-month all-you-can-eat value proposition of subscription services (e.g., Spotify and Rdio). Having someone or something tell you what to listen to in a seamless way happens to be worth a lot of money. This is best exemplified (and quantified) with Pandora One, a $4.99-a-month subscription service that removes the ads. The service counts more than three million paying subscribers; for just a few bucks more ($10 per month), they can get Spotify Premium, which offers all the same plus a vastly larger catalog, any song on-demand (as opposed to opaque radio), unlimited skips, offline access, etc.

Yet, Pandora’s success formula of one-click and listen to something easy and familiar outweighs these many bells and whistles. An even more extreme example is SiriusXM, where people will pay $15+ per month for ~200 channels with better playlisting (and Howard Stern) in the car; meanwhile, they could easily pipe Rdio from their mobile phone into the car speakers.

Simply put, the average music consumer doesn’t know what to listen to. It’s like back in the old days, when we walked into a Virgin Megastore that carried 20,000 CDs but wouldn’t know what to buy. Playlisting, and differentiation in playlisting, is the cornerstone to the survival of a classic FM radio station (with an average of 200 songs on rotation) and even Pandora (a small library of 300,000 songs, of which you may experience 300 to 400 tracks on a weekly basis).

Credit goes to Spotify for realizing this first (through its purchase of The Echo Nest), followed by Google’s acquisition of Songza (even if that was mostly just a talent acquisition) and, most recently, Apple Music’s emphasis on curation and DJs. In a world where record labels tightly control distribution and pricing, superior playlisting and curation is essentially the only way in which music subscription services can differentiate and compete.

Interestingly enough, the two best curators of content and playlists (i.e., 8tracks and Shazam, both companies in which I have a direct involvement) are still operating independently. As a smaller pure-play online radio, armed with a community of DJs creating thousands of mixes, 8tracks is the 800-pound gorilla in playlisting. Better playlisting has allowed the company to quietly grow to millions of users worldwide (mostly landing the dearly coveted 18-to-24-year-old demographic) and turn a profit (without spending a dollar on marketing).

Shazam, meanwhile, has compiled personal playlists for every single person who ever used the service (hundreds of millions of people, including the more casual music fans). If either company were to to add (or be able to afford) an on-demand component to its core offering, I believe that it can trump any playlisting effort undertaken by Google, Apple or Spotify. And that would serve the labels well, since it both augments the value of music subscriptions and decreases the value one finds in piracy.

Third, the music industry is (slowly) moving towards a release-window system, making content exclusively available at different prices depending on time and other parameters (geography, format, etc.). Tidal has made the biggest waves, boasting exclusive content from the likes of Rihanna and Madonna; Vessel signed an exclusive music video deal with Universal Music.

Record label execs have taken a page out of the movie/TV book (explained in detail here) and the practice of windowing has been widely accepted by consumers: Few people complain about the difference between a $10 movie-theater ticket (upon release) and $4 VOD rental (at home, six months later).

Harvesting consumer willingness to pay is a great way for the labels to boost revenue and profitability without shrinking the market. This release strategy works particularly well in the context of music subscription services. I expect record labels to increasingly play off the various providers (Spotify, Apple, Google, etc) against each other, and possibly even use their market clout to force a higher-paying tier (say, $20/month) for subscription plans without any holdouts. It’s worth every bit for the avid music buyer; s/he was spending more than $120 a year on CDs and digital downloads, anyway.

Finally, music subscription services lend themselves much better to monetizing the back catalog. Today, I listen to my old albums on Spotify. Essentially, I am paying again for the same music I already purchased years ago, because many streaming pennies do make up for real dollars. As absurd as it may sound, this is akin to people replacing their vinyl collection with CDs in the ’90s.

In addition, streaming services are also much better at (re)monetizing the back catalog of songs and albums that people would otherwise never have bought (yes, even if only penny by penny again). This revenue is pure profit, since the direct costs are nonexistent: No A&R, virtually no distribution, and no marketing expense.

I personally believe that the music industry has a phenomenal opportunity to launch a cheap $2-to-$3-a-month subscription service consisting of back-catalog music only. This is nothing different from what we observe in the CD world when older (platinum) albums are sold for as little as $3 (just peruse Walmart or Best Buy). A lower-priced subscription plan uniquely captures the casual music fan, and squeezes the last dollar out of the addressable market.

As jazzed up as I may sound, it will be difficult for the music industry to attain 1999 sales figures again. However, profit margins are bound to go up significantly (and likely exceed 20 percent) as digital music and subscription services are gaining adoption and scale. With scale, the technology promise behind digital music becomes real, and it runs top to bottom:

  • The discovery of artists (or traditional A&R) is less of an art, and has been injected a dose of automation (for example, HumanHuman, analyzing social media, etc.).
  • Distribution has cheapened; it’s virtually free compared to manufacturing and shipping physical CDs.
  • Marketing is highly targeted and performance-driven — compare direct artist relationships via Twitter or Shazam to plastering music posters on the street.

Sadly, this also means that fewer people will be needed to operate a record label. Today, Universal Music employs ~7,500 people; Netflix achieves roughly the same amount of sales with ~2,100 people. A normalization of revenue per employee alone would propel recording margins to new heights. Marc Andreessen would proudly tell you that software is finally eating the music world. And with that, our economies ultimately grow and prosper.

Philip Inghelbrecht has had a long-lasting love affair with the music industry ever since he co-founded Shazam in 1999. After Shazam, he ran sports and entertainment partnerships for YouTube, joined TrueCar as its third employee and president, and currently works at Yahoo, following its acquisition of Rockmelt. Originally from Belgium, he lives with his wife and two children in San Francisco. Reach him @inghelbrecht.

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