Record Companies Starting to Shun iTunes

by: Markham Lee August 29, 2008 | about stocks: AAPL / WMG    
Markham Lee

Markham Lee

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The following relates to my previous article on how digital music is drastically changing the economics of the music business in such a way that it's hurting profitably:

(From the WSJ): "...a growing number of record companies are trying to steer clear of Apple Inc.'s (AAPL) behemoth music store, because they say selling single songs on iTunes in some cases is crimping overall music sales.

Kid Rock's "Rock 'n Roll Jesus" album was kept off iTunes' virtual shelves. It has nonetheless sold 1.7 million copies in the U.S. since its release last year -- a sizable number for the depressed music industry. Sales of the album have increased in 19 of the past 22 weeks, according to Nielsen SoundScan, vaulting it to No. 3 on the Billboard 200 sales chart. After witnessing the album's performance, his label, Warner Music Group Corp.'s (WMG) Atlantic Records, last week yanked an album by R&B singer Estelle from the iTunes Store, four months after it went on sale there -- and the same week that one of its songs entered the top-10-selling tracks on Apple's download service...

...Label executives, managers and artists chafe against the iTunes policy that prevents them from selling an album only. ITunes, with few exceptions, requires that songs be made available separately. Consumers strongly prefer that, though Apple also typically offers a special price for buyers who purchase all the songs on an album...

...The launch of Apple's iTunes service in 2003 was hailed as a potential savior for the industry: It allows consumers an easy, legal way to buy music online, while still cutting record companies in on a portion of the sales. But iTunes' rapid growth has turned it into a Goliath, music executives complain. It often asks for exclusive sales rights for songs in exchange for prominent placement on its home page. (full article here)

The problem here is that Album sales generate significantly more revenue than a digital download (the $10 wholesale cost of a CD vs. $0.70 per download), in the case of Katy Perry she (and her record company) made more from the sale of the CD ($2.8 Million) then from the digital download ($1.54 Million). Even when you factor in manufacturing costs CD sales are still way more profitable, because manufacturing costs are in the range of $0.30-$0.50/CD if not lower. Say what you will about record companies, their prices, attacks on downloaders, etc, but it's not a favorable model for them (or the artist) when the sale of a CD that is barely 1/2 way to gold generates more revenue than 2.2 million downloads.

While the commonly expressed risk for artists that shun iTunes is that it will push consumers to just download the song illegally, rip their friend's CD, etc, I wonder if the risk is worth it if it results in more CD sales/higher profit transactions. For the answer to that question take a look at the analysis below:

*The CD sale % is the % of digital downloads that would be translated to CD sales if the artist wasn't on iTunes.

click to enlarge

Based on the above it's actually worth it if 85% of your former "iTunes single track" download customers elect to download your music illegally/not buy it all, because if the remaining 15% buy your CD you wind up doubling your revenue. When the numbers shake out like the above you really can't blame the record companies for deciding to shun iTunes, or at the very least being wary of working with them.

Moving forward the question offered is: what kind of model can be put in place that will allow the record companies to continue to survive, yet offer the digital music the consumer wants at the prices they're used to paying? After all if the iTunes model is hurting the record company's chances of survival, it's also hurting the production of the product (pop music) that people want to purchase/listen to. A quick look at the top ten songs on iTunes reveals that most of the songs are "pop songs" that benefit greatly from the record company marketing machine, so what happens to those artists (and the music most people like) when that machine goes away or has far fewer dollars to work with?

You can read more on the subject here.

Source

The WSJ:"More Artists Steer Clear of iTunes" -- Ethan Smith and Nick Wingfield, August 28, 2008

Disclosure: At the time of publishing the author didn't own a position in any of the companies mentioned in this article.

