Can Legacy Industries Survive? The Case of Music
European Straits | Work in Progress
I’ve been pulling on a thread recently with the music industry, from my essay on Understanding Capitalism to the 11 Notes on Warner Music earlier this week. An intermediate step was expanding on the idea of the ‘grip’ that every company needs to have over its industry’s value chain if it wants to excel at doing capitalism.
That’s what’s interesting with record companies within the specific case of the music industry: nobody thought they would survive the shift to the Entrepreneurial Age, yet they have—because they never let go of their ‘grip’, eventually using it to successfully reposition and flourish once again. Below is the detailed story of how it happened, as I see it 👇
[July 3, 2020, 7:30am] This “work in progress” essay is just that, a work in progress that is yet to be completed. (It should be within the next few hours, sometime around midday.)
1/ Let’s start with a short depiction of the music industry’s value chain, from top to bottom:
At the top, you need the music to be written, usually through the combined efforts of a composer and a lyricist (ok, sometimes the lyrics are optional 😅). It’s rare for composers and lyricists to manage the proceeds from their music’s direct recordings: usually they rely on a copyright collective, which will track down people who make use of their music, enforce payments, and then take a cut before most of it is paid to the original artist(s).
Before it can be turned into a record, however, that music needs to be published: that’s what music publishers do. They make the music available in many forms (including sheet music, which is their traditional core business) and manage the related rights. The business of a publisher is to make sure that a given song generates money. For instance, they will pitch it to artists to have them record a cover of it, or to film directors to have them include it in a movie soundtrack.
When recording a song (or an entire album) is finally agreed upon, the producer arrives. That person will bring forward the money to pay for recording sessions, select the musicians if necessary, as well as the sound engineer and others (an arranger, etc.). Note that the artist recording the song might have also written it, but those are two very different functions generating two separate streams of income. What comes out of the recording sessions are the master tapes. They’re owned by the producer. Related royalties are split between the interpreter, the publisher, the authors (as represented by a collective), and the producer themselves.
The ‘artist’ is the main interpreter in those recording sessions, and typically the one whose name will appear on the cover of the album. All their dealings with the producer are usually handled through an intermediary: the manager. This is the person handling the artist’s interests on a day-to-day basis, catering to their needs, managing the entourage, etc. But the manager, unlike all the others, doesn’t get a direct cut of the money that comes from selling recorded music. They’re paid by the artist and act solely on their behalf.
Once the producer has a master tape ready for commercial use, they will grant a license to the record label that has the artist under contract. That’s the point—at least it was in the past—where the capitalist game begins. Once it owns the rights to commercialize a recorded song, the label operates three different businesses: printing many copies of the album (as many as it expects to sell); marketing the album, notably by securing radio airplay; and making sure that the album is available wherever consumers want to buy it, which involves lots of salespeople criss-crossing the country to make sure the album is visible in every record store.
Down the stream, you’ll find players that directly interact with consumers, music fans, and journalists: record dealers, tour promoters, road managers, press officers, etc. Labels tend to think it’s their job to handle all those people, especially by making sure that the artists are getting paid and no money is embezzled by the tour promoter or the record dealer. And what happens when record executives do all those things well (like Lyor Cohen, as described in my Warner Music essay)? They inspire trust, and they can take a larger cut of that money.
As a reminder, here’s the extract from Fred Goodman’s Fortune’s Fool (2014):
Lyor became Run-DMC’s road manager on the eve of the group’s first overseas trip when a friend of the rappers handling those duties went AWOL. Cohen got the passports together, ferried them to their show in London, and—miracle of miracles—got them paid. “He’ll get it done,” says Adler. “He assumes responsibility and executes. He will get it done.” Adds Santoro: “Lyor didn’t know how to be a road manager. But he did know how to go in there like an Israeli tank commander and say, ‘I’m here to get paid.’”.
2/ What’s a record company? It’s typically a conglomerate bringing together various labels:
The reason why it makes sense for record labels to come together and form a conglomerate is so they can pool certain things that come with high fixed costs, notably the ability to market an album on radio and TV (it takes some influence and a very large rolodex), and printing and distributing the albums so that they’re available everywhere (which takes a huge salesforce as well as quite a logistics infrastructure).
