It's always darkest before the dawn. This could be said about the music industry, only the phrase is historically uttered by the guy who lives through the night, while at the moment the major labels are bleeding like a hemophiliac with a razor fetish.
The numbers are grim. Figures released by SoundScan this summer for the first half of the year showed a 20 percent contraction on CD sales and a 9.3 percent fall in total music sales, including digital downloads. This follows a 6.2 percent drop last year, and a 22 percent drop in music sales since their peak in 1999.
The phenomenon isn't limited to America. Germany has seen music sales cut in half since 2000; its industry is suffering from file-sharing and a massive epidemic of burned and counterfeit CDs, which are funneled into Eastern Europe. Music sales worldwide are expected to sink 11 percent in 2007.
Responsible for a disproportionate amount of music sales (around 70 percent of the market), the major music labels are feeling the pain most intensely. It's especially acute because over the last few decades they have built their business model on the back of a handful of multiplatinum albums, which paid for everything. The majors — burdened with the dead weight of bad contracts and failed commercial acts — saw their fortunes nosedive when sales of their chart-toppers fell precipitously. For example, Warner Music Group's stock price has fallen from a height of $30 a share to under $7 a share since last spring.
It is past the point of arguing about blame; to their credit, the labels seem to have realized this. "We used to fool ourselves. We used to think our content was perfect just exactly as it was," offered Warners boss Edgar Bronfman, speaking to the mobile phone trade organization, GSMA, at the Mobile Asia Congress in Macau last month. "By standing still or moving at a glacial pace, we inadvertently went to war with consumers by denying them what they wanted and could otherwise find, and as a result, of course, consumers won."
Major labels' size and muscle, which once afforded them so much power, hasn't left them nimble enough to adjust to the changing environment. The Internet has been a great leveler, neutralizing advantages in distribution and promotion as well as retail and radio access. Money the labels spend on videos, advertising, and retail end caps just doesn't buy what it used to in terms of sales, exposing the inefficiency of this business model.
"Everybody feels the pain," says Vagrant Records owner Rich Egan. "What the indies have over the majors is that we can't and don't spend stupid money. If you keep your costs relatively in check, this is still a fairly healthy business model. Is it what it was even two years ago? No, and certainly not what it was five years ago."
Egan points to the long-term, front-loaded contracts majors typically use to lock in established artists. As Radiohead proved so poignantly, many musicians capable of selling millions of discs don't need labels. In Vagrant's case, its willingness to do one-off deals and offer artist-friendly terms allows it to sign major-label escapees such as Eels, Paul Westerberg, and Thrice.
If the majors are to retain their profitable artists, they need to keep them happy. No longer can they operate on the old studio system of indentured servitude — if for no other reason than that there simply isn't enough money in music anymore. Realizing this, the labels have made initial efforts to address the problem, homing in on artists' merchandising and tour monies. This is the idea behind the so-called 360-degree deals signed by Madonna and Korn with Live Nation and EMI, respectively. These give the label a cut of all the artists' revenue, from concerts and endorsements to T-shirts and publishing. But for artists to assent, the labels will have to erase a long history of self-interest and artist exploitation.
"We will need to give artists at all levels a deal that is fair to both sides, perhaps one that moves away from the large-advances model of old and provides a true alignment of interests and transparency," wrote Guy Hands, the head of EMI's new owner, Terra Firma Capital, in a memo leaked in October.
Beyond whether major labels can act as agents rather than employers is the question of whether they're even equipped to deliver what they promise. While they've proven reasonably competent at creating stars, there's a lot more to the business these days than selling music.
"The major labels aren't staffed with people who know about touring, merchandise, or a whole lot about publishing," says Egan, who managed punkers Face to Face before starting Vagrant in 1996. "Just because you fly on planes a lot doesn't mean you know how to fly them. ... Until they completely restaff these labels with people who have experience and are experts in those particular fields, [if I'm with an artist] I'm thinking, 'Your business is messed up, so I'm going to cut you in on our business?'"
Gerd Leonhard and David Kusek, authors of The Future of Music: Manifesto for the Digital Music Revolution, suggest a "utility model" whereby labels work out a deal with ISPs to recover sales lost to file-sharing by charging users, similar to the surcharge on blank tapes and recording equipment.
Leonhard also suggests licensing music to huge social networks like MySpace and Facebook. "What [the major labels] really have to sell [consumers] is access to the music and to the artist, to the brand, and to the experience that goes with the music," he says. "Companies like Sony and Matsushita, which owned MCA, they got into music because the profits were obscene right after CDs. ... They got in because it was easy. Now if you want to sell CDs, you have to be a lot smarter — because you can't control the system, because there are so many people involved now. It's no longer about just music."
The thinner margins and a more difficult environment could also mean more private equity deals like Terra Firma's, which would benefit the labels. Entertainment is a volatile business which rewards a risk-taking attitude that's a lot tougher with stockholders breathing down your neck. Private investors are better able to ride out industry turmoil until labels recover more of their value, just as Providence Equity Partners hopes to do with its pending purchase of Clear Channel.
"It's not enough [for a public company] to just make money," Leonhard says. "You have to keep making more money, and I think a lot of media businesses are not suited to that because they could be having a huge profit one quarter and none the next."
The majors have already borne the cost of inaction, but Beggars Banquet CEO Lesley Bleakley cautions against overreaction, noting that Beggars' success has come through recognizing its core competencies. "If you don't do what you're good at, you dilute everything that you're doing that's good while you're investing in other areas," she says. "It's going to take some very aggressive CEOs and some unpopular CEOs to actually change things enough to be able to get back to those economies of scale."
Capitalism is based on cycles of destruction catalyzed by new technologies. While the Internet poses an imminent threat to the recording business, music remains vital. (Concert revenues have gone from $1.7 to $3.1 billion in the last seven years, according to Pollstar.) The labels may be shedding ground faster than the Arctic shelf, but if they can retool their thinking, there's plenty of new territory opening up.