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This article has 23 comments:

  •  
    Aug 29 05:12 AM
    the CD model is done so this article is moot.. the record companies need to get with the program... why buy a CD when the owner is just going to turn around and copy it to their computer to use on their ipod or other MP3 anyway.. the CD is dead... get with the program
    Reply | Link to Comment
  •  
    Aug 29 07:07 AM
    the author mentions two successful albums but what about the dozens and dozens that were not as successful...I would not buy an album when there is usually just a couple of song I might like.
    Reply | Link to Comment
  •  
    Aug 29 07:13 AM
    Yes. The CD model is done. The record companies will be forced to adjust to this new way of doing business. If not, labels will cease to exist. You can no longer expect people to pay for a bottle of wine but force them to buy 11 other cheaper wines along with it. The labels should focus on providing customers with better products (ie digital booklets, better music) if sales are down. Raising rates (which, in effect is what this is) to prevent sales is something any Finance 101 student will tell you is inane.
    Reply | Link to Comment
  •  
    Aug 29 07:20 AM
    The labels "chafe" against the idea that I will buy what I want instead of the package they mandate? I hope they get chafed right down to the economic bone. It's called "giving the customers what they want".

    Second, if it weren't available on iTunes, I wouldn't get it at all. Think of the huge numbers of "I want it now" consumers, and this trend is only going to increase. The"I'd buy it on CD" percentage of my iTunes purchases is about 2%.

    The real problem for the labels is that this 'piecemeal' approach is screwing up their accounting. Instead of buying albums from 10 star performers, I'm buying singles from a hundred.

    And finally, the environmental cost of those CDs should be considered. Not that computers are free of environmental sin, but every download I buy is one less bundle of CD, case, plastic, paper, and sales slip. It's a fraction of a reduced trip to the CD shop, complete with burning gasoline, wasted time, and parking fees. And as an earlier poster noted, I'm just going to rip the thing in iTunes anyway.

    Chafe away, labels. You deserve it.
    Reply | Link to Comment
  •  
    Aug 29 08:10 AM
    Oftentimes I will rip a CD then delete the tracks I don't want.

    Artists arguing their work is a magnum opus only to be listened to as an album are shills for the music labels. A collection of individualist songs are just that.

    I want to buy one painting not a collection, one book not a trilogy, one film not a series...

    Money greed, money....
    Reply | Link to Comment
  •  
    Aug 29 08:14 AM
    it's time for the artists to abandon the record companies..
    Reply | Link to Comment
  •  
    Aug 29 09:08 AM
    record companies jam this "POP" crud down peoples throats and say its what every body likes. lock me in an elevator and push all the buttons. the I-tunes music store has turned the music companies file cabinets into gold mines they are selling muddy waters, dr professor longhair,pinetop perkins,bill Kirtchen, Arlin Roth, Old and in the way, Great specled bird, procul harum,Dr john,les mcann eddie harris,dexter gordon ,thelonios monk, clifton chineer, buddy guy, duke robalard, rl burnside,need i go on . . . find any of these artists in a record store they are all selling on i-tunes
    Reply | Link to Comment
  •  
    Aug 29 09:51 AM
    The real issue is that compared to the CD model selling music on iTunes is mathematically analogous to Toyota having to sell Camrys for $2.5k instead of $25k.

    What company can survive when the economics change so drastically, especially when your production costs aren't getting cheaper by a similar order of magnitude?

    It's easy to talk about a "new model" but quite frankly I haven't seen anyone suggest one that enables the record companies to survive. The CD model may be dead, but digital music is killing off the record companies. If selling 250k CDs generates more profits than 2.2 million downloads and the market is heading towards the latter, the record companies are going to die off.

    At this point is pretty simple math yes iTunes favors the customer and that's great, but at some point you'll have fewer record companies (if any), which means fewer producers of the music we all love.

    I prefer Jazz and Classical, most people my age prefer Hip-Hop and Pop music, but we all love the music we listen to.

    Record companies die off, we all wind up with fewer choices - because the indie channel won't be able to generate as much exposure for artists nor will it be able to market a pop artist (a musical commodity of sorts).

