Tuesday, June 28, 2005

Digital Music Industry

Earlier this week, the Supreme Court ruled that the creators of file sharing software can be held liable for copyrights infringement. This decision will likely set of a chain of events as file sharing services either restrict their offering or accept the possibility of prosecution. Although much of the near term focus will be on these events, longer term the industry dynamics have likely changed to make this decision and file sharing in general irrelevant.

Illegal music sharing gained popularity in the late 1990's as a host of internet software became available. The driving reason music was one of the major applications to gain popularity stems from the fact that most consumers believed that to obtain music through legal channels was too expensive. The music industry regularly charged more than $15 for a CD where the customer only really want a couple of songs. As Courtney Love points out, the majority of this is captured by recording companies and various middle men, with relatively little going to the artists.

Looking at the division of functions in this arrangement, recording companies provide financing, marketing (through direct promotion and relationships with radio stations), and distribution (through relationships with record stores). The artist just creates the product (with the help of producers). The digital technology changes this dynamic in two ways: 1. Distribution costs fall almost to zero; and 2. Recording costs fall and will continue to fall as technology advances. In short the product the value that record companies bring to the table is being replaced by technological advance.

The one piece of the equation that is not directly effected is marketing; consumers still have to learn about a new song or artist before they will want to make a purchase. The question is how will these new marketing channels operate? One possibility is that consumers will develop trust in opinion leaders directly through the use of the internet, possibly in conjunction with online music distributors.

Assuming alternate marketing channels can be established, artist will have much less incentive to pursue contracts with traditional record companies. This will broaden the playing field and allow more opportunity for non-superstar artists. Currently the vast majority of music sold is created by very small subset of artists. With the wide variety of taste in music in this country and the world, there is no reason to believe that all music listeners will continue to patronize this small group of people. The likely result will be an overall increase in revenue for the music industry, with more of the value finding its way to a much larger group of artists. Far from destroying the incentive to produce new music the internet will greatly expand the revenue potential for the industry and choice for consumers.

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