Indeed, the high fixed costs explain why the sector of record labels is so concentrated. Quite simply, it makes good financial sense for independent labels to merge with one another. And once it’s done, it’s very difficult for any new entrant to compete with those large conglomerates. Without their level of firepower, why would any artist agree to a contract with you?
So it’s precisely at that level that capitalism is easily done in the music industry. Record labels are the link in this long and complex value chain where it’s easier to generate increasing returns to scale. That explains the emergence of the so-called ‘major’ record conglomerates. This is where the bigger surplus could be generated, and also the position from which a ‘grip’ could be imposed on the rest of the value chain, upstream and downstream.
3/ Let’s discuss that particular ‘grip’ in more detail, starting up the stream. Why was it so easy, historically, for record labels to have the upper hand on artists? Three reasons, mostly:
Artists are simply not very good at handling money. Either you’re good at creating great music, or you’re good at getting paid, but you’re very rarely both. This is why artists rely on their managers for such things, and even then negotiating with a record label is tough because they’ll lure you into signing that contract with a very large sum of money known as an advance—which is probably all you’ll earn for a long period of time, until the revenue from selling your records becomes large enough to recoup that initial payment (according to the label). Check out the Miles Davis quote in my Warner Music essay again (Note #2).
Then there are those weird accounting practices described by Steve Albini in this article published 6 years ago:“The costs of making a record wasn’t borne by the record label, except initially. Those costs were recouped or taken out of the income the band might otherwise run as royalties. The same was true of all those promo copies, posters, radio pluggers and payola men, producers, publicists, tour support, 8x10 glossies, shipping, freight – basically anything that could be associated with a specific band or record was ultimately paid for by the band, not by the record label.” You read that right: labels didn’t pay for much. They just advanced the money, and then recovered it with (very high) interest... but it was very rare for artists to realize that! The initial advance kind of put them to sleep (= let them focus on creating music).
And then there’s the simple dynamics of dealing with the most powerful link in the industry value chain—that which excels at doing capitalism! Again, record labels were positioned at exactly the right level to impose their ‘grip’ on the rest of the value chain. As they consolidated into recording conglomerates, they became even more powerful. At some point (sometime during the 1970s), an ambitious artist had no choice but to submit to the demands of any record executive working for one of the major recording companies. That was the price to pay for having a shot at hearing your songs played on the radio and your records available in every store in the country. (This is very similar to an author’s relationship with a publishing house—which, like a traditional record label, is essentially a salesforce combined with a giant logistics platform.)
4/ The rise of hip hop proved to be a major challenge to the major labels’ ‘grip’ over artists. What happened is the following:
As I mentioned in the essay about Warner Music, hip hop saved the music industry from itself. Until the 1970s, the industry was fragmented enough so that there was room for competition, creativity, authenticity, and risk-taking. But from the end of the 1970s onward, the major recording companies became so large and omnipotent that they imposed too much on artists from a creative perspective. They thought they were the ones who best knew how to engineer music to maximize the public’s response, and ultimately, they failed. Early in the 1980s, most recorded music had become so soulless that there was a widespread fear of younger consumers abandoning buying records altogether, turning instead to video games and bringing doom to the entire industry.
The industry was salvaged by doubling down on mass production. I love this anecdote about Bruce Swedien, the legendary sound engineer behind Michael Jackson’s most famous albums, starting with Thriller and Bad. In his book Make Mine Music, Swedien recalls producer Quincy Jones (also a legend) telling his team, as they were about to start recording Thriller, that they were here to save the music industry from its demise. And they did! Overall, one factor was the upheaval in production: Thriller is a testament to sheer perfectionism from absolutely every perspective. Another factor was the launch of MTV and a new breed of creativity in producing musical clips (the Thriller clip itself was the first of a kind: a song with a scripted story with characters, intrigue and all); the third factor was replacing vinyl records with CDs, making consumers pay a second time. Together, these three things bought the industry ten more prosperous years.
5/ The feeling of crisis started to mount again at the end of the 1980s. Not only was the industry starting to lose touch with the public again (it was the period of Dangerous rather than Thriller, with Quincy Jones having left the stage):
Overengineering music simply took too long in a period when the public’s taste was changing faster and faster. In an interview in 2018 about my book Hedge, journalist Sarah J. Robbins and I discussed our shared passion for the all-but-forgotten heavy metal band T-Ride: “[Nicolas] lights up when he talks about music and is quick to make links to entrepreneurship: flexibility, creativity, timing. Like, for instance, the ultimate downfall of a little-known California heavy metal band called T-Ride (which he discovered as a teenager in the mid-90s, with a bootleg cassette tape) was the fact that they labored for far too long on their debut—and well past 1992—at which point grunge had rendered them wholly irrelevant.”