    It's great to put on our "music snob" hats (I've been guilty of this too) and say that no one should listen to pop music, and all artists should work it like Ani Difranco and tour a lot, put out their own CDs, etc, etc....

    but.......

    That's a myopic perspective, yes I happen to love Ani's music, but most music buyers aren't interested nor will they ever be. The top songs on iTunes are all pop music and the people who listen to it ENJOY IT, and the money generated by those pop stars has helped subsidize artists like Jeff Buckley, Tori Amos, the big labels Jazz and Classical labels, etc.

    If the pop stars go, we lose a lot of the stars we music snobs like too.

    I think there are a lot of unforseen consequences that people aren't thinking about.

    For me this argument isn't about pop vs. jazz, or greed or the death of the CD model, it's about the fact that no company can survive if the price of their product drops by 90%, when their production costs are the same.


    -M
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  •  
    Aug 29 10:47 AM
    The basic cost assumptions of what it costs to "manufacture"... a CD are ridiculous and naive in the model presented in this article. Anytime you are handling a manufactured good, your costs are considerably higher. You have packaging costs, warehousing costs, inventory systems, shipping, stocking, returned product from retailers when they don't sell, defective product, instore promotion costs, costs for all the people associated with these activities, etc. etc. etc. Also, the cost to record albums has dropped dramatically in that digital equipment has enabled the recording and mixing of albums to be done much more efficiently. This is an industry that has historically been fat in their expenses, and passed down very little to their artists except at the very top tier (maybe 2 - 5% of the artists in their mix). The industry is changing dramatically and they need to adjust. Having said that, it would be in Apple's best interest, and that of the artist and industry, to sell select albums only as albums, but which ones? Who is going to play Solomon? If you try to sell them all as albums it would be a huge step backwards, and a return to piracy. Here's a concept for you music industry, have each of your acts write and produce albums on which ALL the songs are great and which consumers will therefore want to buy!

    Lastly, the biggest danger to the music industry is not single track sales, but the lack of music programs in our schools that help develop top talent and keep great artists coming. Artists that can actually carry a tune and play instruments rather than sample other peoples work! In other words, a creative renaissance!
    Reply | Link to Comment
  •  
    Aug 29 11:03 AM
    I don't buy CDs anymore at all, unless I can find them used.
    Reply | Link to Comment
  •  
    Aug 29 12:07 PM
    My cost assumptions were a rough estimate from when I worked as an audio engineer, like I said an independent artist can get a run of 1,000 CDs for about $0.80/CD, so with the scale the record companies work with...even when you add in the things you mentioned, their costs are relatively small compared to the cost of the CD.

    Digital Equipment Helps a lot to be sure to the point where it reduces costs so that selling on iTunes isn't a problem? Doubtful.

    Can you record an album with a cheap digital set-up that is no more expensive than the average home studio?

    Yes.

    But the top end digital equipment, converters, mixers, microphone pre-amps, monitors, microphones, etc, that you'll find in a top studio are still vary pricey. So for most big artists I doubt the price has come down that much.

    Especially many people still like to record in Analog or some form of hybrid analog/digital set-up.

    -M
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  •  
    Aug 29 12:15 PM
    Two things. One, if singles downloads are not as financially attractive as CD sales, why is only iTunes being mentioned? Isn't the whole digital download market threatened, like Amazon as well?

    Two, if we use your example of say, 330k CDs sold, to presumably 330k individuals, compared to say 2.2M downloads. Of course, that would not be to 2.2M individuals, but still a substantially larger number of individuals than the number who bought CDs, aren't you losing out exposure to a much wider audience? Isn't that what marketing is for? So, it may not be immediately lucrative to the artist to sell downloads vs CDs, but it may lay the groundwork for a much larger audience, and better attendance at shows.
    Reply | Link to Comment
  •  
    Aug 29 01:15 PM
    Markham, I'm not sure how you are getting to your conclusion, but I can tell you that it's about the survival of the fittest. If the music labels, cannot adapt, then they will surely be extinct.

    There is absolutely no way, that people are going to buy more albums simply because iTunes if forced to sell only albums. That will only take us back to full piracy.

    As FreeRange mentions, this article cannot be trusted as it is very obvious that the numbers are incorrect. There is no way that the cost of manufacturing a CD is lower than placing the song on Apples servers. I place the cost of a CD at no less than $.50 for the CD ONLY, no inserts, which ALL CDs have. The cost of a complete CD delivered to the store has to be in $1.50 each, and that leave other expenses that FreeRange mentions. Just look it up on line if you wish.

    Can the author prove that even 7% of all albums that cannot be purchased as individual songs on iTunes will actually be purchased as an entire album sale on itunes or at a store?

    Perhaps, the labels didn't learn their lesson the first time, I suggest they pull all the albums from iTunes and see where the cookie crumbles this time.
    Reply | Link to Comment
  •  
    Aug 29 02:17 PM
    I'll believe the labels when they won't let the radio stations play individual songs.
    Reply | Link to Comment
  •  
    Aug 29 02:33 PM
    <The real issue is that compared to the CD model selling music on iTunes is mathematically analogous to Toyota having to sell Camrys for $2.5k instead of $25k. >

    Markham, I think what you're missing is that a full album from itunes runs around $10, which is equivalent to a the full album if you bought it in a CD format.

    iTunes broke new ground when it allowed users to buy only one SONG from the album, so instead of paying $10 for a CD, now users pay $1 for each of the songs they like. The car analogy makes no sense, since Toyota can't sell you 1/10th of a Camry, while Sony music can certainly sell you 1/10th of an album (i.e. 1 song).

    The real question here is: Do the record companies make more money by forcing some people to buy 9 songs they don't want along with the 1 song they do, even if it means that a large percentage of their customers will now go download that song illegally. They obviously think that they will, or they wouldn't be pushing this model.

    However, iTunes has paved the way for single-song downloads, and any ONLINE music shop that makes you buy an entire album will be at a disadvantage as a result. Sure, Target and Walmart may still only sell full albums, but have you looked at what has happened to their market share of retail music sales since iTunes came out? People WANT digital downloads, and now they WANT the flexibility to get them per song and not buy 9 crappy songs just to get the one they want.

    I think the record companies are being very short-sighted here. All they are doing is legitimizing (in many peoples' minds, mine included) the illegal downloading of music. Instead, they should be trying to support legitimate online music as much as they possibly can, not undermining it. Either that, or make Katy Perry record 10 goods songs rather than 1 song people like and a whole bunch of garbage.
    Reply | Link to Comment
  •  
    Aug 29 02:50 PM
    CDs are dead. The vinyl album will outlive them. When the record companies die a new model will take over just as the auto replaced the buggy. I wonder if they raised the price on buggy whips just before there were no more buggies?
    Reply | Link to Comment
  •  
    Aug 29 02:58 PM
    Quick thoughts:

    1) If the record companies die then we won't have any music to buy.

    2) I've personally supervised the production of CDs in runs of less than 1,000 for small artists, where the cost was under $1/CD often in the $0.80 range.

    If you're running off millions of CDs, have your own facilities, etc, the cost is undoubtedly lower.

    3) The analysis is a hypothetical to be sure, but it does illustrate why many artists and the record companies prefer to sell albums.

    It would be different if iTunes sold more albums than single songs or a given artists, as the $7/sale the record company received would be close to a CD sale and would be "good enough" to keep everyone happy.

    4) I don't disagree with the fact that many people prefer to buy singles and it does favor the consumer, just noting that eventually it could kill the producer of the content you're paying for.

    5) The Camry example is meant to indicate order of magnitude i.e. selling 200k CDs generates more $ than 2.2 million digital downloads of single track.