And then there was hip hop, which initially was much more problematic for the industry. Grunge was a problem for metal bands with bad timing, like T-Ride, but not for the record labels, who had the likes of Nirvana under contract anyway. Hip hop artists, on the other hand, were an entirely different matter. They were a tough match for traditional record labels for at least two reasons. First, record executives had neglected hip hop for so long that the latter had good reasons to refuse to submit to the harsh conditions traditionally imposed on upcoming artists by the industry. (The neglect was both because hip hop hardly sounded like music to record executives at the time, and, yes, because those artists were Black and with an attitude ✊🏿). Second, as I explained on Wednesday, hip hop artists already had a fan base and a revenue stream, without any support from the labels, so why would they submit to those terrible contracts and be cheated like all the others?
It took a whole decade to orchestrate the convergence between the legacy industry and this new breed of artists who had very different expectations when it came to record labels. Ultimately, recording companies managed to get the upper hand again, notwithstanding controversies such as the one around Body Count’s “Cop Killer”. But it took a lot of diplomacy by brilliant middlemen such as Rick Rubin, Russell Simmons, Jimmy Iovine, and the other builders of the early hip hop labels. And it was a battle with winners and losers. Warner Music lost the battle for reasons that I explained before. Universal, on the other hand, won that battle and thus became the leading record conglomerate on the market—a position they retain to this day.
But just as everyone was thinking the dust had finally settled, along came another foe: the Internet. Overnight, consumers decided they wouldn’t buy records anymore. They started to download music online, without paying. Nowadays, we all know that software is eating the world. Well, that’s why the music industry is so interesting: software ate the music industry first! And it was brutal.
6/ In short, the Internet made it possible for anyone to copy any song for free and store it on their personal device for future listening. This was made clear by startups such as Napster (which was famously sued by right holders). And it didn’t take long for everyone to realize that the traditional way of consuming music was essentially a ripoff. That breach of trust destroyed the foundations of the entire industry.
The main problem was asynchronicity. Music had always been available for free, played over the radio or broadcast on MTV, but only in a synchronous manner: you had to be lucky enough to be in front of your screen or radio at the right time. (Even with cassettes, recording the song from the radio wasn’t that easy. You had to be ready to hit the ‘record’ button, and even then you’d miss the song’s intro.) If you really wanted the music for yourself, able to listen to it whenever you wanted with a good audio quality, you really had to buy that rigid, overpriced bundle that was the album (a vinyl, and then later a CD). Recording companies knew that, and they were extremely good at making you pay a very high price.
When everyone realized that you could listen to music whenever you wanted, without paying for the song, let alone the entire album, the entire edifice collapsed. And record executives were even less prepared to deal with it because they had had such a wild ride until then. Think about it: record labels spent 30 years making lots and lots of money selling vinyl records; then they spent 20 years making EVEN MORE money selling CDs, because many people were buying the same records a second time; and then came hip hop—and with it, the creation of a new, fast-growing, extremely lucrative segment of the market. Alas, CDs, and then hip hop made record executives so wealthy and successful in the 1990s that they couldn’t even fathom the idea that their beloved industry was ripe for disruption.
7/ The other thing the Internet changed forever was the scale of the market. I remember once having an in-depth conversation with an industry veteran. He told me something to the tune of:
We’re all talking about ‘the music industry’. The truth is that there isn’t such a thing as a global industry. That’s because the industry only exists in five (developed) countries: the US, Britain, Germany, France, and Japan. As for the rest of the world, either the domestic market size is minuscule (as in Denmark or Canada, for instance), or institutions are so weak that we can’t enforce copyright and get that money from people listening to our music.
You read that right: The prosperity of the music industry has always been dependent on the ability to enforce rules related to intellectual property. In most regions of the world (such as Latin America, Africa, and of course Asia), albums were sold, yes, but the money didn’t flow back up the stream. Most copies sold were illegal, and the counterfeiters kept all the money for themselves.
The reason why it didn’t make the entire industry collapse is that each market was independent. Rights management, marketing, distribution: all were handled at the national level, without any interference from other markets. I’m sure those who travelled could get their hand on a cheap, illegal copy of Thriller in Asia, but they were the minority. Everyone else on those five markets was trapped within their national borders and had the high price for listening.