    Anyway, we all agree a new model is needed, we all agree that selling albums is more profitable, we agree that consumers prefer track downloads.

    BUT

    What kind of model allows the record companies to survive and make consumers happy at the same time? Right now both goals are at odds with each other.

    And if the record companies die?

    There won't be much of anything new to download

    I suppose I should probably point that I've never bought a digital download in my life, I use rhapsody to listen to music at work or occasionally drop a song on my Mp3 player, but to buy a digital track?

    Never.

    I always buy CDs prefer I like the sound quality better, but I suppose that's a topic for another discussion.


    As always thanks for reading.


    -Markham
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  •  
    Aug 29 09:06 PM
    If it's not on iTunes I don't buy it.
    Reply | Link to Comment
  •  
    Aug 29 09:09 PM
    Almost all of my digital collection has been ripped from thousands of CDs that I've collected during the past 20 years. But I haven't been buying new CDs. Lately, most of what comes off of CD has been from the purchase of used CDs. I haven't ripped everything from them, because (oh, focus on the topic) a majority of albums as a whole suck. Digitally, speaking, about 12% of my 7,500 track collection comes from iTunes Store, and about half of that is protected AAC--the store just that convenient. But none of that has stopped me from collecting purchased Discipline Global Mobile downloads, an independent web site, or Nine Inch Nails, or Burning Shed, where my Roger Eno fix comes from, and so on. For those of us legally purchasing digital music, the arguments recently presented in these articles and blogs regarding the album are all sound and fury, signifying nothing. I'm obtaining my music digitally, I'll buy or rip an album when I want to. And without regard to "new" (read: label) physical CDs. If you do the math, I buy a lot of music. Most of it from independent artists. It is *MY* purchasing model is threatened by this move to force album sales. So I don't think the independent artist is at risk. The Bentley artist, the caviar manager, the deceiver label? Yes, absolutely.
    Reply | Link to Comment
  •  
    Aug 29 10:28 PM
    Hey, I know where to get really cheap music when it's not on iTunes. So, I'm not worried.
    Reply | Link to Comment
  •  
    Aug 30 11:32 AM
    So let the record companies die. who cares? A new way will rise from the ashes, and if it wants to survive, it will find a way to favor the consumers, and hopefully will send truckloads of money back to the artists.

    One thing that no one has touched on... Surveys and market research from 2 years ago indicated that digital singles promoted album sales. So, what about Katie Perry? She had 2.2 million digital singles downloaded, and what, 5-600,000 CD sales. How many of those 5-600k CDs were sold after people downloaded a couple of her singles an decided to go for it?

    No way to prove that, but what if without people hearing (purchasing) 1-2 of her singles on iTunes, tht her cd sales would be hovering at 100,00 or lower?
    Reply | Link to Comment
  •  
    Aug 30 11:44 AM
    Markham,

    You are correct. The music business cannot survive if things continue in the current direction. The problem is obviously piracy. If people had to procure music legitimately the market would be large enough to support the "new model" everyone seems to think the record labels owe us. Nothing will stop piracy altogether, but our govenrment has a responsibility (one of the few legitimate responsibilities of governement) to allow businesses and people to contol private property. It seems obvious that property laws are not being enforced and the recording industry is punished for this abrogation of duty. Ignore the hecklers from the peanut gallery. Anyone who has listened to an mp3 file believes he is an expert on the economics of producing and distributing music. My fear is that the hecklers are so vocal, and the victims so weak, that the music business will cease to exist before the world realizes what it has killed. BTW, I also agree with you on the best way to procure music. I subscribe to Napster and love it. Cheers.
    Reply | Link to Comment
  •  
    Sep 01 04:46 PM
    Since the arrival of the iTunes Store I have spent about $1,000 on music there. Had it not been for the iTS, my music spending over the same period would have been $0. No kidding.

    My experience, I'm sure, is not unique.

    If the music industry wants it to be the way it was, it deserves to die.
    Reply | Link to Comment
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