The Internet, obviously, put an end to that. To this day, iTunes is still divided into national stores, which was clearly imposed by the labels (they have a hard time thinking at the global level). But if you’re looking to download music illegally, you’re instantly connected to all your fellow pirates on the planet. There is no such thing as national borders anymore when it comes to enforcing copyright laws. And no amount of effort by either the industry (which once decided to sue individual consumers) or national governments (which, as was the case in France in 2007-2008, tried to help with stricter tracking down of pirates) could slow that trend: consumers had gotten used to the convenience of accessing music online, and they weren’t going to go back.
About that, see my 2016 article The Five Stages of Denial, particularly stage 3—that is, when the industry tries to enroll officials to help them counter tech-driven new entrants.
8/ One major recording company did better than the others: Bertelsmann Music Group (BMG). There was once a time when there were five major recording companies: Universal Music Group (a US-based subsidiary of the French conglomerate Vivendi), Sony Music (a US-based subsidiary of the eponymous Japanese conglomerate), Warner Music Group (once a subsidiary of the American conglomerate Time Warner, now a standalone company), EMI (a British company), and BMG (a subsidiary of the German conglomerate Bertelsmann). But then, in the face of the Internet radically changing the equation, the industry entered a phase of rapid consolidation: Sony acquired BMG in 2004 and Universal acquired most of EMI in 2012, bringing the number of major label conglomerates down to three.
What I find particularly interesting is what happened with Bertelsmann when they sold BMG to Sony (in 2004). It’s a story I tell all the time when I give a talk or a course on corporate strategy—a masterful playbook to be followed by any incumbent that doesn’t want to deal with the radical upheaval of their value chain in the context of software eating the world:
What I think happened is that the top people at Bertelsmann realized they didn’t understand anything about what was happening down the stream in this new world—one of consumers listening to music on the Internet, with almost no other option other than illegally downloading songs for free (iTunes was around but still tiny, and every other option, including those brought forward by the labels themselves, were ridiculously user-unfriendly). And so Bertelsmann decided to divest its record labels altogether. Maybe one day people would be ready to pay for music again, but it would certainly not be by buying records. It was better to get out of that market rather than trying to reposition an entire organization within an industry that was unravelling so quickly!
Yet they also realized there was still money to be made in the music industry—just not in selling records. And so they reinvested the proceeds of the Sony sale into buying catalogues—again, not for selling records, but rather to hold music publishing rights (up the stream) and master tapes (a little bit further down the stream). And that makes a big difference: if you own publishing rights and the master tape for a given song, you can make money no matter what is happening down the stream—whether it’s selling records (the old way), downloading MP3s (iTunes), shaking down social media platforms (YouTube, Facebook, TikTok), streaming music (Spotify), the song being included in a movie or a video game, or any other business model discovered by some enterprising tech entrepreneur.
The result was the rebuilding of BMG from the ground up—a brand new company called BMG Rights Management, which initially was a joint venture between Bertelsmann and KKR (the former bought out the latter a few years later). Apart from buying catalogues, they focused on deploying a whole infrastructure for managing the rights (setting a price, tracking usage, collecting payments), which made the new BMG both neutral in terms of how money was made down the stream (they don’t care if it’s downloaded or streamed: they’re still getting paid) and extremely responsive to how the market evolves (effectively it’s a platform, in the tech sense of the word). In the end, radically repositioning up the stream was such a success that they decided to drop the “Rights Management” part and to become just BMG again. In this new world eaten by software, the music business had become almost entirely about managing rights—and much less about marketing artists for radio or TV, and not at all about selling records.
9/ The prejudices in the industry explain why it was easier to sell it all and then rebuild, as Bertelsmann did, rather than reposition the existing organization. Indeed, what I learned in my years working with industry veterans is that there was a deeply ingrained rivalry between publishers, who are essentially quiet and unassuming lawyers and right managers, and the flamboyant (and occasionally frightening) record executives (like Lyor Cohen).
For a long time, the latter had the upper hand. They were the ones hanging out with the artists, twisting the arms of radio executives, guaranteeing the album’s exposure in record stores, collecting the money. Since selling albums represented the main source of revenue for artists, record labels really had that ‘grip’ and overshadowed the tedious work of music publishers.
Emmanuel de Buretel, another Virgin Records alumnus along with Patrick Zelnik (whom I mentioned in 11 Notes on Warner Music), once told me that he had an early passion for publishing because it made it possible to diversify revenue streams for artists, but that it had always been impossible to educate his colleague Zelnik on the matter. For people like Patrick, producing and selling albums was all that mattered. It made all the more sense because the record business was (seemingly) so entrepreneurial: you had to market the album, you had to sell it. Publishers, on the other hand, were those boring people sitting in their dusty office, counting beans and essentially relying on other people’s efforts. But the BMG business case exemplifies what really happened in the industry: overnight, the Internet transferred all the power and most of the money from record sellers to right managers.
10/ Interestingly, the first people who saw this revolution starting to happen were the artists themselves. When the revenue they derived from selling albums initially collapsed, most artists had to double down on live performances to maintain their lifestyles. (It’s the reason why you’ve seen so many ‘comeback’ tours by old, tired music stars over the past 15 years—it’s not because they like being on the road, which is mostly awful, but because they REALLY need the money.)
Record labels, realizing that money was flowing in from a source that wasn’t about selling albums, tried to reposition by negotiating those 360 deals I mentioned in the Warner essay. But artists were starting to see the painting on the wall: record executives were out of their depth and couldn’t cope with the new pace of the business. Some artists were already seeing money coming in thanks to the publisher’s efforts at bringing revenue in from places other than record stores. Others, especially the biggest stars (people like Beyoncé, Kanye West, and Taylor Swift), were busy building a direct relationship with their audience, largely via the Internet, and diversifying their portfolio of activities (fashion brands, stores, etc.).
Today, everything is more or less stabilized, with revenue having reached the levels seen before the Internet disrupted the whole industry—but with a few differences:
Publishers and right managers have the upper hand now, not those specialized in selling records (which nobody buys anymore anyway).
Artists have more leverage because they can connect with the audience. The younger ones burst forward thanks to the Internet anyway—not because they were scouted by some A&R person.
As in every industry shifting to the Entrepreneurial Age, the links down the stream are much more concentrated, even though the winner (Spotify) is still struggling to make money in music.
Ultimately, what saved the music industry? I’d say three things
The value chain collapsed instead of being merely deformed. As usually happens in such cases, value was redistributed both up (artists, publishers) and down the stream (Apple, Spotify), at the expense of the middle (record labels). But mostly value was essentially disappearing altogether due to online piracy. It was a wake-up-call that made everyone realize they needed to get back to work (and that governments wouldn’t save them).
Key takeaway: It helps to be hit on the head with a sledgehammer and to hear everyone (consumers, artists, governments) screaming at you because you’re screwing up.
Bertelsmann showed the way. Warner Music’s Edgar Bronfman Jr. and Lyor Cohen had the intent of changing the industry, but they fell short because they were too early considering that theirs was an incremental approach. Bertelsmann was even earlier (they sold the old BMG in 2004), but they opted for a radical approach (divesting, then rebuilding), which soon revealed the new shape of the industry’s value chain and made it possible for later followers to succeed with an incremental approach.
Key takeaway: You can succeed with an incremental approach, but only if you’re a follower. An industry needs a leader to show the way, and the leader has to act in a radical way.
The industry never let go of its assets—that is, the songs, the master tapes, and the many other rights at every level of the value chain (check out the list again 👆). People were struggling to understand how exactly you could make money with those, but nobody ever doubted the fact that there was value—and the industry still had the power to enforce those rights with the entities such as Spotify and Google (YouTube) who were willing to play by the rules. Those assets are the buoy that helped the industry navigate the storm.
Key takeaway: It helped that the key assets were not only owned by players up the stream (in this case, authors and artists) but also by those dominating in the middle (record labels). It bought them the time they needed to figure out the situation and ultimately reposition.
I personally find that there are interesting lessons to be drawn for Europe, where legacy players in old industries are still so strong and influential. Maybe their repositioning, more than startups bursting from the outside, is the key to a successful shift to the Entrepreneurial Age?
What do you think? Are there lessons to be learned in other industries? Is there a playbook for shifting an entire industry when it’s not exactly a new entrant down the stream that’s imposing the pace and the direction, but rather a key player in the middle, like Bertelsmann here?
From Normandy, France 🇫🇷